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 ended June
30, 2012







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 Applicable




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



Indicate
by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. YesxNo ̈



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). YesxNo ̈



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
    Companyx





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



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 6, 2012
|------------------------------ | -----------------------------
|Common Stock, par value $0.625 | 3,201,606                    



















QNB CORP.
AND SUBSIDIARY

FORM 10-Q

QUARTER ENDED
JUNE 30, 2012



INDEX



PART I - FINANCIAL
INFORMATION





|ITEM 1.                     | CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)                         | PAGE
|--------------------------- | --------------------------------------------------------------------- | ----
|                            |                                                                       |     
|                            | Consolidated Balance Sheets at June 30, 2012                          |     
|                            | and December 31, 2011                                                 | 3   
|                            |                                                                       |     
|                            | Consolidated Statements of Income for the Three and Six               |     
|                            | Months Ended June 30, 2012 and 2011                                   | 4   
|                            |                                                                       |     
|                            | Consolidated Statements of Comprehensive Income for the Three and Six |     
|                            | Months Ended June 30, 2012 and 2011                                   | 5   
|                            |                                                                       |     
|                            | Consolidated Statement of Shareholders’ Equity for the Six            |     
|                            | Months Ended June 30, 2012                                            | 6   
|                            |                                                                       |     
|                            | Consolidated Statements of Cash Flows for the Six                     |     
|                            | Months Ended June 30, 2012 and 2011                                   | 7   
|                            |                                                                       |     
|                            | Notes to Consolidated Financial Statements                            | 8   
|                            |                                                                       |     
|ITEM 2.                     | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL                     |     
|                            | CONDITION AND RESULTS OF OPERATIONS                                   | 45  
|                            |                                                                       |     
|ITEM 3.                     | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT                        |     
|                            | MARKET RISK                                                           | 74  
|                            |                                                                       |     
|ITEM 4.                     | CONTROLS AND PROCEDURES                                               | 74  
|                            |                                                                       |     
|PART II - OTHER INFORMATION
|                            |                                                                       |     
|ITEM 1.                     | LEGAL PROCEEDINGS                                                     | 75  
|                            |                                                                       |     
|ITEM 1A.                    | RISK FACTORS                                                          | 75  
|                            |                                                                       |     
|ITEM 2.                     | UNREGISTERED SALES OF EQUITY SECURITIES AND                           |     
|                            | USE OF PROCEEDS                                                       | 75  
|                            |                                                                       |     
|ITEM 3.                     | DEFAULTS UPON SENIOR SECURITIES                                       | 75  
|                            |                                                                       |     
|ITEM 4.                     | MINE SAFETY DISCLOSURES                                               | 75  
|                            |                                                                       |     
|ITEM 5.                     | OTHER INFORMATION                                                     | 75  
|                            |                                                                       |     
|ITEM 6.                     | EXHIBITS                                                              | 76  
|                            |                                                                       |     
|SIGNATURES                  |                                                                       | 77  
|                            |                                                                       |     
|CERTIFICATIONS              |                                                                       |     



- 2 -











|QNB
    Corp. and Subsidiary    |  |  | 
|------------------------------- |  |  | 
|CONSOLIDATED BALANCE
    SHEETS |  |  | 



|                                                             |  | (in thousands, except share data) |        
|------------------------------------------------------------ |  | --------------------------------- | -------
|                                                             |  | (unaudited)                       |        
|                                                             |  | June 30,                          |        
|                                                             |  | 2012                              |        
|Assets                                                       |  |                                   |        
|Cash and due from banks                                      |  | $                                 | 12,221 
|Interest-bearing deposits in banks                           |  |                                   | 8,042  
|Total cash and cash equivalents                              |  |                                   | 20,263 
|                                                             |  |                                   |        
|Investment securities                                        |  |                                   |        
|Available-for-sale (amortized cost $351,762 and $341,023)    |  |                                   | 358,794
|Held-to-maturity (fair value $312 and $1,365)                |  |                                   | 287    
|Restricted investment in bank stocks                         |  |                                   | 1,636  
|Loans held-for-sale                                          |  |                                   | 589    
|Total loans, net of unearned fees and costs                  |  |                                   | 491,263
|Allowance for loan losses                                    |  |                                   | (9,467 
|Net loans                                                    |  |                                   | 481,796
|Bank-owned life insurance                                    |  |                                   | 9,887  
|Premises and equipment, net                                  |  |                                   | 8,242  
|Accrued interest receivable                                  |  |                                   | 3,007  
|Other assets                                                 |  |                                   | 5,635  
|Total assets                                                 |  | $                                 | 890,136
|                                                             |  |                                   |        
|Liabilities                                                  |  |                                   |        
|Deposits                                                     |  |                                   |        
|Demand, non-interest bearing                                 |  | $                                 | 69,856 
|Interest-bearing demand                                      |  |                                   | 159,476
|Money market                                                 |  |                                   | 71,222 
|Savings                                                      |  |                                   | 195,456
|Time                                                         |  |                                   | 181,554
|Time of $100,000 or more                                     |  |                                   | 103,443
|Total deposits                                               |  |                                   | 781,007
|Short-term borrowings                                        |  |                                   | 26,570 
|Long-term debt                                               |  |                                   | 5,293  
|Accrued interest payable                                     |  |                                   | 509    
|Other liabilities                                            |  |                                   | 2,078  
|Total liabilities                                            |  |                                   | 815,457
|                                                             |  |                                   |        
|Shareholders' Equity                                         |  |                                   |        
|Common stock, par value $0.625 per share;                    |  |                                   |        
|authorized 10,000,000 shares; 3,366,175 shares and 3,338,814 |  |                                   |        
|shares issued; 3,201,606 and 3,174,245 shares outstanding    |  |                                   | 2,104  
|Surplus                                                      |  |                                   | 12,205 
|Retained earnings                                            |  |                                   | 58,205 
|Accumulated other comprehensive income, net of tax           |  |                                   | 4,641  
|Treasury stock, at cost; 164,569 shares                      |  |                                   | (2,476 
|Total shareholders' equity                                   |  |                                   | 74,679 
|Total liabilities and
    shareholders' equity               |  | $                                 | 890,136



|The accompanying notes
    are an integral part of the unaudited consolidated financial statements |  |  |  |  |  |  |  | 
|-------------------------------------------------------------------------------------------------- |  |  |  |  |  |  |  | 





- 3 -









|QNB Corp.
    and Subsidiary          |  |  |  |  |  |  | 
|------------------------------------- |  |  |  |  |  |  | 
|CONSOLIDATED STATEMENTS
    OF INCOME |  |  |  |  |  |  | 



|                                                                    |  | (in thousands, except share data
    - unaudited) |      
|------------------------------------------------------------------- |  | ------------------------------------------------- | -----
|                                                                    |  | Three Months                                      |      
|                                                                    |  | Ended June 30,                                    |      
|                                                                    |  | 2012                                              |      
|Interest Income                                                     |  |                                                   |      
|Interest and fees on loans                                          |  | $                                                 | 6,163
|Interest and dividends on investment securities:                    |  |                                                   |      
|Taxable                                                             |  |                                                   | 1,558
|Tax-exempt                                                          |  |                                                   | 693  
|Interest on interest-bearing balances and other
    interest income |  |                                                   | 10   
|Total
    interest income                                           |  |                                                   | 8,424
|                                                                    |  |                                                   |      
|Interest Expense                                                    |  |                                                   |      
|Interest on deposits                                                |  |                                                   |      
|Interest-bearing demand                                             |  |                                                   | 159  
|Money market                                                        |  |                                                   | 66   
|Savings                                                             |  |                                                   | 315  
|Time                                                                |  |                                                   | 612  
|Time of $100,000 or more                                            |  |                                                   | 375  
|Interest on short-term borrowings                                   |  |                                                   | 26   
|Interest on long-term debt                                          |  |                                                   | 95   
|Total
    interest expense                                          |  |                                                   | 1,648
|Net interest income                                                 |  |                                                   | 6,776
|Provision for loan losses                                           |  |                                                   | -    
|Net
    interest income after provision for loan losses             |  |                                                   | 6,776
|                                                                    |  |                                                   |      
|Non-Interest Income                                                 |  |                                                   |      
|Net gain on sale of investment securities                           |  |                                                   | 141  
|Fees for services to customers                                      |  |                                                   | 345  
|ATM and debit card                                                  |  |                                                   | 367  
|Bank-owned life insurance                                           |  |                                                   | 78   
|Merchant income                                                     |  |                                                   | 101  
|Net gain on sale of loans                                           |  |                                                   | 231  
|Other                                                               |  |                                                   | 63   
|Total non-interest income                                           |  |                                                   | 1,326
|                                                                    |  |                                                   |      
|Non-Interest Expense                                                |  |                                                   |      
|Salaries and employee benefits                                      |  |                                                   | 2,548
|Net occupancy                                                       |  |                                                   | 397  
|Furniture and equipment                                             |  |                                                   | 373  
|Marketing                                                           |  |                                                   | 256  
|Third party services                                                |  |                                                   | 365  
|Telephone, postage and supplies                                     |  |                                                   | 156  
|State taxes                                                         |  |                                                   | 167  
|FDIC insurance premiums                                             |  |                                                   | 162  
|Other                                                               |  |                                                   | 404  
|Total
    non-interest expense                                      |  |                                                   | 4,828
|Income
    before income taxes                                      |  |                                                   | 3,274
|Provision for income taxes                                          |  |                                                   | 769  
|Net
    Income                                                      |  | $                                                 | 2,505
|Earnings Per Share
    - Basic                                      |  | $                                                 | 0.79 
|Earnings Per Share
    - Diluted                                    |  | $                                                 | 0.78 
|Cash Dividends Per
    Share                                        |  | $                                                 | 0.26 



|The accompanying notes
    are an integral part of the unaudited consolidated financial statements
|--------------------------------------------------------------------------------------------------



- 4 -











|QNB Corp. and Subsidiary                                         |  |                           |       |   |                |   |       |      |  |   |       |  
|---------------------------------------------------------------- |  | ------------------------- | ----- | - | -------------- | - | ----- | ---- |  | - | ----- | -
|CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME                  |  |                           |       |   |                |   |       |      |  |   |       |  
|                                                                 |  | (in thousands, unaudited) |      
|                                                                 |  | Three Months              |       |   | Six Months     |  
|                                                                 |  | Ended June 30,            |       |   | Ended June 30, |  
|                                                                 |  | 2012                      |       |   | 2011           |   |       | 2012 |  |   | 2011  |  
|Net income                                                       |  | $                         | 2,505 |   |                | $ | 2,435 |      |  | $ | 4,976 |  
|Other comprehensive income, net of tax:                          |  |                           |       |   |                |   |       |      |  |   |       |  
|Unrealized holding gains (losses) on securities:                 |  |                           |       |   |                |   |       |      |  |   |       |  
|Unrealized holding gains arising during the period               |  |                           | 261   |   |                |   | 1,665 |      |  |   | 326   |  
|Reclassification adjustment
    for gains included in net income |  |                           | (93   | ) |                |   | (36   | )    |  |   | (350  | )
|Other comprehensive income
    (loss), net of tax                |  |                           | 168   |   |                |   | 1,629 |      |  |   | (24   | )
|Comprehensive income                                             |  | $                         | 2,673 |   |                | $ | 4,064 |      |  | $ | 4,952 |  



|The accompanying notes are an integral part
    of the unaudited consolidated financial statements
|--------------------------------------------------------------------------------------------------





- 5 -











|QNB Corp. and Subsidiary                          
|--------------------------------------------------
|CONSOLIDATED STATEMENT OF SHAREHOLDERS'
    EQUITY
|                                                  



|                                              |  |             |           |  |        |   |       |         |  |   |          |  |  | Accumulated   |        |   |          |   |       |       | 
|--------------------------------------------- |  | ----------- | --------- |  | ------ | - | ----- | ------- |  | - | -------- |  |  | ------------- | ------ | - | -------- | - | ----- | ----- | 
|                                              |  | Number of   |           |  |        |   |       |         |  |   |          |  |  | other         |        |   |          |   |       |       | 
|(in thousands, except share data)             |  | shares      |           |  | Common |   |       |         |  |   | Retained |  |  | comprehensive |        |   | Treasury |   |       |       | 
|(unaudited)                                   |  | outstanding |           |  | stock  |   |       | Surplus |  |   | earnings |  |  | income        |        |   | stock    |   |       | Total | 
|Balance, December 31, 2011                    |  |             | 3,174,245 |  |        | $ | 2,087 |         |  | $ | 11,679   |  |  | $             | 54,886 |   |          | $ | 4,665 |       | 
|Net income                                    |  |             |           |  |        |   | -     |         |  |   | -        |  |  |               | 4,976  |   |          |   | -     |       | 
|Other comprehensive loss, net of tax          |  |             |           |  |        |   | -     |         |  |   | -        |  |  |               | -      |   |          |   | (24   | )     | 
|Cash dividends declared ($0.52 per share)     |  |             |           |  |        |   | -     |         |  |   | -        |  |  |               | (1,657 | ) |          |   | -     |       | 
|Stock issued in connection with dividend      |  |             |           |  |        |   |       |         |  |   |          |  |  |               |        |   |          |   |       |       | 
|reinvestment and stock purchase plan          |  |             | 18,215    |  |        |   | 11    |         |  |   | 411      |  |  |               | -      |   |          |   | -     |       | 
|Stock issued for employee stock purchase plan |  |             | 2,186     |  |        |   | 2     |         |  |   | 41       |  |  |               | -      |   |          |   | -     |       | 
|Stock issued for options exercised            |  |             | 6,960     |  |        |   | 4     |         |  |   | 28       |  |  |               | -      |   |          |   | -     |       | 
|Tax benefit of stock options exercised        |  |             |           |  |        |   | -     |         |  |   | 4        |  |  |               | -      |   |          |   | -     |       | 
|Stock-based compensation expense              |  |             |           |  |        |   | -     |         |  |   | 42       |  |  |               | -      |   |          |   | -     |       | 
|Balance, June 30, 2012                        |  |             | 3,201,606 |  |        | $ | 2,104 |         |  | $ | 12,205   |  |  | $             | 58,205 |   |          | $ | 4,641 |       | 



|The accompanying notes
    are an integral part of the unaudited consolidated financial statements
|--------------------------------------------------------------------------------------------------





- 6 -







|QNB Corp.
    and Subsidiary              |  |  | 
|----------------------------------------- |  |  | 
|CONSOLIDATED STATEMENTS
    OF CASH FLOWS |  |  | 



|                                                                                         |  | (in thousands, unaudited) |         
|---------------------------------------------------------------------------------------- |  | ------------------------- | --------
|Six months ended June 30,                                                                |  | 2012                      |         
|Operating Activities                                                                     |  |                           |         
|Net income                                                                               |  | $                         | 4,976   
|Adjustments to reconcile net income to net cash provided
    by operating activities:    |  |                           |         
|Depreciation and amortization                                                            |  |                           | 472     
|Provision for loan losses                                                                |  |                           | 300     
|Net gains on investment securities available-for-sale                                    |  |                           | (530    
|Net (gain) loss on sale or disposal of repossessed assets
    and premises and equipment |  |                           | (5      
|Net gain on sale of loans                                                                |  |                           | (458    
|Proceeds from sales of residential mortgages held-for-sale                               |  |                           | 11,942  
|Originated of residential mortgages held-for-sale                                        |  |                           | (11,138 
|Income on bank-owned life insurance                                                      |  |                           | (156    
|Stock-based compensation expense                                                         |  |                           | 42      
|Deferred income tax (benefit) expense                                                    |  |                           | (47     
|Net increase (decrease) in income taxes payable                                          |  |                           | 70      
|Net (increase) decrease in accrued interest receivable                                   |  |                           | (17     
|Amortization of mortgage servicing rights and change in
    valuation allowance          |  |                           | 95      
|Net amortization (accretion) of premiums and discounts
    on investment securities      |  |                           | 958     
|Net decrease in accrued interest payable                                                 |  |                           | (280    
|Increase in other assets                                                                 |  |                           | (316    
|Decrease in other liabilities                                                            |  |                           | (64     
|Net cash provided by operating
    activities                                            |  |                           | 5,844   
|Investing Activities                                                                     |  |                           |         
|Proceeds from maturities and calls of investment securities                              |  |                           |         
|available-for-sale                                                                       |  |                           | 78,563  
|held-to-maturity                                                                         |  |                           | 1,040   
|Proceeds from the sale of investment securities                                          |  |                           |         
|available-for-sale                                                                       |  |                           | 15,798  
|Purchases of investment securities                                                       |  |                           |         
|available-for-sale                                                                       |  |                           | (105,528
|Proceeds from redemption of investment in restricted bank
    stock                      |  |                           | 139     
|Net (increase) decrease in loans                                                         |  |                           | (1,933  
|Redemption of Bank Owned Life Insurance                                                  |  |                           | -       
|Net purchases of premises and equipment                                                  |  |                           | (1,112  
|Proceeds from sales of
    repossessed assets                                            |  |                           | 215     
|Net cash used in investing
    activities                                                |  |                           | (12,818 
|Financing Activities                                                                     |  |                           |         
|Net increase in non-interest bearing deposits                                            |  |                           | 3,006   
|Net increase in interest-bearing deposits                                                |  |                           | 27,289  
|Net increase in short-term borrowings                                                    |  |                           | 2,549   
|Repayments of long-term debt                                                             |  |                           | (15,006 
|Tax benefit from exercise of stock options                                               |  |                           | 4       
|Cash dividends paid, net of reinvestment                                                 |  |                           | (1,500  
|Proceeds from issuance
    of common stock                                               |  |                           | 340     
|Net cash provided by financing
    activities                                            |  |                           | 16,682  
|Increase in cash and cash equivalents                                                    |  |                           | 9,708   
|Cash and cash equivalents
    at beginning of year                                       |  |                           | 10,555  
|Cash and cash equivalents
    at end of period                                           |  | $                         | 20,263  
|Supplemental Cash Flow Disclosures                                                       |  |                           |         
|Interest paid                                                                            |  | $                         | 3,755   
|Income taxes paid                                                                        |  |                           | 1,490   
|Non-cash transactions                                                                    |  |                           |         
|Transfer of loans to repossessed assets or other real
    estate owned                   |  |                           | 532     



|The accompanying notes are an integral part
    of the unaudited consolidated financial statements |  |  |  |  |  |  |  | 
|-------------------------------------------------------------------------------------------------- |  |  |  |  |  |  |  | 





- 7 -









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 2011 Annual
Report incorporated in the Form 10-K. Operating results for the three and six month periods ended June 30, 2012 are not necessarily
indicative of the results that may be expected for the year ending December 31, 2012.



The unaudited consolidated financial statements
reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the results of operations
for the interim periods and are of a normal and recurring nature. Certain items in the 2011 consolidated financial statements
have been reclassified to conform to the 2012 financial statement presentation format.



Tabular information, other than share
and per share data, is presented in thousands of dollars.



In preparing the consolidated financial
statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities
at the dates of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from such estimates.



The Company has evaluated events and transactions
occurring subsequent to the balance sheet date of June 30, 2012, for items that should potentially be recognized or disclosed
in these financial statements.





2. RECENT ACCOUNTING PRONOUNCEMENTS



In
April 2011, the FASB issued ASU No. 2011-03 Transfers and Servicing (Topic 860) — Reconsideration of Effective Control
for Repurchase Agreements. Under the amended guidance, a transferor maintains effective control over transferred financial
assets if there is an agreement that both entitles and obligates the transferor to repurchase the financial assets before maturity.
In addition, the following requirements must be met: (a) the financial asset to be repurchased or redeemed is the same or substantially
the same as those transferred, (b) the agreement is to repurchase or redeem the transferred financial asset before maturity at
a fixed or determinable price, and (c) the agreement is entered into contemporaneously with, or in contemplation of the transfer.
This guidance is effective prospectively for transactions, or modifications of existing transactions, that occur on or after the
first interim or annual period beginning on or after December 15, 2011. The adoption of the guidance did not have a material impact
on the Company’s consolidated financial statements.



In May 2011, the FASB issued ASU 2011-04
Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU amends
FASB ASC Topic 820, Fair Value Measurements, to bring U.S. GAAP for fair value measurements in line with International
Accounting Standards. The ASU clarifies existing guidance for items such as: the application of the highest and best use concept
to non-financial assets and liabilities; the application of fair value measurement to financial instruments classified in a reporting
entity’s stockholders’ equity; and disclosure requirements regarding quantitative information about unobservable inputs
used in the fair value measurements of level 3 assets. The ASU also creates an exception to Topic 820 for entities which carry
financial instruments within a portfolio or group, under which the entity is now permitted to base the price used for fair valuation
upon a price that would be received to sell the net asset position or transfer a net liability position in an orderly transaction.
The ASU also allows for the application of premiums and discounts in a fair value measurement if the financial instrument is categorized
in level 2 or 3 of the fair value hierarchy. Lastly, the ASU contains new disclosure requirements regarding fair value amounts
categorized as level 3 in the fair value hierarchy such as: disclosure of the valuation process used; effects of and relationships
between unobservable inputs; usage of nonfinancial assets for purposes other than their highest and best use when that is the
basis of the disclosed fair value; and categorization by level of items disclosed at fair value, but not measured at fair value
for financial statement purposes. This ASU is effective for the Company for interim and annual periods beginning after December
15, 2011. The adoption of the guidance did not have a material impact on the Company’s consolidated financial statements.
The additional disclosures are included in Note 9 of the unaudited financial statements.







- 8 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)










2. RECENT ACCOUNTING PRONOUNCEMENTS
(continued)





In June 2011, the FASB issued ASU 2011-05
Presentation of Comprehensive Income. The provisions of this ASU amend FASB ASC Topic 220, Comprehensive Income,
to facilitate the continued alignment of U.S. GAAP with International Accounting Standards. The ASU prohibits the presentation
of the components of comprehensive income in the statement of stockholders’ equity. Reporting entities are allowed to present
either: a statement of comprehensive income, which reports both net income and other comprehensive income; or separate statements
of net income and other comprehensive income. Under previous GAAP, all three presentations were acceptable. Regardless of the
presentation selected, the reporting entity is required to present all reclassifications between other comprehensive and net income
on the face of the new statement or statements. The provisions of this ASU are effective for the Company for fiscal years and
interim periods beginning after December 31, 2011. QNB has included a separate statement of comprehensive income in these unaudited
financial statements to address the new required presentation.



In December, 2011, the FASB issued ASU
2011-12, Deferral of the Effective Date to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive
Income in Accounting Standards Update 2011-05.In response to stakeholder concerns regarding the operational ramifications
of the presentation of these reclassifications for current and previous years, the FASB has deferred the implementation date of
this provision to allow time for further consideration. The requirement in ASU 2011-05, Presentation of Comprehensive Income,for the presentation of a combined statement of comprehensive income or separate, but consecutive, statements of net income
and other comprehensive income is still effective for fiscal years and interim periods beginning after December 15, 2011. The
adoption of the guidance did not have a material impact on the Company’s consolidated financial statements.





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.



Stock-based compensation expense was approximately
$26,000 and $17,000for the three months ended June 30, 2012 and 2011, respectively, and
$42,000 and $29,000 for the six months ended June 30, 2012 and 2011, respectively. As of June 30, 2012, there was approximately
$110,000 of unrecognized compensation cost related to unvested share-based compensation award grants 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 authorized 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, 2012, there were 225,058
options granted, 28,444 options forfeited, 135,114 options exercised and 61,500 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, 2012, there were 123,200 options granted, 41,175 options forfeited and 82,025 options outstanding under this
Plan. The 2005 Plan expires March 15, 2015.





- 9 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








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



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:        |  | 2012 |       |   | 2011 | 
|----------------------- |  | ---- | ----- | - | ---- | 
|Risk-free interest rate |  |      | 0.39  | % |      | 
|Dividend yield          |  |      | 4.68  |   |      | 
|Volatility              |  |      | 33.81 |   |      | 
|Expected life (years)   |  |      | 5.00  |   |      | 







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



The fair market value of options granted
in the first six months of 2012 and 2011 was $3.81 and $3.24, respectively.



Stock option activity during the six months
ended June 30, 2012 is as follows:





|                               |  | Number
     of options |         |   | Weighted
     average exercise price |   |       | Weighted
    average remaining contractual term (in yrs.) |  |  | Aggregate
    intrinsic value of in-the-money options | 
|------------------------------ |  | ---------------------- | ------- | - | ------------------------------------ | - | ----- | --------------------------------------------------------- |  |  | ----------------------------------------------------- | 
|Outstanding at January 1, 2012 |  |                        | 156,275 |   |                                      | $ | 21.93 |                                                           |  |  |                                                       | 
|Exercised                      |  |                        | (20,700 | ) |                                      |   | 16.13 |                                                           |  |  |                                                       | 
|Forfeited                      |  |                        | (12,050 | ) |                                      |   | 25.15 |                                                           |  |  |                                                       | 
|Granted                        |  |                        | 20,000  |   |                                      |   | 21.35 |                                                           |  |  |                                                       | 
|Outstanding at June 30, 2012   |  |                        | 143,525 |   |                                      | $ | 22.41 |                                                           |  |  | 2.2                                                   | 
|Exercisable at June 30, 2012   |  |                        | 86,625  |   |                                      | $ | 24.09 |                                                           |  |  | 1.3                                                   | 









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, 2012. As
of June 30, 2012, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000.





- 10 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






5. EARNINGS PER SHARE



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



|                                                                                                 |  | For the Three Months |           |  | For the Six Months |  
|------------------------------------------------------------------------------------------------ |  | -------------------- | --------- |  | ------------------ | -
|                                                                                                 |  | Ended June 30,       |           |  | Ended June 30,     |  
|                                                                                                 |  | 2012                 |           |  | 2011               |  
|Numerator
    for basic and diluted earnings per share - net income                              |  | $                    | 2,505     |  |                    | $
|Denominator for basic earnings per share - weighted average   
    shares outstanding            |  |                      | 3,190,552 |  |                    |  
|Effect of dilutive securities
    - employee stock options                                       |  |                      | 17,774    |  |                    |  
|Denominator for diluted earnings per share
    - adjusted    weighted average shares outstanding |  |                      | 3,208,326 |  |                    |  
|Earnings per share-basic                                                                         |  | $                    | 0.79      |  |                    | $
|Earnings per share-diluted                                                                       |  | $                    | 0.78      |  |                    | $



There were 52,300 stock options that were
anti-dilutive for both the three and six-month periods ended June 30, 2012. There were 41,850and 58,850 stock options that were anti-dilutive for the three and six-month periods ended June 30 2011, respectively.
These stock options were not included in the above calculation.





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 three months ended June 30, 2012 and 2011:





|Three months ended
    June 30, 2012                             |  | Pretax |      |   | Tax
     effect |   |      | After-tax | 
|---------------------------------------------------------------- |  | ------ | ---- | - | --------------- | - | ---- | --------- | 
|Unrealized holding gains arising during the
    period           |  | $      | 396  |   |                 | $ | (135 | )         | 
|Reclassification adjustment
    for gains included in net income |  |        | (141 | ) |                 |   | 48   |           | 
|Total
    other comprehensive income                             |  | $      | 255  |   |                 | $ | (87  | )         | 







|Three months ended
    June 30, 2011                             |  | Pretax |       |   | Tax
     effect |   |      | After-tax | 
|---------------------------------------------------------------- |  | ------ | ----- | - | --------------- | - | ---- | --------- | 
|Unrealized holding gains arising during the
    period           |  | $      | 2,522 |   |                 | $ | (857 | )         | 
|Reclassification adjustment
    for gains included in net income |  |        | (54   | ) |                 |   | 18   |           | 
|Total
    other comprehensive income                             |  | $      | 2,468 |   |                 | $ | (839 | )         | 





- 11 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








6. COMPREHENSIVE INCOME (continued)



The following shows the components and
activity of comprehensive income during the six months ended June 30, 2012 and 2011:





|Six months ended
    June 30, 2012                               |  | Pretax |      |   | Tax
     effect |   |      | After-tax | 
|---------------------------------------------------------------- |  | ------ | ---- | - | --------------- | - | ---- | --------- | 
|Unrealized holding gains arising during the
    period           |  | $      | 494  |   |                 | $ | (168 | )         | 
|Reclassification adjustment
    for gains included in net income |  |        | (530 | ) |                 |   | 180  |           | 
|Total
    other comprehensive loss                               |  | $      | (36  | ) |                 | $ | 12   |           | 







|Six months ended June 30, 2011                                   |  | Pretax |       |   | Tax
     effect |   |      | After-tax | 
|---------------------------------------------------------------- |  | ------ | ----- | - | --------------- | - | ---- | --------- | 
|Unrealized holding gains arising during the
    period           |  | $      | 2,394 |   |                 | $ | (814 | )         | 
|Reclassification adjustment
    for gains included in net income |  |        | (11   | ) |                 |   | 4    |           | 
|Total
    other comprehensive income                             |  | $      | 2,383 |   |                 | $ | (810 | )         | 



7. INVESTMENT SECURITIES



The amortized cost and estimated fair
values of investment securities available-for-sale at June 30, 2012 and December 31, 2011 were as follows:





|Available-for-Sale                                                       |  |       |         |  |            |   |       |            |  |   |           | 
|------------------------------------------------------------------------ |  | ----- | ------- |  | ---------- | - | ----- | ---------- |  | - | --------- | 
|June 30, 2012                                                            |  |       |         |  |            |   |       |            |  |   |           | 
|                                                                         |  |       |         |  | Gross      |   |       | Gross      |  |   |           | 
|                                                                         |  |       |         |  | unrealized |   |       | unrealized |  |   |           | 
|                                                                         |  | Fair  |         |  | holding    |   |       | holding    |  |   | Amortized | 
|                                                                         |  | value |         |  | gains      |   |       | losses     |  |   | cost      | 
|U.S. Government agency securities                                        |  | $     | 69,740  |  |            | $ | 643   |            |  | $ | 12        | 
|State and municipal securities                                           |  |       | 81,592  |  |            |   | 2,839 |            |  |   | 118       | 
|U.S. Government agencies and sponsored enterprises (GSEs) - residential: |  |       |         |  |            |   |       |            |  |   |           | 
|Mortgage-backed securities                                               |  |       | 117,628 |  |            |   | 3,622 |            |  |   | 1         | 
|Collateralized mortgage obligations (CMOs)                               |  |       | 81,368  |  |            |   | 1,445 |            |  |   | 60        | 
|Pooled trust preferred securities                                        |  |       | 2,015   |  |            |   | 44    |            |  |   | 1,638     | 
|Corporate debt securities                                                |  |       | 2,503   |  |            |   | 46    |            |  |   | -         | 
|Equity securities                                                        |  |       | 3,948   |  |            |   | 402   |            |  |   | 180       | 
|Total investment
    securities available-for-sale                       |  | $     | 358,794 |  |            | $ | 9,041 |            |  | $ | 2,009     | 







- 12 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








7. INVESTMENT SECURITIES (continued)





|December
    31, 2011                                                    |  |       |         |  |            |   |       |            |  |   |           | 
|------------------------------------------------------------------------ |  | ----- | ------- |  | ---------- | - | ----- | ---------- |  | - | --------- | 
|                                                                         |  |       |         |  | Gross      |   |       | Gross      |  |   |           | 
|                                                                         |  |       |         |  | unrealized |   |       | unrealized |  |   |           | 
|                                                                         |  | Fair  |         |  | holding    |   |       | holding    |  |   | Amortized | 
|                                                                         |  | value |         |  | gains      |   |       | losses     |  |   | cost      | 
|U.S. Government agency securities                                        |  | $     | 68,493  |  |            | $ | 635   |            |  | $ | 5         | 
|State and municipal securities                                           |  |       | 78,786  |  |            |   | 2,861 |            |  |   | 6         | 
|U.S. Government agencies and sponsored enterprises (GSEs) - residential: |  |       |         |  |            |   |       |            |  |   |           | 
|Mortgage-backed securities                                               |  |       | 113,243 |  |            |   | 3,169 |            |  |   | 16        | 
|Collateralized mortgage obligations (CMOs)                               |  |       | 79,345  |  |            |   | 1,577 |            |  |   | 27        | 
|Pooled trust preferred securities                                        |  |       | 1,929   |  |            |   | 12    |            |  |   | 1,723     | 
|Corporate debt securities                                                |  |       | 2,495   |  |            |   | 44    |            |  |   | 4         | 
|Equity securities                                                        |  |       | 3,800   |  |            |   | 610   |            |  |   | 59        | 
|Total investment
    securities available-for-sale                       |  | $     | 348,091 |  |            | $ | 8,908 |            |  | $ | 1,840     | 





The amortized cost and estimated fair
value of securities available-for-sale by contractual maturity at June 30, 2012 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.





|                                                   |  |            |         |  | Amortized |  
|-------------------------------------------------- |  | ---------- | ------- |  | --------- | -
|                                                   |  | Fair value |         |  | cost      |  
|Due in one year or less                            |  | $          | 15,197  |  |           | $
|Due after one year through five years              |  |            | 220,792 |  |           |  
|Due after five years through ten years             |  |            | 68,270  |  |           |  
|Due after ten years                                |  |            | 50,587  |  |           |  
|Equity securities                                  |  |            | 3,948   |  |           |  
|Total
    investment securities available-for-sale |  | $          | 358,794 |  |           | $





Proceeds from sales of investment securities
available-for-sale were $15,798,000 and $23,434,000 for the six months ended June 30, 2012 and 2011, respectively.



At June 30, 2012 and December 31, 2011,
investment securities available-for-sale totaling $122,720,000 and $158,189,000, 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:



- 13 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)




7. INVESTMENT SECURITIES (continued)



|Six months ended
    June 30, 2012: |  |          |     |  |          |   |    |             |  |   |           | 
|----------------------------------- |  | -------- | --- |  | -------- | - | -- | ----------- |  | - | --------- | 
|                                    |  |          |     |  |          |   |    | Other-than- |  |   |           | 
|                                    |  | Gross    |     |  | Gross    |   |    | temporary   |  |   |           | 
|                                    |  | realized |     |  | realized |   |    | impairment  |  |   |           | 
|                                    |  | gains    |     |  | losses   |   |    | losses      |  |   | Net gains | 
|Equity securities                   |  | $        | 427 |  |          |   | -  |             |  | $ | -         | 
|Debt securities                     |  |          | 107 |  |          | $ | (4 | )           |  |   | -         | 
|Total                               |  | $        | 534 |  |          | $ | (4 | )           |  | $ | -         | 



|Six months ended
    June 30, 2011: |  |          |     |  |          |   |      |             |  |   |           | 
|----------------------------------- |  | -------- | --- |  | -------- | - | ---- | ----------- |  | - | --------- | 
|                                    |  |          |     |  |          |   |      | Other-than- |  |   |           | 
|                                    |  | Gross    |     |  | Gross    |   |      | temporary   |  |   |           | 
|                                    |  | realized |     |  | realized |   |      | impairment  |  |   | Net gains | 
|                                    |  | gains    |     |  | losses   |   |      | losses      |  |   | (losses)  | 
|Equity securities                   |  | $        | 141 |  |          |   | -    |             |  | $ | -         | 
|Debt securities                     |  |          | 248 |  |          | $ | (378 | )           |  |   | -         | 
|Total                               |  | $        | 389 |  |          | $ | (378 | )           |  | $ | -         | 



The tax expense applicable to the net
realized gains for the six-month periods ended June 30, 2012 and 2011 amounted to $180,000 and $4,000, respectively.



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 cost 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 following table 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, 2012. Credit-impaired debt securities must be presented 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). No credit impairments were recognized in 2012.





- 14 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








7. INVESTMENT SECURITIES (continued)



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, 2012 |       |  | Six
    Months Ended June 30, 2012 |  
|--------------------------------- |  | ------------------------------------ | ----- |  | ---------------------------------- | -
|Balance, beginning of period      |  | $                                    | 1,279 |  |                                    | $
|Additions:                        |  |                                      |       |  |                                    |  
|Initial credit impairments        |  |                                      | -     |  |                                    |  
|Subsequent
    credit impairments |  |                                      | -     |  |                                    |  
|Balance, end of period            |  | $                                    | 1,279 |  |                                    | $





The amortized cost and estimated fair
values of investment securities held-to-maturity at June 30, 2012 and December 31, 2011 were as follows:





|Held-To-Maturity                   |  |               |     |  |                       |   |    |            |  |  |       |  |  |           |     |  |            |   |       |            |  |   |       | 
|---------------------------------- |  | ------------- | --- |  | --------------------- | - | -- | ---------- |  |  | ----- |  |  | --------- | --- |  | ---------- | - | ----- | ---------- |  | - | ----- | 
|                                   |  | June 30, 2012 |     |  | December 31,
    2011 |  
|                                   |  |               |     |  | Gross                 |   |    | Gross      |  |  |       |  |  |           |     |  | Gross      |   |       | Gross      |  |   |       | 
|                                   |  |               |     |  | unrealized            |   |    | unrealized |  |  |       |  |  |           |     |  | unrealized |   |       | unrealized |  |   |       | 
|                                   |  | Amortized     |     |  | holding               |   |    | holding    |  |  | Fair  |  |  | Amortized |     |  | holding    |   |       | holding    |  |   | Fair  | 
|                                   |  | cost          |     |  | gains                 |   |    | losses     |  |  | value |  |  | cost      |     |  | gains      |   |       | losses     |  |   | value | 
|State and
    municipal securities |  | $             | 287 |  |                       | $ | 25 |            |  |  | -     |  |  | $         | 312 |  |            | $ | 1,327 |            |  | $ | 38    | 





The amortized cost and estimated fair
value of securities held-to-maturity by contractual maturity at June 30, 2012 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.



|                                                 |  |            |     |  | Amortized |  
|------------------------------------------------ |  | ---------- | --- |  | --------- | -
|                                                 |  | Fair value |     |  | cost      |  
|Due in one year or less                          |  | $          | 145 |  |           | $
|Due after one year through five years            |  |            | 167 |  |           |  
|Due after five years through ten years           |  |            | -   |  |           |  
|Due after ten years                              |  |            | -   |  |           |  
|Total
    investment securities held-to-maturity |  | $          | 312 |  |           | $





There were no sales of investment securities
classified as held-to-maturity during the six months ended June 30, 2012 or 2011.





- 15 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






7. INVESTMENT SECURITIES (continued)



The following table indicates the length
of time individual securities have been in a continuous unrealized loss position at June 30, 2012 and December 31, 2011:





|June 30, 2012                              |  |            |    |  |                         |   |        |                         |  |   |       |  |  |            |       |  |       |   |       |            | 
|------------------------------------------ |  | ---------- | -- |  | ----------------------- | - | ------ | ----------------------- |  | - | ----- |  |  | ---------- | ----- |  | ----- | - | ----- | ---------- | 
|                                           |  |            |    |  | Less than 12
    months |   |        | 12 months or
    longer |  |   | Total | 
|                                           |  | No. of     |    |  | Fair                    |   |        | Unrealized              |  |   | Fair  |  |  | Unrealized |       |  | Fair  |   |       | Unrealized | 
|                                           |  | securities |    |  | value                   |   |        | losses                  |  |   | value |  |  | losses     |       |  | value |   |       | losses     | 
|U.S. Government agency securities          |  |            | 12 |  |                         | $ | 16,004 |                         |  | $ | 12    |  |  |            | -     |  |       |   | -     |            | 
|State and municipal securities             |  |            | 19 |  |                         |   | 10,004 |                         |  |   | 118   |  |  |            | -     |  |       |   | -     |            | 
|Mortgage-backed securities                 |  |            | 1  |  |                         |   | 884    |                         |  |   | 1     |  |  |            | -     |  |       |   | -     |            | 
|Collateralized mortgage obligations (CMOs) |  |            | 13 |  |                         |   | 14,936 |                         |  |   | 60    |  |  |            | -     |  |       |   | -     |            | 
|Pooled trust preferred securities          |  |            | 5  |  |                         |   | -      |                         |  |   | -     |  |  | $          | 1,579 |  |       | $ | 1,638 |            | 
|Equity securities                          |  |            | 12 |  |                         |   | 1,242  |                         |  |   | 153   |  |  |            | 103   |  |       |   | 27    |            | 
|Total                                      |  |            | 62 |  |                         | $ | 43,070 |                         |  | $ | 344   |  |  | $          | 1,682 |  |       | $ | 1,665 |            | 



|December 31, 2011                          |  |            |    |  |                         |   |        |                         |  |   |       |  |  |            |       |  |       |   |       |            | 
|------------------------------------------ |  | ---------- | -- |  | ----------------------- | - | ------ | ----------------------- |  | - | ----- |  |  | ---------- | ----- |  | ----- | - | ----- | ---------- | 
|                                           |  |            |    |  | Less than 12
    months |   |        | 12 months or
    longer |  |   | Total | 
|                                           |  | No. of     |    |  | Fair                    |   |        | Unrealized              |  |   | Fair  |  |  | Unrealized |       |  | Fair  |   |       | Unrealized | 
|                                           |  | securities |    |  | value                   |   |        | losses                  |  |   | value |  |  | losses     |       |  | value |   |       | losses     | 
|U.S. Government agency securities          |  |            | 6  |  |                         | $ | 6,995  |                         |  | $ | 5     |  |  |            | -     |  |       |   | -     |            | 
|State and municipal securities             |  |            | 5  |  |                         |   | 1,772  |                         |  |   | 5     |  |  | $          | 302   |  |       | $ | 1     |            | 
|Mortgage-backed securities                 |  |            | 4  |  |                         |   | 7,531  |                         |  |   | 16    |  |  |            | -     |  |       |   | -     |            | 
|Collateralized mortgage obligations (CMOs) |  |            | 6  |  |                         |   | 7,270  |                         |  |   | 27    |  |  |            | -     |  |       |   | -     |            | 
|Pooled trust preferred securities          |  |            | 5  |  |                         |   | -      |                         |  |   | -     |  |  |            | 1,495 |  |       |   | 1,723 |            | 
|Corporate debt securities                  |  |            | 2  |  |                         |   | 2,000  |                         |  |   | 4     |  |  |            | -     |  |       |   | -     |            | 
|Equity securities                          |  |            | 8  |  |                         |   | 490    |                         |  |   | 44    |  |  |            | 324   |  |       |   | 15    |            | 
|Total                                      |  |            | 36 |  |                         | $ | 26,058 |                         |  | $ | 101   |  |  | $          | 2,121 |  |       | $ | 1,739 |            | 



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,
2012 in U.S. Government securities, state and municipal securities, mortgage-backed securities, and CMOs 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.



QNB holds eight pooled trust preferred
securities as of June 30, 2012. These securities have a total amortized cost of $3,609,000 and a fair value of $2,015,000. Five
of the eight securities have been in an unrealized loss position for more than twelve months. All of the pooled trust preferred
securities are available-for-sale securities and are carried at fair value.





- 16 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






7. INVESTMENT SECURITIES (continued)



The following table provides additional
information related to pooled trust preferred securities (PreTSLs) as of June 30, 2012:





|Deal            |  | Class      |  | Book
    value |       |  | Fair
    value |   |       | Unreal-
    ized gains (losses) |  |   | Realized
    OTTI credit loss (YTD 2012) |   |  | Total
    Recognized OTTI Credit Loss |   |  | Moody's
    /Fitch ratings |   | Current
    number of performing banks |   |  | Current
    number of performing insurance companies |  |  | Actual
    deferrals and defaults as a % of total collateral |  |  | Total
    performing collateral as a % of outstanding bonds |   
|--------------- |  | ---------- |  | -------------- | ----- |  | -------------- | - | ----- | ------------------------------- |  | - | ---------------------------------------- | - |  | ------------------------------------- | - |  | -------------------------- | - | -------------------------------------- | - |  | ---------------------------------------------------- |  |  | ------------------------------------------------------------ |  |  | ----------------------------------------------------------- | --
|PreTSL IV       |  | Mezzanine* |  | $              | 242   |  |                | $ | 198   |                                 |  | $ | (44                                      | ) |  | $                                     | - |  |                            | $ | (1                                     | ) |  | Caa2/CCC                                             |  |  | 4                                                            |  |  |                                                             | - 
|PreTSL V        |  | Mezzanine* |  |                | -     |  |                |   | -     |                                 |  |   | -                                        |   |  |                                       | - |  |                            |   | (118                                   | ) |  | C/D                                                  |  |  | -                                                            |  |  |                                                             | - 
|PreTSL VI       |  | Mezzanine* |  |                | 91    |  |                |   | 104   |                                 |  |   | 13                                       |   |  |                                       | - |  |                            |   | (8                                     | ) |  | Ca/D                                                 |  |  | 3                                                            |  |  |                                                             | - 
|PreTSL XVII     |  | Mezzanine  |  |                | 752   |  |                |   | 367   |                                 |  |   | (385                                     | ) |  |                                       | - |  |                            |   | (222                                   | ) |  | C/C                                                  |  |  | 29                                                           |  |  |                                                             | 4 
|PreTSL XIX      |  | Mezzanine  |  |                | 988   |  |                |   | 422   |                                 |  |   | (566                                     | ) |  |                                       | - |  |                            |   | -                                      |   |  | C/C                                                  |  |  | 35                                                           |  |  |                                                             | 12
|PreTSL XXV      |  | Mezzanine  |  |                | 766   |  |                |   | 350   |                                 |  |   | (416                                     | ) |  |                                       | - |  |                            |   | (222                                   | ) |  | C/C                                                  |  |  | 42                                                           |  |  |                                                             | 6 
|PreTSL XXVI     |  | Mezzanine  |  |                | 469   |  |                |   | 242   |                                 |  |   | (227                                     | ) |  |                                       | - |  |                            |   | (270                                   | ) |  | C/C                                                  |  |  | 40                                                           |  |  |                                                             | 8 
|PreTSL
    XXVI |  | Mezzanine  |  |                | 301   |  |                |   | 332   |                                 |  |   | 31                                       |   |  |                                       | - |  |                            |   | (438                                   | ) |  | C/C                                                  |  |  | 40                                                           |  |  |                                                             | 8 
|                |  |            |  | $              | 3,609 |  |                | $ | 2,015 |                                 |  | $ | (1,594                                   | ) |  | $                                     | - |  |                            | $ | (1,279                                 | ) |  |                                                      |  |  |                                                              |  |  |                                                             |   



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



The market for these securities at June
30, 2012 is not active and markets for similar securities also are 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 all factors contributing to the temporary 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.



On a quarterly basis we evaluate our debt
securities for other-than-temporary impairment (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 book value and the fair
value of the security less any current quarter credit related impairment. For the six months ended June 30, 2012, no 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 effective yield implicit in the security at the date of acquisition
or the prospective yield for those securities with prior OTTI charges. The discounted cash flow analysis is considered to be the
primary evidence when determining whether credit related other-than-temporary impairment exists.





- 17 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








7. INVESTMENT SECURITIES (continued)





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
                                                                                                                                 0-1%).
                                                                                                                                 In
                                                                                                                                 addition
                                                                                                                                 to
                                                                                                                                 the
                                                                                                                                 base
                                                                                                                                 prepayment
                                                                                                                                 assumption,
                                                                                                                                 due
                                                                                                                                 to
                                                                                                                                 the
                                                                                                                                 recent
                                                                                                                                 enactment
                                                                                                                                 of
                                                                                                                                 the
                                                                                                                                 Dodd-Frank
                                                                                                                                 financial
                                                                                                                                 legislation
                                                                                                                                 additional
                                                                                                                                 prepayment
                                                                                                                                 analysis
                                                                                                                                 was
                                                                                                                                 performed.
                                                                                                                                 First,
                                                                                                                                 trust
                                                                                                                                 preferred
                                                                                                                                 securities
                                                                                                                                 issued
                                                                                                                                 by
                                                                                                                                 banks
                                                                                                                                 with
                                                                                                                                 more
                                                                                                                                 than
                                                                                                                                 $15
                                                                                                                                 billion
                                                                                                                                 in
                                                                                                                                 total
                                                                                                                                 assets
                                                                                                                                 at
                                                                                                                                 December
                                                                                                                                 31,
                                                                                                                                 2009
                                                                                                                                 were
                                                                                                                                 identified.
                                                                                                                                 The
                                                                                                                                 current
                                                                                                                                 credit
                                                                                                                                 rating
                                                                                                                                 of
                                                                                                                                 these
                                                                                                                                 institutions
                                                                                                                                 was
                                                                                                                                 reviewed
                                                                                                                                 and
                                                                                                                                 it
                                                                                                                                 was
                                                                                                                                 assumed
                                                                                                                                 that
                                                                                                                                 any
                                                                                                                                 issuer
                                                                                                                                 with
                                                                                                                                 an
                                                                                                                                 investment
                                                                                                                                 grade
                                                                                                                                 credit
                                                                                                                                 rating
                                                                                                                                 would
                                                                                                                                 prepay
                                                                                                                                 their
                                                                                                                                 issuance
                                                                                                                                 on
                                                                                                                                 January
                                                                                                                                 1,
                                                                                                                                 2013
                                                                                                                                 or
                                                                                                                                 July
                                                                                                                                 1,
                                                                                                                                 2015
                                                                                                                                 for
                                                                                                                                 bank
                                                                                                                                 holding
                                                                                                                                 company
                                                                                                                                 subsidiaries
                                                                                                                                 of
                                                                                                                                 foreign
                                                                                                                                 banking
                                                                                                                                 organizations
                                                                                                                                 that
                                                                                                                                 have
                                                                                                                                 relied
                                                                                                                                 on
                                                                                                                                 Supervision
                                                                                                                                 and
                                                                                                                                 Regulation
                                                                                                                                 Letter
                                                                                                                                 SR-01-1.
                                                                                                                                 For
                                                                                                                                 those
                                                                                                                                 institutions
                                                                                                                                 rated
                                                                                                                                 below
                                                                                                                                 investment
                                                                                                                                 grade
                                                                                                                                 the
                                                                                                                                 holding
                                                                                                                                 companies’
                                                                                                                                 approximate
                                                                                                                                 cost
                                                                                                                                 of
                                                                                                                                 long-term
                                                                                                                                 funding
                                                                                                                                 given
                                                                                                                                 their
                                                                                                                                 rating
                                                                                                                                 and
                                                                                                                                 marketplace
                                                                                                                                 interest
                                                                                                                                 rate
                                                                                                                                 was
                                                                                                                                 estimated.
                                                                                                                                 The
                                                                                                                                 following
                                                                                                                                 assumption
                                                                                                                                 was
                                                                                                                                 made;
                                                                                                                                 any
                                                                                                                                 holding
                                                                                                                                 company
                                                                                                                                 that
                                                                                                                                 could
                                                                                                                                 refinance
                                                                                                                                 for
                                                                                                                                 a
                                                                                                                                 cost
                                                                                                                                 savings
                                                                                                                                 of
                                                                                                                                 more
                                                                                                                                 than
                                                                                                                                 2%
                                                                                                                                 will
                                                                                                                                 refinance
                                                                                                                                 and
                                                                                                                                 will
                                                                                                                                 do
                                                                                                                                 so
                                                                                                                                 on
                                                                                                                                 January
                                                                                                                                 1,
                                                                                                                                 2013,
                                                                                                                                 or
                                                                                                                                 July
                                                                                                                                 1,
                                                                                                                                 2015.
                                                                                                                                 Finally,
                                                                                                                                 for
                                                                                                                                 issuers
                                                                                                                                 not
                                                                                                                                 impacted
                                                                                                                                 by
                                                                                                                                 the
                                                                                                                                 Tier
                                                                                                                                 1
                                                                                                                                 regulatory
                                                                                                                                 capital
                                                                                                                                 legislation
                                                                                                                                 enacted
                                                                                                                                 by
                                                                                                                                 the
                                                                                                                                 Dodd-Frank
                                                                                                                                 act,
                                                                                                                                 we
                                                                                                                                 identified
                                                                                                                                 the
                                                                                                                                 issuers
                                                                                                                                 that
                                                                                                                                 have
                                                                                                                                 shown
                                                                                                                                 a
                                                                                                                                 recent
                                                                                                                                 history
                                                                                                                                 of
                                                                                                                                 prepayment
                                                                                                                                 of
                                                                                                                                 both
                                                                                                                                 floating
                                                                                                                                 rate
                                                                                                                                 and
                                                                                                                                 fixed
                                                                                                                                 rate
                                                                                                                                 issues
                                                                                                                                 and
                                                                                                                                 assumed
                                                                                                                                 these
                                                                                                                                 issuers
                                                                                                                                 will
                                                                                                                                 prepay
                                                                                                                                 as
                                                                                                                                 soon
                                                                                                                                 as
                                                                                                                                 possible.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | 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%.
                                                                                                                                 Thus,
                                                                                                                                 in
                                                                                                                                 addition
                                                                                                                                 to
                                                                                                                                 the
                                                                                                                                 specific
                                                                                                                                 bank
                                                                                                                                 default
                                                                                                                                 assumptions
                                                                                                                                 used
                                                                                                                                 for
                                                                                                                                 the
                                                                                                                                 near
                                                                                                                                 term,
                                                                                                                                 future
                                                                                                                                 defaults
                                                                                                                                 on
                                                                                                                                 the
                                                                                                                                 individual
                                                                                                                                 banks
                                                                                                                                 in
                                                                                                                                 the
                                                                                                                                 analysis
                                                                                                                                 for
                                                                                                                                 2013
                                                                                                                                 and
                                                                                                                                 beyond
                                                                                                                                 the
                                                                                                                                 rate
                                                                                                                                 used
                                                                                                                                 is
                                                                                                                                 calculated
                                                                                                                                 based
                                                                                                                                 on
                                                                                                                                 using
                                                                                                                                 the
                                                                                                                                 above
                                                                                                                                 mentioned
                                                                                                                                 thirty-six
                                                                                                                                 basis
                                                                                                                                 points
                                                                                                                                 and
                                                                                                                                 factoring
                                                                                                                                 that
                                                                                                                                 number
                                                                                                                                 based
                                                                                                                                 on
                                                                                                                                 a
                                                                                                                                 comparison
                                                                                                                                 of
                                                                                                                                 key
                                                                                                                                 financial
                                                                                                                                 ratios
                                                                                                                                 of
                                                                                                                                 active
                                                                                                                                 individual
                                                                                                                                 issuers
                                                                                                                                 without
                                                                                                                                 a
                                                                                                                                 short-term
                                                                                                                                 probability
                                                                                                                                 of
                                                                                                                                 default
                                                                                                                                 compared
                                                                                                                                 to
                                                                                                                                 all
                                                                                                                                 FDIC
                                                                                                                                 insured
                                                                                                                                 banks.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | 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
                                                                                                                                 defaults
                                                                                                                                 projected
                                                                                                                                 in
                                                                                                                                 2013
                                                                                                                                 and
                                                                                                                                 thereafter.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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 the asset quality in those pools
can be monitored more closely for potential deterioration of credit quality.





- 18 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






7. INVESTMENT SECURITIES (continued)



Based upon the analysis performed by management
as of June 30, 2012, it is probable that we will collect all contractual principal and interest payments on two of our eight pooled
trust preferred securities, PreTSL XIX and PreTSL VI (which was paid off entirely in July 2012). The expected principal shortfall
on the remaining pooled trust preferred securities has resulted in credit related other-than-temporary impairment charges in previous
years. All of these pooled trust preferred securities held by QNB could be subject to additional writedowns in the future if additional
deferrals and defaults occur.



8. LOANS & ALLOWANCE FOR LOAN LOSSES



Loans that management
has the intent and ability to hold for the foreseeable future or until maturity or pay-off are stated at the principal amount
outstanding, net of deferred loan fees and costs. Interest income is accrued on the principal amount outstanding. Loan origination
and commitment fees and related direct costs are deferred and amortized to income over the term of the respective loan and loan
commitment period as a yield adjustment.



Loans held-for-sale consists
of residential mortgage loans that are carried at the lower of aggregate cost or fair value. Net unrealized losses, if any, are
recognized through a valuation allowance charged to income. Gains and losses on residential mortgages held-for-sale are included
in non-interest income.



QNB maintains an allowance
for loan losses, which is intended to absorb probable known and inherent losses in the outstanding loan portfolio. The allowance
is reduced by actual credit losses and is increased by the provision for loan losses and recoveries of previous losses. The provisions
for loan losses are charged to earnings to bring the total allowance for loan losses to a level considered necessary by management.



The allowance for loan
losses is based on management’s continuing review and evaluation of the loan portfolio. The level of the allowance is determined
by assigning specific reserves to individually identified problem credits and general reserves to all other loans. For such loans
that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value) of the
impaired loan is lower than the carrying value of that loan. The portion of the allowance that is allocated to internally criticized
and non-accrual loans is determined by estimating the inherent loss on each credit after giving consideration to the value of
underlying collateral. The general component covers pools of loans by loan class including commercial loans not considered impaired,
as well as smaller balance homogeneous loans, such as residential real estate, home equity and other consumer loans. These pools
of loans are evaluated for loss exposure based upon historical loss rates. These loss rates are based on a three year history
of charge-offs and are more heavily weighted for recent experience for each of these categories of loans, adjusted for qualitative
factors. These qualitative risk factors include:



| | 1. | Lending policies
                                                                                  and procedures, including underwriting standards
                                                                                  and collection, charge-off and recovery practices.
                                                                                  Effect of external factors, such as legal and
                                                                                  regulatory requirements.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2. | National, regional,
                                                                                  and local economic and business conditions as
                                                                                  well as the condition of various market segments,
                                                                                  including the value of underlying collateral
                                                                                  for collateral dependent loans.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3. | Nature and volume
                                                                                  of the portfolio including growth.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Experience,
                                                                                  ability, and depth of lending management and
                                                                                  staff.
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 5. | Volume and severity
                                                                                  of past due, classified and nonaccrual loans.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | 6. | Quality of the
                                                                                  Company’s loan review system, and the
                                                                                  degree of oversight by the Company’s Board
                                                                                  of Directors.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 7. | Existence and
                                                                                  effect of any concentrations of credit and changes
                                                                                  in the level of such concentrations.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Each factor is assigned
a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information
available at the time of the evaluation.



- 19 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



An unallocated component
is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio.



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 using 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, there can be no assurance
that increases to the allowance will not be necessary should the quality of any loans deteriorate as a result of the factors discussed
above.



Major classes of loans
are as follows:

|                                   |  | June 30, |         |   | December 31, |  
|---------------------------------- |  | -------- | ------- | - | ------------ | -
|                                   |  | 2012     |         |   | 2011         |  
|Commercial:                        |  |          |         |   |              |  
|Commercial and industrial          |  | $        | 106,539 |   |              | $
|Construction                       |  |          | 15,687  |   |              |  
|Secured by commercial real estate  |  |          | 195,857 |   |              |  
|Secured by residential real estate |  |          | 43,564  |   |              |  
|State and political subdivisions   |  |          | 30,872  |   |              |  
|Loans to depository institutions   |  |          | 4,500   |   |              |  
|Indirect lease financing           |  |          | 10,990  |   |              |  
|Retail:                            |  |          |         |   |              |  
|1-4 family residential mortgages   |  |          | 26,847  |   |              |  
|Home equity loans and lines        |  |          | 54,280  |   |              |  
|Consumer                           |  |          | 2,164   |   |              |  
|Total loans                        |  |          | 491,300 |   |              |  
|Net unearned (fees) costs          |  |          | (37     | ) |              |  
|Loans receivable                   |  | $        | 491,263 |   |              | $





Loans secured by commercial real estate
include all loans collateralized at least in part by commercial real estate. These loans may not be for the expressed purpose
of conducting commercial real estate transactions.





- 20 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



Overdrafts are reclassified as loans and
are included in consumer loans above and total loans on the balance sheet. At June 30, 2012 and December 31, 2011, overdrafts
were $102,000 and $91,000, respectively.



QNB generally lends in its trade area
which is comprised of Quakertown and the surrounding communities. To a large extent, QNB makes loans collateralized at least in
part by real estate. Its lending activities could be affected by changes in the general economy, the regional economy, or real
estate values. Other than disclosed in the table above, at June 30, 2012, there were no concentrations of loans exceeding 10%
of total loans.



The Company engages in a variety of lending
activities, including commercial, residential real estate and consumer transactions. The Company focuses its lending activities
on individuals, professionals and small to medium sized businesses. Risks associated with lending activities include economic
conditions and changes in interest rates, which can adversely impact both the ability of borrowers to repay their loans and the
value of the associated collateral.



Commercial and industrial loans, commercial
real estate loans, construction loans and residential real estate loans with a business purpose are generally perceived as having
more risk of default than residential real estate loans with a personal purpose and consumer loans. These types of loans involve
larger loan balances to a single borrower or groups of related borrowers and are more susceptible to a risk of loss during a downturn
in the business cycle. These loans may involve greater risk because the availability of funds to repay these loans depends on
the successful operation of the borrower’s business. The assets financed are used within the business for its ongoing operation.
Repayment of these kinds of loans generally comes from the cash flow of the business or the ongoing conversions of assets, such
as accounts receivable and inventory, to cash. Typical collateral for commercial and industrial loans includes the borrower’s
accounts receivable, inventory and machinery and equipment. Commercial real estate and residential real estate loans secured for
a business purpose are originated primarily within the eastern Pennsylvania market area at conservative loan-to-value ratios and
often backed by the individual guarantees of the borrowers or owners. Repayment of this kind of loan is dependent upon either
the ongoing cash flow of the borrowing entity or the resale of or lease of the subject property. Commercial real estate loans
may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because
commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties, as
well as the factors affecting residential real estate borrowers.



Loans to state and political subdivisions
are tax-exempt or taxable loans to municipalities, school districts and housing and industrial development authorities. These
loans can be general obligations of the municipality or school district repaid through their taxing authority, revenue obligations
repaid through the income generated by the operations of the authority, such as a water or sewer authority, or loans issued to
a housing and industrial development agency, for which a private corporation is responsible for payments on the loans.



Loans to depository institutions consist
of a loan to a commercial bank in Lehigh County, Pennsylvania. This loan is secured by shares of common stock of the borrowing
institution.



Indirect lease financing receivables represent
loans to small businesses that are collateralized by equipment. These loans tend to have higher risk characteristics but generally
provide higher rates of return. These loans are originated by a third party and purchased by QNB based on criteria specified by
QNB. The criteria include minimum credit scores of the borrower, term of the lease, type and age of equipment financed and geographic
area. The geographic area primarily represents states contiguous to Pennsylvania. QNB is not the lessor and does not service these
loans.



The Company originates fixed-rate and
adjustable-rate real estate-residential mortgage loans for personal purposes that are secured by first liens on the underlying
1-4 family residential properties. Credit risk exposure in this area of lending is minimized by the evaluation of the credit worthiness
of the borrower, including debt-to-income ratios, credit scores and adherence to underwriting policies that emphasize conservative
loan-to-value ratios of generally no more than 80%. Residential mortgage loans granted in excess of the 80% loan-to-value ratio
criterion are generally insured by private mortgage insurance.





- 21 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



The real estate-home equity portfolio
consists of fixed-rate home equity loans and variable-rate home equity lines of credit. Risks associated with loans secured by
residential properties are generally lower than commercial loans and include general economic risks, such as the strength of the
job market, employment stability and the strength of the housing market. Since most loans are secured by a primary or secondary
residence, the borrower’s continued employment is the greatest risk to repayment.



The Company offers a variety of loans
to individuals for personal and household purposes. Consumer loans are generally considered to have greater risk than first or
second mortgages on real estate because they may be unsecured, or, if they are secured, the value of the collateral may be difficult
to assess and is more likely to decrease in value than real estate. Credit risk in this portfolio is controlled by conservative
underwriting standards that consider debt-to-income levels and the creditworthiness of the borrower and, if secured, collateral
values.



The Company employs an eight (8) grade
risk rating system related to the credit quality of commercial loans, loans to state and political subdivisions and indirect lease
financing of which the first four categories are pass categories (credits not adversely rated). The following is a description
of the internal risk ratings and the likelihood of loss related to each risk rating.

1 - Excellent - no apparent
risk

2 - Good - minimal risk

3 - Acceptable - average risk

4 - Watch List - greater than
average risk

5 - Special Mention - potential
weaknesses

6 - Substandard - well defined
weaknesses

7 - Doubtful - full collection
unlikely

8 - Loss - considered uncollectible



The Company maintains a loan review system,
which allows for a periodic review of our loan portfolio and the early identification of potential problem loans. Each loan officer
assigns a rating to all loans in the portfolio at the time the loan is originated. Loans with risk ratings of one through three
are reviewed annually based on the borrower’s fiscal year. Loans with risk ratings of four are reviewed every six to twelve
months based on the dollar amount of the relationship with the borrower. Loans with risk ratings of five through eight are reviewed
at least quarterly, and as often as monthly, at management’s discretion. The Company also utilizes an outside loan review
firm to review the portfolio on a semi-annual basis to provide the Board of Directors and senior management an independent review
of the Bank’s loan portfolio on an ongoing basis. These reviews are designed to recognize deteriorating credits in their
earliest stages in an effort to reduce and control risk in the lending function as well as identifying potential shifts in the
quality of the loan portfolio. The examinations by the outside loan review firm include the review of lending activities with
respect to underwriting and processing new loans, monitoring the risk of existing loans and to provide timely follow-up and corrective
action for loans showing signs of deterioration in quality. In addition, the outside firm reviews the methodology for the allowance
for loan losses to determine compliance to policy and regulatory guidance.





- 22 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



The following tables present the classes
of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful
within the Company’s internal risk rating system as of June 30, 2012 and December 31, 2011:





|June 30, 2012                      |  | Pass |         |  | Special mention |   |        | Substandard |  |   | Doubtful |  |  | Total |   
|---------------------------------- |  | ---- | ------- |  | --------------- | - | ------ | ----------- |  | - | -------- |  |  | ----- | --
|Commercial:                        |  |      |         |  |                 |   |        |             |  |   |          |  |  |       |   
|Commercial and industrial          |  | $    | 93,088  |  |                 | $ | 4,701  |             |  | $ | 8,713    |  |  | $     | 37
|Construction                       |  |      | 8,544   |  |                 |   | 1,568  |             |  |   | 5,575    |  |  |       | - 
|Secured by commercial real estate  |  |      | 156,750 |  |                 |   | 8,734  |             |  |   | 30,373   |  |  |       | - 
|Secured by residential real estate |  |      | 37,604  |  |                 |   | 2,343  |             |  |   | 3,617    |  |  |       | - 
|State and political subdivisions   |  |      | 28,837  |  |                 |   | -      |             |  |   | 2,035    |  |  |       | - 
|Loans to depository institutions   |  |      | 4,500   |  |                 |   | -      |             |  |   | -        |  |  |       | - 
|Indirect lease financing           |  |      | 10,464  |  |                 |   | -      |             |  |   | 526      |  |  |       | - 
|                                   |  | $    | 339,787 |  |                 | $ | 17,346 |             |  | $ | 50,839   |  |  | $     | 37





|December 31, 2011                  |  | Pass |         |  | Special mention |   |        | Substandard |  |   | Doubtful |  |  | Total |    
|---------------------------------- |  | ---- | ------- |  | --------------- | - | ------ | ----------- |  | - | -------- |  |  | ----- | ---
|Commercial:                        |  |      |         |  |                 |   |        |             |  |   |          |  |  |       |    
|Commercial and industrial          |  | $    | 83,477  |  |                 | $ | 2,313  |             |  | $ | 10,332   |  |  | $     | 41 
|Construction                       |  |      | 6,608   |  |                 |   | 3,067  |             |  |   | 6,284    |  |  |       | -  
|Secured by commercial real estate  |  |      | 152,637 |  |                 |   | 9,323  |             |  |   | 33,402   |  |  |       | 451
|Secured by residential real estate |  |      | 39,657  |  |                 |   | 1,220  |             |  |   | 4,193    |  |  |       | -  
|State and political subdivisions   |  |      | 32,928  |  |                 |   | 2,013  |             |  |   | 186      |  |  |       | -  
|Loans to depository institutions   |  |      | 4,515   |  |                 |   | -      |             |  |   | -        |  |  |       | -  
|Indirect lease financing           |  |      | 11,548  |  |                 |   | -      |             |  |   | 380      |  |  |       | -  
|                                   |  | $    | 331,370 |  |                 | $ | 17,936 |             |  | $ | 54,777   |  |  | $     | 492





For retail loans, the Company evaluates
credit quality based on the performance of the individual credits. The following tables present the recorded investment in the
retail classes of the loan portfolio based on payment activity as of June 30, 2012 and December 31, 2011:





|June
    30, 2012                |  | Performing |        |  | Non-performing |   |     | Total | 
|-------------------------------- |  | ---------- | ------ |  | -------------- | - | --- | ----- | 
|Retail:                          |  |            |        |  |                |   |     |       | 
|1-4 family residential mortgages |  | $          | 26,495 |  |                | $ | 352 |       | 
|Home equity loans and lines      |  |            | 54,115 |  |                |   | 165 |       | 
|Consumer                         |  |            | 2,127  |  |                |   | 37  |       | 
|                                 |  | $          | 82,737 |  |                | $ | 554 |       | 







- 23 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)





|December
    31, 2011            |  | Performing |        |  | Non-performing |   |     | Total | 
|-------------------------------- |  | ---------- | ------ |  | -------------- | - | --- | ----- | 
|Retail:                          |  |            |        |  |                |   |     |       | 
|1-4 family residential mortgages |  | $          | 25,003 |  |                | $ | 515 |       | 
|Home equity loans and lines      |  |            | 57,211 |  |                |   | 368 |       | 
|Consumer                         |  |            | 2,308  |  |                |   | -   |       | 
|                                 |  | $          | 84,522 |  |                | $ | 883 |       | 





The performance and credit quality of
the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded
payment is past due. The following table presents the classes of the loan portfolio summarized by the past due status as of June
30, 2012 and December 31, 2011:





|June
    30, 2012                  |  | 30-59
    days past due |       |  | 60-89
    days past due |   |     | 90
    days or more past due |  |   | Total
    past due loans |  |  | Current |       |  | Total
    loans receivable |  
|---------------------------------- |  | ----------------------- | ----- |  | ----------------------- | - | --- | ---------------------------- |  | - | ------------------------ |  |  | ------- | ----- |  | -------------------------- | -
|Commercial:                        |  |                         |       |  |                         |   |     |                              |  |   |                          |  |  |         |       |  |                            |  
|Commercial and industrial          |  | $                       | 62    |  |                         | $ | 52  |                              |  |   | -                        |  |  | $       | 114   |  |                            | $
|Construction                       |  |                         | -     |  |                         |   | -   |                              |  | $ | 408                      |  |  |         | 408   |  |                            |  
|Secured by commercial real estate  |  |                         | 1,253 |  |                         |   | 16  |                              |  |   | 2,190                    |  |  |         | 3,459 |  |                            |  
|Secured by residential real estate |  |                         | 727   |  |                         |   | -   |                              |  |   | 143                      |  |  |         | 870   |  |                            |  
|State and political subdivisions   |  |                         | 44    |  |                         |   | -   |                              |  |   | -                        |  |  |         | 44    |  |                            |  
|Loans to depository institutions   |  |                         | -     |  |                         |   | -   |                              |  |   | -                        |  |  |         | -     |  |                            |  
|Indirect lease financing           |  |                         | 190   |  |                         |   | 78  |                              |  |   | 58                       |  |  |         | 326   |  |                            |  
|Retail:                            |  |                         |       |  |                         |   |     |                              |  |   |                          |  |  |         |       |  |                            |  
|1-4 family residential mortgages   |  |                         | -     |  |                         |   | 198 |                              |  |   | 52                       |  |  |         | 250   |  |                            |  
|Home equity loans and lines        |  |                         | 194   |  |                         |   | 155 |                              |  |   | -                        |  |  |         | 349   |  |                            |  
|Consumer                           |  |                         | 22    |  |                         |   | -   |                              |  |   | 37                       |  |  |         | 59    |  |                            |  
|                                   |  | $                       | 2,492 |  |                         | $ | 499 |                              |  | $ | 2,888                    |  |  | $       | 5,879 |  |                            | $







- 24 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



|December 31, 2011                  |  | 30-59
    days past due |       |  | 60-89
    days past due |   |       | 90
    days or more past due |  |   | Total
    past due loans |  |  | Current |       |  | Total
    loans receivable |  
|---------------------------------- |  | ----------------------- | ----- |  | ----------------------- | - | ----- | ---------------------------- |  | - | ------------------------ |  |  | ------- | ----- |  | -------------------------- | -
|Commercial:                        |  |                         |       |  |                         |   |       |                              |  |   |                          |  |  |         |       |  |                            |  
|Commercial and industrial          |  | $                       | 113   |  |                         |   | -     |                              |  |   | -                        |  |  | $       | 113   |  |                            | $
|Construction                       |  |                         | 1,436 |  |                         |   | -     |                              |  |   | -                        |  |  |         | 1,436 |  |                            |  
|Secured by commercial real estate  |  |                         | 1,857 |  |                         | $ | 1,699 |                              |  | $ | 1,017                    |  |  |         | 4,573 |  |                            |  
|Secured by residential real estate |  |                         | 778   |  |                         |   | 70    |                              |  |   | 395                      |  |  |         | 1,243 |  |                            |  
|State and political subdivisions   |  |                         | 50    |  |                         |   | -     |                              |  |   | 44                       |  |  |         | 94    |  |                            |  
|Loans to depository institutions   |  |                         | -     |  |                         |   | -     |                              |  |   | -                        |  |  |         | -     |  |                            |  
|Indirect lease financing           |  |                         | 353   |  |                         |   | 146   |                              |  |   | 123                      |  |  |         | 622   |  |                            |  
|Retail:                            |  |                         |       |  |                         |   |       |                              |  |   |                          |  |  |         |       |  |                            |  
|1-4 family residential mortgages   |  |                         | 200   |  |                         |   | 166   |                              |  |   | -                        |  |  |         | 366   |  |                            |  
|Home equity loans and lines        |  |                         | 158   |  |                         |   | 66    |                              |  |   | 190                      |  |  |         | 414   |  |                            |  
|Consumer                           |  |                         | 14    |  |                         |   | -     |                              |  |   | -                        |  |  |         | 14    |  |                            |  
|                                   |  | $                       | 4,959 |  |                         | $ | 2,147 |                              |  | $ | 1,769                    |  |  | $       | 8,875 |  |                            | $





The following tables disclose the recorded
investment in loans receivable that are either on non-accrual status or past due 90 days or more and still accruing interest as
of June 30, 2012 and December 31, 2011:



|June 30, 2012                      |  | 90
    days or more past due (still accruing) |     |  | Non-accrual |  
|---------------------------------- |  | --------------------------------------------- | --- |  | ----------- | -
|Commercial:                        |  |                                               |     |  |             |  
|Commercial and industrial          |  |                                               | -   |  |             | $
|Construction                       |  | $                                             | 408 |  |             |  
|Secured by commercial real estate  |  |                                               | -   |  |             |  
|Secured by residential real estate |  |                                               | -   |  |             |  
|State and political subdivisions   |  |                                               | -   |  |             |  
|Loans to depository institutions   |  |                                               | -   |  |             |  
|Indirect lease financing           |  |                                               | 30  |  |             |  
|Retail:                            |  |                                               |     |  |             |  
|1-4 family residential mortgages   |  |                                               | -   |  |             |  
|Home equity loans and lines        |  |                                               | -   |  |             |  
|Consumer                           |  |                                               | 37  |  |             |  
|                                   |  | $                                             | 475 |  |             | $





- 25 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)





|December 31, 2011                  |  | 90
    days or more past due (still accruing) |     |  | Non-accrual |  
|---------------------------------- |  | --------------------------------------------- | --- |  | ----------- | -
|Commercial:                        |  |                                               |     |  |             |  
|Commercial and industrial          |  |                                               | -   |  |             | $
|Construction                       |  |                                               | -   |  |             |  
|Secured by commercial real estate  |  | $                                             | 286 |  |             |  
|Secured by residential real estate |  |                                               | -   |  |             |  
|State and political subdivisions   |  |                                               | 40  |  |             |  
|Loans to depository institutions   |  |                                               | -   |  |             |  
|Indirect lease financing           |  |                                               | 54  |  |             |  
|Retail:                            |  |                                               |     |  |             |  
|1-4 family residential mortgages   |  |                                               | -   |  |             |  
|Home equity loans and lines        |  |                                               | -   |  |             |  
|Consumer                           |  |                                               | -   |  |             |  
|                                   |  | $                                             | 380 |  |             | $





Activity in the allowance for loan
losses for the three months ended June 30, 2012 and 2011 are as follows:





|Three months ended
    June 30, 2012 |  | Balance,
    beginning of period |       |  | Provision
    for (credit to) loan losses |   |      | Charge-offs |  |   | Recoveries |   |  | Balance,
    end of period |    
|------------------------------------ |  | -------------------------------- | ----- |  | ----------------------------------------- | - | ---- | ----------- |  | - | ---------- | - |  | -------------------------- | ---
|Commercial:                          |  |                                  |       |  |                                           |   |      |             |  |   |            |   |  |                            |    
|Commercial and industrial            |  | $                                | 3,317 |  |                                           | $ | 164  |             |  | $ | (74        | ) |  | $                          | 60 
|Construction                         |  |                                  | 333   |  |                                           |   | 20   |             |  |   | -          |   |  |                            | -  
|Secured by commercial real estate    |  |                                  | 3,126 |  |                                           |   | 2    |             |  |   | -          |   |  |                            | 62 
|Secured by residential real estate   |  |                                  | 773   |  |                                           |   | 88   |             |  |   | (50        | ) |  |                            | -  
|State and political subdivisions     |  |                                  | 301   |  |                                           |   | (79  | )           |  |   | -          |   |  |                            | -  
|Loans to depository institutions     |  |                                  | 20    |  |                                           |   | -    |             |  |   | -          |   |  |                            | -  
|Indirect lease financing             |  |                                  | 238   |  |                                           |   | 21   |             |  |   | (13        | ) |  |                            | 22 
|Retail:                              |  |                                  |       |  |                                           |   |      |             |  |   |            |   |  |                            |    
|1-4 family residential mortgages     |  |                                  | 303   |  |                                           |   | (5   | )           |  |   | -          |   |  |                            | 2  
|Home equity loans and lines          |  |                                  | 547   |  |                                           |   | 37   |             |  |   | (1         | ) |  |                            | 12 
|Consumer                             |  |                                  | 17    |  |                                           |   | 10   |             |  |   | (11        | ) |  |                            | 2  
|Unallocated                          |  |                                  | 481   |  |                                           |   | (258 | )           |  |   | N/A        |   |  |                            | N/A
|                                     |  | $                                | 9,456 |  |                                           | $ | -    |             |  | $ | (149       | ) |  | $                          | 160





- 26 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



|Three months ended
    June 30, 2011 |  | Balance,
    beginning of period |       |  | Provision
    for (credit to) loan losses |   |      | Charge-offs |  |   | Recoveries |   |  | Balance,
    end of period |    
|------------------------------------ |  | -------------------------------- | ----- |  | ----------------------------------------- | - | ---- | ----------- |  | - | ---------- | - |  | -------------------------- | ---
|Commercial:                          |  |                                  |       |  |                                           |   |      |             |  |   |            |   |  |                            |    
|Commercial and industrial            |  | $                                | 3,119 |  |                                           | $ | (276 | )           |  | $ | (24        | ) |  | $                          | 7  
|Construction                         |  |                                  | 660   |  |                                           |   | 345  |             |  |   | (397       | ) |  |                            | -  
|Secured by commercial real estate    |  |                                  | 3,180 |  |                                           |   | 284  |             |  |   | (349       | ) |  |                            | 4  
|Secured by residential real estate   |  |                                  | 625   |  |                                           |   | 62   |             |  |   | -          |   |  |                            | -  
|State and political subdivisions     |  |                                  | 107   |  |                                           |   | 44   |             |  |   | -          |   |  |                            | -  
|Indirect lease financing             |  |                                  | 470   |  |                                           |   | (99  | )           |  |   | -          |   |  |                            | 5  
|Retail:                              |  |                                  |       |  |                                           |   |      |             |  |   |            |   |  |                            |    
|1-4 family residential mortgages     |  |                                  | 205   |  |                                           |   | 29   |             |  |   | -          |   |  |                            | -  
|Home equity loans and lines          |  |                                  | 605   |  |                                           |   | 52   |             |  |   | (43        | ) |  |                            | 2  
|Consumer                             |  |                                  | 27    |  |                                           |   | (11  | )           |  |   | (2         | ) |  |                            | 5  
|Unallocated                          |  |                                  | 194   |  |                                           |   | 20   |             |  |   | N/A        |   |  |                            | N/A
|                                     |  | $                                | 9,192 |  |                                           | $ | 450  |             |  | $ | (815       | ) |  | $                          | 23 





Activity in the allowance for loan
losses for the six months ended June 30, 2012 and 2011 are as follows:





|Six months ended
    June 30, 2012 |  | Balance,
    beginning of year |       |  | Provision
    for (credit to) loan losses |   |      | Charge-offs |  |   | Recoveries |   |  | Balance,
    end of period |    
|---------------------------------- |  | ------------------------------ | ----- |  | ----------------------------------------- | - | ---- | ----------- |  | - | ---------- | - |  | -------------------------- | ---
|Commercial:                        |  |                                |       |  |                                           |   |      |             |  |   |            |   |  |                            |    
|Commercial and industrial          |  | $                              | 2,959 |  |                                           | $ | 520  |             |  | $ | (74        | ) |  | $                          | 62 
|Construction                       |  |                                | 556   |  |                                           |   | (203 | )           |  |   | -          |   |  |                            | -  
|Secured by commercial real estate  |  |                                | 3,124 |  |                                           |   | 4    |             |  |   | -          |   |  |                            | 62 
|Secured by residential real estate |  |                                | 746   |  |                                           |   | 151  |             |  |   | (86        | ) |  |                            | -  
|State and political subdivisions   |  |                                | 195   |  |                                           |   | 27   |             |  |   | -          |   |  |                            | -  
|Loans to depository institutions   |  |                                | 20    |  |                                           |   | -    |             |  |   | -          |   |  |                            | -  
|Indirect lease financing           |  |                                | 312   |  |                                           |   | (47  | )           |  |   | (23        | ) |  |                            | 26 
|Retail:                            |  |                                |       |  |                                           |   |      |             |  |   |            |   |  |                            |    
|1-4 family residential mortgages   |  |                                | 249   |  |                                           |   | 70   |             |  |   | (21        | ) |  |                            | 2  
|Home equity loans and lines        |  |                                | 625   |  |                                           |   | (23  | )           |  |   | (19        | ) |  |                            | 12 
|Consumer                           |  |                                | 20    |  |                                           |   | 13   |             |  |   | (20        | ) |  |                            | 5  
|Unallocated                        |  |                                | 435   |  |                                           |   | (212 | )           |  |   | N/A        |   |  |                            | N/A
|                                   |  | $                              | 9,241 |  |                                           | $ | 300  |             |  | $ | (243       | ) |  | $                          | 169





- 27 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)





|Six months ended
    June 30, 2011 |  | Balance,
    beginning of period |       |  | Provision
    for (credit to) loan losses |   |       | Charge-offs |  |   | Recoveries |   |  | Balance,
    end of period |    
|---------------------------------- |  | -------------------------------- | ----- |  | ----------------------------------------- | - | ----- | ----------- |  | - | ---------- | - |  | -------------------------- | ---
|Commercial:                        |  |                                  |       |  |                                           |   |       |             |  |   |            |   |  |                            |    
|Commercial and industrial          |  | $                                | 2,136 |  |                                           | $ | 769   |             |  | $ | (89        | ) |  | $                          | 10 
|Construction                       |  |                                  | 633   |  |                                           |   | 372   |             |  |   | (397       | ) |  |                            | -  
|Secured by commercial real estate  |  |                                  | 3,875 |  |                                           |   | (119  | )           |  |   | (641       | ) |  |                            | 4  
|Secured by residential real estate |  |                                  | 676   |  |                                           |   | 65    |             |  |   | (54        | ) |  |                            | -  
|State and political subdivisions   |  |                                  | 108   |  |                                           |   | 43    |             |  |   | -          |   |  |                            | -  
|Indirect lease financing           |  |                                  | 496   |  |                                           |   | (129  | )           |  |   | -          |   |  |                            | 9  
|Retail:                            |  |                                  |       |  |                                           |   |       |             |  |   |            |   |  |                            | -  
|1-4 family residential mortgages   |  |                                  | 212   |  |                                           |   | 22    |             |  |   | -          |   |  |                            | -  
|Home equity loans and lines        |  |                                  | 646   |  |                                           |   | 20    |             |  |   | (53        | ) |  |                            | 3  
|Consumer                           |  |                                  | 32    |  |                                           |   | (16   | )           |  |   | (6         | ) |  |                            | 9  
|Unallocated                        |  |                                  | 141   |  |                                           |   | 73    |             |  |   | N/A        |   |  |                            | N/A
|                                   |  | $                                | 8,955 |  |                                           | $ | 1,100 |             |  | $ | (1,240     | ) |  | $                          | 35 



As previously discussed, the Company maintains
a loan review system, which includes a continuous review of the loan portfolio by internal and external parties to aid in the
early identification of potential impaired loans. A loan is considered impaired when, based on current information and events,
it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status,
collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment
delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan
and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and
the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for
commercial loans, loans to state and political subdivisions and indirect lease financing loans by using either the present value
of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the
loan is collateral dependent.



Large groups of smaller balance homogeneous
loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and
residential mortgage loans for impairment disclosures, unless such loans are part of a larger relationship that is impaired, or
are classified as a troubled debt restructuring.



An allowance for loan losses is established
for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of the majority of the
Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.



For commercial loans secured by real estate,
estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired,
a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on
various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal
and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral,
which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.





- 28 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



For commercial loans secured by non-real
estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s
financial statements, inventory reports, accounts receivable agings or equipment appraisals or invoices. Indications of value
from these sources are generally discounted based on the age of the financial information or the quality of the assets.



From time to time, QNB may extend, restructure,
or otherwise modify the terms of existing loans, on a case-by-case basis, to remain competitive and retain certain customers,
as well as assist other customers that may be experiencing financial difficulties. A loan is considered to be a troubled debt
restructuring (“TDR”) loan when the Company grants a concession to the borrower because of the borrower’s financial
condition that it would not otherwise consider. Such concessions include the reduction of interest rates, forgiveness of principal
or interest, or other modifications of interest rates to less than the current market rate for new obligations with similar risk.
Loans classified as TDRs are considered non-performing and are also designated as impaired.



The concessions made for TDRs involve
lowering the monthly payments on loans through periods of interest only payments, a reduction in interest rate below a market
rate or an extension of the term of the loan without a corresponding adjustment to the risk premium reflected in the interest
rate, or a combination of these three methods. The restructurings rarely result in the forgiveness of principal or accrued interest.
If the borrower has demonstrated performance under the previous terms and our underwriting process shows the borrower has the
capacity to continue to perform under the restructured terms, the loan will continue to accrue interest. Non-accruing restructured
loans may be returned to accrual status when there has been a sustained period of repayment performance (generally six consecutive
months of payments) and both principal and interest are deemed collectible. TDR loans that are in compliance with their modified
terms and that yield a market rate may be removed from the TDR status after a period of performance.



QNB assesses all loan restructurings under
the guidance of ASU 2011-02. Performing TDRs (not reported as non-accrual or past due 90 days or more and still accruing) totaled
$4,085,000 and $2,413,000 as of June 30, 2012 and December 31, 2011, respectively. Non-performing TDRs totaled $2,628,000
and $2,437,000 as of June 30, 2012 and December 31, 2011, respectively. All TDRs are included in impaired loans presented
in the section above.



The following tables present loans by
loan class modified as TDRs during the three and six months ended June 30, 2012. The pre-modification and post-modification outstanding
recorded investments disclosed in the tables below, represent carrying amounts immediately prior to the modification and at June
30, 2012, respectively.





|Three months ended
    June 30, 2012 |  | Number
    of contracts |   |  | Pre-modification
    outstanding recorded investment |   |       | Post-modification
    outstanding recorded investment | 
|------------------------------------ |  | ----------------------- | - |  | ---------------------------------------------------- | - | ----- | ----------------------------------------------------- | 
|Commercial:                          |  |                         |   |  |                                                      |   |       |                                                       | 
|Commercial and industrial            |  |                         | 2 |  |                                                      | $ | 482   |                                                       | 
|Secured by commercial real estate    |  |                         | 1 |  |                                                      |   | 2,380 |                                                       | 
|Retail:                              |  |                         |   |  |                                                      |   |       |                                                       | 
|1-4 family residential
    mortgages |  |                         | 1 |  |                                                      |   | 145   |                                                       | 
|                                     |  |                         | 4 |  |                                                      | $ | 3,007 |                                                       | 





- 29 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)





|Six months ended
    June 30, 2012 |  | Number
    of contracts |   |  | Pre-modification
    outstanding recorded investment |   |       | Post-modification
    outstanding recorded investment | 
|---------------------------------- |  | ----------------------- | - |  | ---------------------------------------------------- | - | ----- | ----------------------------------------------------- | 
|Commercial:                        |  |                         |   |  |                                                      |   |       |                                                       | 
|Commercial and industrial          |  |                         | 2 |  |                                                      | $ | 482   |                                                       | 
|Secured by commercial real estate  |  |                         | 1 |  |                                                      |   | 2,380 |                                                       | 
|Retail:                            |  |                         |   |  |                                                      |   |       |                                                       | 
|1-4 family residential mortgages   |  |                         | 1 |  |                                                      |   | 145   |                                                       | 
|Home equity loans and
    lines    |  |                         | 1 |  |                                                      |   | 38    |                                                       | 
|                                   |  |                         | 5 |  |                                                      | $ | 3,045 |                                                       | 





The TDR concessions made during the six
months ended June 30, 2012 primarily involved the reduction of interest rates and/or interest only repayment periods on the loans.
There were specific reserve for loan losses allocated to the loans modified as TDRs during the three and six months ended June
30, 2012 of $365,000 and $373,000, respectively. Any required specific reserves are included in the allowance for loan losses
for loans individually evaluated for impairment. There were no charge-offs resulting from loans modified as TDRs during the six
months ended June 30, 2012.



The following table presents loans modified
as TDRs within 12 months prior to June 30, 2012, and for which there was a payment default (90 days or more past due or on non-accrual)
during the three and six months ended June 30, 2012:





|                                 |  | Three
    Months Ended June 30, 2012 |   |  | Six
    Months Ended June 30, 2012 |  
|-------------------------------- |  | ------------------------------------ | - |  | ---------------------------------- | -
|TDRs subsequently defaulted      |  | Number of contracts                  |   |  | Recorded investment                |  
|Commercial:                      |  |                                      |   |  |                                    |  
|Commercial and industrial        |  |                                      | 1 |  |                                    | $
|Retail:                          |  |                                      |   |  |                                    |  
|1-4 family residential mortgages |  |                                      | 1 |  |                                    |  
|                                 |  |                                      | 2 |  |                                    | $





The following tables present the balance
in the allowance for loan losses at June 30, 2012 and December 31, 2011 disaggregated on the basis of the Company’s impairment
method by class of loans receivable along with the balance of loans receivable by class, excluding unearned fees and costs, disaggregated
on the basis of the Company’s impairment methodology:





- 30 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



|                                   |  | Allowance
    for Loan Losses |       |  | Loans
    Receivable                                               |  
|---------------------------------- |  | ----------------------------- | ----- |  | ------------------------------------------------------------------ | -
|June 30, 2012                      |  | Balance                       |       |  | Balance related
    to loans individually evaluated for impairment |  
|Commercial:                        |  |                               |       |  |                                                                    |  
|Commercial and industrial          |  | $                             | 3,467 |  |                                                                    | $
|Construction                       |  |                               | 353   |  |                                                                    |  
|Secured by commercial real estate  |  |                               | 3,190 |  |                                                                    |  
|Secured by residential real estate |  |                               | 811   |  |                                                                    |  
|State and political subdivisions   |  |                               | 222   |  |                                                                    |  
|Loans to depository institutions   |  |                               | 20    |  |                                                                    |  
|Indirect lease financing           |  |                               | 268   |  |                                                                    |  
|Retail:                            |  |                               |       |  |                                                                    |  
|1-4 family residential mortgages   |  |                               | 300   |  |                                                                    |  
|Home equity loans and lines        |  |                               | 595   |  |                                                                    |  
|Consumer                           |  |                               | 18    |  |                                                                    |  
|Unallocated                        |  |                               | 223   |  |                                                                    |  
|                                   |  | $                             | 9,467 |  |                                                                    | $



|                                   |  | Allowance
    for Loan Losses |       |  | Loans
    Receivable                                               |  
|---------------------------------- |  | ----------------------------- | ----- |  | ------------------------------------------------------------------ | -
|December 31, 2011                  |  | Balance                       |       |  | Balance related
    to loans individually evaluated for impairment |  
|Commercial:                        |  |                               |       |  |                                                                    |  
|Commercial and industrial          |  | $                             | 2,959 |  |                                                                    | $
|Construction                       |  |                               | 556   |  |                                                                    |  
|Secured by commercial real estate  |  |                               | 3,124 |  |                                                                    |  
|Secured by residential real estate |  |                               | 746   |  |                                                                    |  
|State and political subdivisions   |  |                               | 195   |  |                                                                    |  
|Loans to depository institutions   |  |                               | 20    |  |                                                                    |  
|Indirect lease financing           |  |                               | 312   |  |                                                                    |  
|Retail:                            |  |                               |       |  |                                                                    |  
|1-4 family residential mortgages   |  |                               | 249   |  |                                                                    |  
|Home equity loans and lines        |  |                               | 625   |  |                                                                    |  
|Consumer                           |  |                               | 20    |  |                                                                    |  
|Unallocated                        |  |                               | 435   |  |                                                                    |  
|                                   |  | $                             | 9,241 |  |                                                                    | $







- 31 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






8. LOANS & ALLOWANCE FOR LOAN LOSSES (continued)



The following tables summarize additional
information in regards to impaired loans by loan portfolio class as of June 30, 2012 and December 31, 2011:





|June 30, 2012                        |  | Recorded
    investment (after charge-offs) |        |  | Unpaid
    principal balance |   |        | Related
    
    allowance |  |   | Average
    recorded investment |  |  | Interest
    income recognized |       
|------------------------------------ |  | ------------------------------------------- | ------ |  | ---------------------------- | - | ------ | -------------------------- |  | - | ------------------------------- |  |  | ------------------------------ | ------
|With no specific allowance recorded: |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|Commercial:                          |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|Commercial and industrial            |  | $                                           | 5,179  |  |                              | $ | 5,339  |                            |  | $ | -                               |  |  |                                |       
|Construction                         |  |                                             | 5,575  |  |                              |   | 5,689  |                            |  |   | -                               |  |  |                                |       
|Secured by commercial real estate    |  |                                             | 15,180 |  |                              |   | 16,197 |                            |  |   | -                               |  |  |                                |       
|Secured by residential real estate   |  |                                             | 800    |  |                              |   | 810    |                            |  |   | -                               |  |  |                                |       
|State and political subdivisions     |  |                                             | 1,905  |  |                              |   | 1,905  |                            |  |   | -                               |  |  |                                |       
|Loans to depository institutions     |  |                                             | -      |  |                              |   | -      |                            |  |   | -                               |  |  |                                |       
|Indirect lease financing             |  |                                             | 36     |  |                              |   | 65     |                            |  |   | -                               |  |  |                                |       
|Retail:                              |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|1-4 family residential mortgages     |  |                                             | 193    |  |                              |   | 205    |                            |  |   | -                               |  |  |                                |       
|Home equity loans and lines          |  |                                             | 46     |  |                              |   | 54     |                            |  |   | -                               |  |  |                                |       
|Consumer                             |  |                                             | -      |  |                              |   | -      |                            |  |   | -                               |  |  |                                |       
|                                     |  | $                                           | 28,914 |  |                              | $ | 30,264 |                            |  | $ | -                               |  |  |                                |       
|                                     |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|With an allowance recorded:          |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|Commercial:                          |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|Commercial and industrial            |  | $                                           | 2,429  |  |                              | $ | 2,496  |                            |  | $ | 1,935                           |  |  |                                |       
|Construction                         |  |                                             | -      |  |                              |   | -      |                            |  |   | -                               |  |  |                                |       
|Secured by commercial real estate    |  |                                             | 636    |  |                              |   | 647    |                            |  |   | 181                             |  |  |                                |       
|Secured by residential real estate   |  |                                             | 1,474  |  |                              |   | 1,510  |                            |  |   | 273                             |  |  |                                |       
|State and political subdivisions     |  |                                             | 10     |  |                              |   | 13     |                            |  |   | 5                               |  |  |                                |       
|Loans to depository institutions     |  |                                             | -      |  |                              |   | -      |                            |  |   | -                               |  |  |                                |       
|Indirect lease financing             |  |                                             | 31     |  |                              |   | 37     |                            |  |   | 9                               |  |  |                                |       
|Retail:                              |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|1-4 family residential mortgages     |  |                                             | 282    |  |                              |   | 290    |                            |  |   | 88                              |  |  |                                |       
|Home equity loans and lines          |  |                                             | 156    |  |                              |   | 165    |                            |  |   | 49                              |  |  |                                |       
|Consumer                             |  |                                             | -      |  |                              |   | -      |                            |  |   | -                               |  |  |                                |       
|                                     |  | $                                           | 5,018  |  |                              | $ | 5,158  |                            |  | $ | 2,540                           |  |  |                                |       
|                                     |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|Total:                               |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|Commercial:                          |  |                                             |        |  |                              |   |        |                            |  |   |                                 |  |  |                                |       
|Commercial and industrial            |  | $                                           | 7,608  |  |                              | $ | 7,835  |                            |  | $ | 1,935                           |  |  | $                              | 7,426 
|Construction                         |  |                                             | 5,575  |  |                              |   | 5,689  |                            |  |   | -                               |  |  |                                | 5,432 
|Secured by commercial real estate    |  |                                             | 15,816 |  |                              |   | 16,844 |                            |  |   | 181                             |  |  |                                | 13,848
|Secured by residential real estate   |  |                                             | 2,274  |  |                              |   | 2,320  |                            |  |   | 273                             |  |  |                                | 2,250 
|State and political subdivisions     |  |                                             | 1,915  |  |                              |   | 1,918  |                            |  |   | 5                               |  |  |                                | 1,137 
|Loans to depository institutions     |  |                                             | -      |  |                              |   | -      |                            |  |   | -                               |  |  |                                | -     
|Indirect lease financing             |  |                                             | 67     |  |                              |   | 102    |                            |  |   | 9                               |  |  |                                | 88    
|Retail:                              |  |                                             | -      |  |                              |   | -      |                            |  |   | -                               |  |  |                                |       
|1-4 family residential mortgages     |  |                                             | 475    |  |                              |   | 495    |                            |  |   | 88                              |  |  |                                | 566   
|Home equity loans and lines          |  |                                             | 202    |  |                              |   | 219    |                            |  |   | 49                              |  |  |                                | 534   
|Consumer                             |  |                                             | -      |  |                              |   | -      |                            |  |   | -                               |  |  |                                | -     
|                                     |  | $                                           | 33,932 |  |                              | $ | 35,422 |                            |  | $ | 2,540                           |  |  | $                              | 31,281





- 32 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








8. LOANS & ALLOWANCE FOR LOAN LOSSES
(continued)





|December
    31, 2011                |  | Recorded
    investment (after charge-offs) |        |  | Unpaid
    
    principal 
    balance |   |        | Related
    
    allowance | 
|------------------------------------ |  | ------------------------------------------- | ------ |  | -------------------------------------- | - | ------ | -------------------------- | 
|With no specific allowance recorded: |  |                                             |        |  |                                        |   |        |                           
|Commercial:                          |  |                                             |        |  |                                        |   |        |                            | 
|Commercial and industrial            |  | $                                           | 4,923  |  |                                        | $ | 5,580  |                            | 
|Construction                         |  |                                             | 4,016  |  |                                        |   | 4,047  |                            | 
|Secured by commercial real estate    |  |                                             | 10,400 |  |                                        |   | 10,841 |                            | 
|Secured by residential real estate   |  |                                             | 1,598  |  |                                        |   | 1,603  |                            | 
|State and political subdivisions     |  |                                             | -      |  |                                        |   | -      |                            | 
|Loans to depository institutions     |  |                                             | -      |  |                                        |   | -      |                            | 
|Indirect lease financing             |  |                                             | 47     |  |                                        |   | 71     |                            | 
|Retail:                              |  |                                             |        |  |                                        |   |        |                            | 
|1-4 family residential mortgages     |  |                                             | 352    |  |                                        |   | 384    |                            | 
|Home equity loans and lines          |  |                                             | 486    |  |                                        |   | 492    |                            | 
|Consumer                             |  |                                             | -      |  |                                        |   | -      |                            | 
|                                     |  | $                                           | 21,822 |  |                                        | $ | 23,018 |                            | 
|                                     |  |                                             |        |  |                                        |   |        |                            | 
|With an allowance recorded:          |  |                                             |        |  |                                        |   |        |                            | 
|Commercial:                          |  |                                             |        |  |                                        |   |        |                            | 
|Commercial and industrial            |  | $                                           | 3,165  |  |                                        | $ | 3,231  |                            | 
|Construction                         |  |                                             | 647    |  |                                        |   | 654    |                            | 
|Secured by commercial real estate    |  |                                             | 3,179  |  |                                        |   | 3,779  |                            | 
|Secured by residential real estate   |  |                                             | 969    |  |                                        |   | 985    |                            | 
|State and political subdivisions     |  |                                             | 4      |  |                                        |   | 5      |                            | 
|Loans to depository institutions     |  |                                             | -      |  |                                        |   | -      |                            | 
|Indirect lease financing             |  |                                             | 74     |  |                                        |   | 84     |                            | 
|Retail:                              |  |                                             |        |  |                                        |   |        |                            | 
|1-4 family residential mortgages     |  |                                             | 288    |  |                                        |   | 293    |                            | 
|Home equity loans and lines          |  |                                             | 220    |  |                                        |   | 224    |                            | 
|Consumer                             |  |                                             | -      |  |                                        |   | -      |                            | 
|                                     |  | $                                           | 8,546  |  |                                        | $ | 9,255  |                            | 
|                                     |  |                                             |        |  |                                        |   |        |                            | 
|Total:                               |  |                                             |        |  |                                        |   |        |                            | 
|Commercial:                          |  |                                             |        |  |                                        |   |        |                            | 
|Commercial and industrial            |  | $                                           | 8,088  |  |                                        | $ | 8,811  |                            | 
|Construction                         |  |                                             | 4,663  |  |                                        |   | 4,701  |                            | 
|Secured by commercial real estate    |  |                                             | 13,579 |  |                                        |   | 14,620 |                            | 
|Secured by residential real estate   |  |                                             | 2,567  |  |                                        |   | 2,588  |                            | 
|State and political subdivisions     |  |                                             | 4      |  |                                        |   | 5      |                            | 
|Loans to depository institutions     |  |                                             | -      |  |                                        |   | -      |                            | 
|Indirect lease financing             |  |                                             | 121    |  |                                        |   | 155    |                            | 
|Retail:                              |  |                                             |        |  |                                        |   |        |                            | 
|1-4 family residential mortgages     |  |                                             | 640    |  |                                        |   | 677    |                            | 
|Home equity loans and lines          |  |                                             | 706    |  |                                        |   | 716    |                            | 
|Consumer                             |  |                                             | -      |  |                                        |   | -      |                            | 
|                                     |  | $                                           | 30,368 |  |                                        | $ | 32,273 |                            | 





- 33 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






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:



| | Level1: | 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.





- 34 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)



The following table sets forth QNB’s
financial assets measured at fair value on a recurring and nonrecurring basis and the fair value measurements by level within
the fair value hierarchy as of June 30, 2012:





|June 30, 2012                                                               |  | 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 period | 
|--------------------------------------------------------------------------- |  | ------------------------------------------------------------------ | ----- |  | ------------------------------------------------ | - | ------- | --------------------------------------------- |  | - | ---------------------------- | 
|Recurring fair value measurements                                           |  |                                                                    |       |  |                                                  |   |         |                                               |  |   |                              | 
|Securities available-for-sale                                               |  |                                                                    |       |  |                                                  |   |         |                                               |  |   |                              | 
|U.S. Government agency securities                                           |  |                                                                    | -     |  |                                                  | $ | 69,740  |                                               |  |   | -                            | 
|State and municipal securities                                              |  |                                                                    | -     |  |                                                  |   | 81,592  |                                               |  |   | -                            | 
|U.S. Government agencies and sponsored enterprises (GSEs)
    - residential |  |                                                                    |       |  |                                                  |   | -       |                                              
|Mortgage-backed securities                                                  |  |                                                                    | -     |  |                                                  |   | 117,628 |                                               |  |   | -                            | 
|Collateralized mortgage  obligations
    (CMOs)                             |  |                                                                    | -     |  |                                                  |   | 81,368  |                                               |  |   | -                            | 
|Pooled trust preferred securities                                           |  |                                                                    | -     |  |                                                  |   | -       |                                               |  | $ | 2,015                        | 
|Corporate debt securities                                                   |  |                                                                    | -     |  |                                                  |   | 2,503   |                                               |  |   | -                            | 
|Equity securities                                                           |  | $                                                                  | 3,948 |  |                                                  |   | -       |                                               |  |   | -                            | 
|Total securities available-for-sale                                         |  | $                                                                  | 3,948 |  |                                                  | $ | 352,831 |                                               |  | $ | 2,015                        | 
|Total recurring fair value measurements                                     |  | $                                                                  | 3,948 |  |                                                  | $ | 352,831 |                                               |  | $ | 2,015                        | 
|                                                                            |  |                                                                    |       |  |                                                  |   |         |                                               |  |   |                              | 
|Nonrecurring fair value measurments                                         |  |                                                                    |       |  |                                                  |   |         |                                               |  |   |                              | 
|Impaired loans                                                              |  | $                                                                  | -     |  |                                                  | $ | -       |                                               |  | $ | 2,478                        | 
|Mortgage servicing rights                                                   |  |                                                                    | -     |  |                                                  |   | -       |                                               |  |   | 483                          | 
|Total nonrecurring fair value measurements                                  |  | $                                                                  | -     |  |                                                  | $ | -       |                                               |  | $ | 2,961                        | 





There were no transfers in and out of
Level 1 and Level 2 fair value measurements during the six months ended June 30, 2012. There were also no transfers in or out
of level 3 for the same period. There were no 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 six-month periods ended June 30, 2012 and 2011, respectively.





- 35 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)



The following table sets forth QNB’s financial assets
measured at fair value on a recurring and nonrecurring basis, the fair value measurements by level within the fair value hierarchy
as of December 31, 2011:





|December 31, 2011                                                           |  | 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 period | 
|--------------------------------------------------------------------------- |  | ------------------------------------------------------------------ | ----- |  | ------------------------------------------------ | - | ------- | --------------------------------------------- |  | - | ---------------------------- | 
|Recurring fair value measurements                                           |  |                                                                    |       |  |                                                  |   |         |                                               |  |   |                              | 
|Securities available-for-sale                                               |  |                                                                    |       |  |                                                  |   |         |                                               |  |   |                              | 
|U.S. Government agency securities                                           |  |                                                                    | -     |  |                                                  | $ | 68,493  |                                               |  |   | -                            | 
|State and municipal securities                                              |  |                                                                    | -     |  |                                                  |   | 78,786  |                                               |  |   | -                            | 
|U.S. Government agencies and sponsored enterprises (GSEs)
    - residential |  |                                                                    |       |  |                                                  |   |         |                                              
|Mortgage-backed securities                                                  |  |                                                                    | -     |  |                                                  |   | 113,243 |                                               |  |   | -                            | 
|Collateralized mortgage  obligations
    (CMOs)                             |  |                                                                    | -     |  |                                                  |   | 79,345  |                                               |  |   | -                            | 
|Pooled trust preferred securities                                           |  |                                                                    | -     |  |                                                  |   | -       |                                               |  | $ | 1,929                        | 
|Corporate debt securities                                                   |  |                                                                    | -     |  |                                                  |   | 2,495   |                                               |  |   | -                            | 
|Equity securities                                                           |  | $                                                                  | 3,800 |  |                                                  |   | -       |                                               |  |   | -                            | 
|Total securities available-for-sale                                         |  | $                                                                  | 3,800 |  |                                                  | $ | 342,362 |                                               |  | $ | 1,929                        | 
|Total recurring fair value measurements                                     |  | $                                                                  | 3,800 |  |                                                  | $ | 342,362 |                                               |  | $ | 1,929                        | 
|                                                                            |  |                                                                    |       |  |                                                  |   |         |                                               |  |   |                              | 
|Nonrecurring fair value measurments                                         |  |                                                                    |       |  |                                                  |   |         |                                               |  |   |                              | 
|Impaired loans                                                              |  | $                                                                  | -     |  |                                                  | $ | -       |                                               |  | $ | 7,808                        | 
|Mortgage servicing rights                                                   |  |                                                                    | -     |  |                                                  |   | -       |                                               |  |   | 490                          | 
|Other real estate owned                                                     |  |                                                                    | -     |  |                                                  |   | -       |                                               |  |   | 126                          | 
|Total nonrecurring fair value measurements                                  |  | $                                                                  | -     |  |                                                  | $ | -       |                                               |  | $ | 8,424                        | 



The following table presents additional
quantitative information about assets measured at fair value on a nonrecurring basis and for which QNB has utilized Level 3 inputs
to determine fair value:





|                          |   | Quantitative
    information about Level 3 fair value measurements
|------------------------- | - | ------------------------------------------------------------------
|June 30, 2012             |   | Fair value                                                        
|Impaired loans            | $ | 2,478                                                             
|                          |   |                                                                   
|Mortgage servicing rights |   | 483                                                               
|                          |   |                                                                   



| | (1) | Fair value is
                                                                                primarily determined through appraisals of the
                                                                                underlying collateral by independent parties,
                                                                                which  generally includes various level 3
                                                                                inputs which are not always identifiable.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (2) | Appraisals may
                                                                                be adjusted by management for qualitative factors
                                                                                such as economic conditions and estimated liquidation expenses.
                                                                                The range is presented as a percent of the initial
                                                                                appraised value.
| | --- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------







- 36 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)



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 for the six months ended June 30, 2012:



|                                         |  | Fair value measurements
    using |      
|---------------------------------------- |  | --------------------------------- | -----
|                                         |  | significant unobservable inputs   |      
|                                         |  | (Level 3)                         |      
|Balance, beginning of year               |  | $                                 | 1,929
|Settlements                              |  |                                   | (30  
|Total realized/unrealized gains (losses) |  |                                   |      
|Included in earnings                     |  |                                   | -    
|Included in other comprehensive income   |  |                                   | 116  
|Transfers in and/or out of Level 3       |  |                                   | -    
|Balance, June 30, 2012                   |  | $                                 | 2,015





The Level
3 securities consist of eight collateralized debt obligation securities, PreTSL securities, that are backed by trust preferred
securities issued by banks, thrifts, and insurance companies. The market for these securities atJune 30, 2012is not active and markets for similar securities also are 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,
                                                                                                               2012;
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | · | 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.



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. In addition to the specific bank default assumptions, overall deal
default rates are modeled. In 2013 and beyond, the CDR rate is calculated based upon a comparison of key financial ratios of active
individual issuers without a short-term probability of default compared to all FDIC insured banks. To derive this long-term default
rate, a comparison of certain key financial ratios of the active issuers in the security to all FDIC insured banks is reviewed.
The active issuers are summarized by creating a weighted average based on issue size, then divided into categories based upon
their status of deferral and whether or not a specific default assumption has been assigned to the issuer. To ensure an accurate
comparison, the standard deviation across the issuers for each ratio is calculated and any issuer that falls more than three standard
deviations above or below the average for that ratio is removed.





- 37 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)








9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)



The base loss severity assumption and
long-term loss severity assumptions are modeled at 95%. 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.



Prepayments
are modeled to take into account the disruption in the asset-backed securities marketplace and the lack of new pooled trust preferred
issuances. For purposes of the cash flow analysis, relatively modest rates of prepayment were forecasted (ranging from 0-1%).
In addition to the base prepayment assumption, due to the recent enactment of the Dodd-Frank financial legislation additional
prepayment analysis was performed. First, all fixed rate trust preferred securities issued by banks with more than $15 billion
in total assets at December 31, 2009 were identified. The current credit rating of these institutions was reviewed and
it was assumed that any issuer with an investment grade credit rating would prepay their issuance on January 1, 2013 or July 1,
2015 for bank holding company subsidiaries of foreign banking organizations that have relied on Supervision and Regulation Letter
SR-01-1. For those institutions rated below investment grade the holding companies’ approximate cost of long-term funding
given their rating and marketplace interest rate was estimated. The following assumption was made; any holding company that could
refinance for a cost savings of more than 2% will refinance and will do so on January 1, 2013, or July 1, 2015. Finally, for issuers
not impacted by the Tier 1 regulatory capital legislation enacted by the Dodd-Frank act, the issuers that have shown a recent
history of prepayment of both floating rate and fixed rate issues were identified and it was assumed these issuers will prepay
as soon as possible.



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 1.80% to 9.42%. 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.



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.



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,
2012 and December 31, 2011:



Cash and cash equivalents, accrued
interest receivable and accrued interest payable (carried at cost): The carrying amounts reported in the balance sheet approximate
those assets’ fair value.





- 38 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)



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 (Level1), 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. Level 2 debt securities are valued by a third-party pricing service commonly used
in the banking industry. Level 2 fair value measurements consider observable data that may include dealer quotes, market spreads,
cash flows, the U.S. Treasury yield curve, live trading levels, trade execution date, market consensus prepayment speeds, credit
information and the security’s terms and conditions, among other things. 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.



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. Included in the fair value of impaired loans
at December 31, 2011 are $1,327,000 of loans that had no specific reserves required at year end; however, were partially charged-off
during 2011.



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 stratified
into tranchesbased 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.



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.





- 39 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)



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.







- 40 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)



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





|                                         |  |                 |         |  |            |   |         | Fair
    value measurements                                        | 
|---------------------------------------- |  | --------------- | ------- |  | ---------- | - | ------- | ------------------------------------------------------------------ | 
|June 30, 2012                            |  | Carrying amount |         |  | Fair value |   |         | Quoted prices
    in active markets for identical assets (Level 1) | 
|Financial assets                         |  |                 |         |  |            |   |         |                                                                    | 
|Cash and cash equivalents                |  | $               | 20,263  |  |            | $ | 20,263  |                                                                    | 
|Investment securities available-for-sale |  |                 | 358,794 |  |            |   | 358,794 |                                                                    | 
|Investment securities held-to-maturity   |  |                 | 287     |  |            |   | 312     |                                                                    | 
|Restricted investment in bank stocks     |  |                 | 1,636   |  |            |   | 1,636   |                                                                    | 
|Loans held-for-sale                      |  |                 | 589     |  |            |   | 609     |                                                                    | 
|Net loans                                |  |                 | 481,796 |  |            |   | 483,729 |                                                                    | 
|Mortgage servicing rights                |  |                 | 483     |  |            |   | 532     |                                                                    | 
|Accrued interest receivable              |  |                 | 3,007   |  |            |   | 3,007   |                                                                    | 
|                                         |  |                 |         |  |            |   |         |                                                                    | 
|Financial liabilities                    |  |                 |         |  |            |   |         |                                                                    | 
|Deposits with no stated maturities       |  | $               | 496,010 |  |            | $ | 496,010 |                                                                    | 
|Deposits with stated maturities          |  |                 | 284,997 |  |            |   | 286,337 |                                                                    | 
|Short-term borrowings                    |  |                 | 26,570  |  |            |   | 26,570  |                                                                    | 
|Long-term debt                           |  |                 | 5,293   |  |            |   | 5,719   |                                                                    | 
|Accrued interest payable                 |  |                 | 509     |  |            |   | 509     |                                                                    | 
|                                         |  |                 |         |  |            |   |         |                                                                    | 
|Off-balance sheet instruments            |  |                 |         |  |            |   |         |                                                                    | 
|Commitments to extend credit             |  | $               | -       |  |            | $ | -       |                                                                    | 
|Standby letters of credit                |  |                 | -       |  |            |   | -       |                                                                    | 







- 41 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






9. FAIR VALUE MEASUREMENTS AND DISCLOSURES (continued)



|                                         |  | Carrying |         |  |            |  
|---------------------------------------- |  | -------- | ------- |  | ---------- | -
|December 31, 2011                        |  | amount   |         |  | Fair value |  
|Financial assets                         |  |          |         |  |            |  
|Cash and cash equivalents                |  | $        | 10,555  |  |            | $
|Investment securities available-for-sale |  |          | 348,091 |  |            |  
|Investment securities held-to-maturity   |  |          | 1,327   |  |            |  
|Restricted investment in bank stocks     |  |          | 1,775   |  |            |  
|Loans held-for-sale                      |  |          | 935     |  |            |  
|Net loans                                |  |          | 480,695 |  |            |  
|Mortgage servicing rights                |  |          | 490     |  |            |  
|Accrued interest receivable              |  |          | 2,990   |  |            |  
|                                         |  |          |         |  |            |  
|Financial liabilities                    |  |          |         |  |            |  
|Deposits with no stated maturities       |  | $        | 465,688 |  |            | $
|Deposits with stated maturities          |  |          | 285,024 |  |            |  
|Short-term borrowings                    |  |          | 24,021  |  |            |  
|Long-term debt                           |  |          | 20,299  |  |            |  
|Accrued interest payable                 |  |          | 789     |  |            |  
|                                         |  |          |         |  |            |  
|Off-balance sheet instruments            |  |          |         |  |            |  
|Commitments to extend credit             |  | $        | -       |  |            | $
|Standby letters of credit                |  |          | -       |  |            |  





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, 2012 |         |  | December
    31, 2011 |  
|----------------------------------------------------------- |  | ----------------- | ------- |  | --------------------- | -
|Commitments to extend credit and unused lines
    of credit |  | $                 | 127,033 |  |                       | $
|Standby letters of credit                                   |  |                   | 4,545   |  |                       |  
|                                                            |  | $                 | 131,578 |  |                       | $





- 42 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






10. OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND GUARANTEES
(continued)



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, 2012 and December
31, 2011 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
QNB Corp., unless such loans are collateralized by specific obligations.



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, 2012, 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.





- 43 -


QNB CORP. AND SUBSIDIARYNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)






11. REGULATORY RESTRICTIONS (continued)



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





|                                                   |  | Capital
    Levels |       
|-------------------------------------------------- |  | ------------------ | ------
|                                                   |  | Actual             |       
|As of June 30, 2012                                |  | Amount             |       
|Total Risk-Based Capital (to Risk Weighted Assets) |  |                    |       
|Consolidated                                       |  | $                  | 77,503
|Bank                                               |  |                    | 73,046
|                                                   |  |                    |       
|Tier I Capital (to Risk Weighted Assets)           |  |                    |       
|Consolidated                                       |  |                    | 70,038
|Bank                                               |  |                    | 65,735
|                                                   |  |                    |       
|Tier I Capital (to Average Assets)                 |  |                    |       
|Consolidated                                       |  |                    | 70,038
|Bank                                               |  |                    | 65,735





|                                                   |  | Capital Levels |       
|-------------------------------------------------- |  | -------------- | ------
|                                                   |  | Actual         |       
|As of December 31, 2011                            |  | Amount         |       
|Total Risk-Based Capital (to Risk Weighted Assets) |  |                |       
|Consolidated                                       |  | $              | 73,694
|Bank                                               |  |                | 69,480
|                                                   |  |                |       
|Tier I Capital (to Risk Weighted Assets)           |  |                |       
|Consolidated                                       |  |                | 66,176
|Bank                                               |  |                | 62,256
|                                                   |  |                |       
|Tier I Capital (to Average Assets)                 |  |                |       
|Consolidated                                       |  |                | 66,176
|Bank                                               |  |                | 62,256







- 44 -









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 2011 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.





- 45 -


QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






CRITICAL ACCOUNTING POLICIES AND ESTIMATES



The discussion and analysis of the financial
condition and results of operations are based on the consolidated financial statements of QNB, which are prepared in accordance
with U.S. generally accepted accounting principles (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.



The Company follows accounting guidance
related to the recognition and presentation of other-than-temporary impairment that specifies (a) if a company does not have the
intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security
prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an
entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before
recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in
earnings and the remaining portion in other comprehensive income. 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 is amortized
prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.



There were no credit-related other-than-temporary
impairment charges in the first half of 2012 or 2011.



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. These restricted securities
are carried at cost.



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.



- 46 -


QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






CRITICAL ACCOUNTING POLICIES AND ESTIMATES
(Continued)



Impairment of Restricted Investment
in Bank Stocks (Continued)

On October 28, 2010, the FHLB announced
their decision to institute a limited excess capital stock repurchase. These capital stock repurchases continued on a quarterly
basis during 2011 and the first half of 2012. In addition on February 22, 2012 the FHLB announced its decision to pay an annual
dividend of 0.10%. Further repurchases or excess capital stock or cash dividends will be evaluated quarterly by the FHLB. Management
believes no impairment charge is necessary related to the restricted stock balance as of June 30, 2012.



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.



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.





- 47 -


QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






CRITICAL ACCOUNTING POLICIES AND ESTIMATES (Continued)



Stock-Based Compensation

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



Income Taxes

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



RESULTS OF OPERATIONS
- OVERVIEW



QNB reported net income for the second
quarter of 2012 of $2,505,000, or $0.78 per share on a diluted basis. This compares to net income of $2,435,000, or $0.77 per
share on a diluted basis, for the same period in 2011.



For the six month period ended June 30,
2012, QNB reported net income of $4,976,000, or $1.55 per share on a diluted basis. This represents a 7.1% increase in net income
compared to the $4,646,000, or $1.47 per share on a diluted basis, reported for the six month period ended June 30, 2011.



The results for both the second quarter
and first six months of 2012 represent record profits for QNB and reflect an increase in non-interest income and lower provisions
for loan losses.



Net income expressed as an annualized
rate of return on average assets and average shareholders’ equity was 1.16% and 14.54%, respectively, for the quarter ended
June 30, 2012 compared with 1.18% and 15.62%, respectively, for the quarter ended June 30, 2011. For the six month periods the
annualized rate of return on average assets and average shareholders’ equity was 1.15% and 14.62%, respectively, for the
period ended June 30, 2012 compared with 1.15% and 15.18%, respectively, for the period ended June 30, 2011.



Net Interest Income and Net Interest
Margin

Net interest income for the quarter ended
June 30, 2012 totaled $6,776,000, a decrease of $375,000, or 5.2%, over the same period in 2011. On a linked quarter basis, net
interest income decreased by $30,000, or 0.4%. Average earning assets for the second quarter of 2012 were $841,561,000, an increase
of $42,053,000, or 5.3%, compared with the same period in 2011, with average investment securities increasing $40,195,000, or
13.2%, to $345,391,000. The yield on earning assets declined 59 basis points from 4.87% for the second quarter of 2011 to 4.28%
for the second quarter of 2012 as the prolonged low interest rate environment has continued to exert pressure on asset yields.
When comparing the change in the yield on earning assets between the two quarters, loans and investment securities declined from
5.76% and 3.72%, respectively, for the second quarter of 2011 to 5.29% and 3.03%, respectively, for the second quarter of 2012,
a decline of 47 basis points and 69 basis points, respectively.





- 48 -


QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






RESULTS OF OPERATIONS
– OVERVIEW (Continued)





On the funding side, average deposits
increased $55,598,000, or 7.8%, with average transaction accounts increasing $61,223,000, or 14.5%. The growth in transaction
accounts was broad-based across all product lines and all customer types with the largest increases centered in QNB's Online eSavings
product. Offsetting a portion of this growth in funding was a decline in average time deposits of $5,625,000, or 1.9%, and a reduction
in average borrowed funds of $17,337,000, or 37.0%, comparing the second quarter 2012 with the same period in 2011. During the
second quarter of 2012 the Company paid off $15,000,000 of repurchase agreements with a cost of 4.75%. The cost of interest-bearing
liabilities declined by 27 basis points from 1.17% for the second quarter of 2011 to 0.90% for the second quarter of 2012. The
interest rate paid on interest-bearing deposits declined by 20 basis points to 0.87% for the second quarter of 2012 compared to
the second quarter of 2011.



The net interest margin for the second
quarter of 2012 was 3.49% compared to 3.84% for the second quarter of 2011 and 3.53% for the linked quarter. The historically
low interest rate environment of the past few years combined with the growth in earning assets, primarily in the investment portfolio
which generally earn a lower yield than loans, resulted in a decline in the net interest margin. During the beginning of this
interest rate cycle, funding costs declined at a faster pace and to a greater degree than rates on earning assets resulting in
an increasing net interest margin. However, since the second quarter of 2011 this trend has reversed as funding costs have approached
bottom while yields on earning assets continue to reprice lower resulting in a decline in the net interest margin.



For the six month period ended June 30,
2012 net interest income was $13,582,000, a decrease of $526,000, or 3.7% lower than the $14,108,000 reported for the first half
of 2011. For the six month period ending June 30, 2012 average earning assets increased $49,471,000, or 6.3%, to $838,856,000,
with average investment securities and loans increasing 15.0% and 0.9%, respectively. Average total deposits increased $56,284,000,
or 8.0%, to $762,086,000 for the six-month period ended June 30, 2012 compared to the same period in 2011. The net interest margin
on a tax-equivalent basis was 3.51% for the six-month period ended June 30, 2012 compared with 3.87% for the same period in 2011.





Asset Quality, Provision for Loan Loss
and Allowance for Loan Loss

QNB closely monitors the quality of its
loan portfolio and considers many factors when calculating the required provision for loan losses each quarter. QNB did not record
a provision for loan losses for the second quarter of 2012 as a result of a stabilization in the amount of non-performing loans
over the past several quarters, net recoveries for the quarter ended June 30, 2012 and modest growth in outstanding loan balances.
A provision for loan losses of $450,000 was recorded in the second quarter of 2011.



QNB recorded a provision for loan losses
of $300,000 for the first six months of 2012 and $1,100,000 in the first half of 2011. Net loan recoveries were $12,000 for the
second quarter of 2012, or -0.01% annualized of total average loans, compared with charge-offs of $792,000 for the second quarter
of 2011, or 0.67% annualized of total average loans. For the six month periods ended June 30, 2012 and 2011 net loan charge-offs
were $73,000, or 0.03% annualized, and $1,205,000, or 0.51% annualized, respectively.



QNB's allowance for loan losses of $9,467,000
represents 1.92% of total loans at June 30, 2012 compared to an allowance for loan losses of $9,241,000, or 1.89% of total loans,
at December 31, 2011 and $8,850,000, or 1.86% of total loans, at June 30, 2011.



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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






RESULTS OF OPERATIONS
– OVERVIEW (Continued)





As noted previously, asset quality
has stabilized over the past several quarters with the reduction in non-accrual loans being offset by an increase in
restructured loans. Total non-performing assets were $23,990,000 at June 30, 2012 compared with $24,145,000 at December 31,
2011 and $13,844,000 at June 30, 2011. Included in this classification are non-performing loans, other real estate owned
(OREO) and repossessed assets, and non-accrual pooled trust preferred securities. Total non-performing loans, which represent
loans on non-accrual status, loans past due more than 90 days and still accruing interest and troubled debt restructured
loans were $20,824,000, or 4.23% of total loans, at June 30, 2012 compared with $21,390,000, or 4.36% of total loans, at
December 31, 2011 and $11,882,000, or 2.49% of total loans, at June 30, 2011. The increase in non-performing loans during
2011 was primarily the result of several large commercial loan relationships that showed signs of financial difficulty and
collateral values that were below the carrying value of the loan. These loans were placed on non-accrual status because it is
possible that all principal and interest payments will not be received as expected. Loans on non-accrual status were
$16,264,000 at June 30, 2012 compared with $18,597,000 at December 31, 2011 and $9,455,000 at June 30, 2011. In cases where
there is a collateral shortfall on non-accrual loans, specific impairment reserves have been established based on updated
collateral values even if the borrower continues to pay in accordance with the terms of the agreement. Of the total amount of
non-accrual loans at June 30, 2012, $10,823,000, or more than 66% of the loans classified as non-accrual, are current or past
due less than 30 days as of the end of the quarter.



QNB had other real estate owned and other
repossessed assets of $1,151,000 as of June 30, 2012 compared with $826,000 at December 31, 2011 and $0 at June 30, 2011. Non-accrual
pooled trust preferred securities are carried at fair value which was $2,015,000, $1,929,000, and $1,962,000 at June 30, 2012,
December 31, 2011 and June 30, 2011, respectively. The increase in the balance of non-accrual pooled trust preferred securities
reflects an improvement in the fair value of these securities.





Non-Interest Income

Total non-interest income was $1,326,000
for the second quarter of 2012, an increase of $256,000 compared with the same period in 2011. Net gains on the sale of investment
securities and residential mortgage loans account for $300,000 of this total increase. QNB recorded $141,000 of net gains on the
sale of investment securities during the second quarter of 2012 compared to net gains of $54,000 recognized in the second quarter
of 2011. As a result of historically low mortgage rates, residential mortgage refinancing activity has increased significantly
as has the amount of gains recorded on the sale of these mortgages. QNB recorded gains of $231,000 on the sale of mortgages during
the second quarter of 2012 compared with $18,000 in the second quarter of 2011. Another result of the increase in mortgage refinancing
activity was a reduction in the value of mortgage servicing assets as well as an increase in the amortization of this asset. As
a result mortgage servicing income declined by $40,000 when comparing the two quarters.



Total non-interest income for the six
month periods ended June 30, 2012 and 2011 was $2,892,000 and $2,010,000, respectively. Net gains on the sale of investment securities
was $530,000 for the six month period ended June 30, 2012 compared with $11,000 for the same period in 2011 while net gains on
the sale of residential mortgage loans was $458,000 for the six month period in 2012 compared with $57,000 for the same period
in 2011. Excluding net gains on investment securities and loans for both periods total non-interest income was $1,904,000 for
the six months ended June 30, 2012 and $1,942,000 for the six months ended June 30, 2011, a decrease of $38,000, or 1.9%.





Non-Interest Expense

Total non-interest expense was $4,828,000
for the second quarter of 2012, an increase of $244,000, or 5.3% compared to $4,584,000 for the second quarter of 2011. Salaries
and benefits expense increased $140,000, or 5.8% when comparing the two quarters. Promotion and merit increases coupled with an
additional two full-time equivalent employees, including the addition of a Chief Information and Technology Officer during the
third quarter of 2011, contributed to the $96,000 increase in salary expense. The remainder of the increase in salary and benefits
expense relates primarily to higher medical and dental benefit premiums and claims.



Net occupancy and furniture and fixtures
expense increased $80,000, or 11.6%, with the majority of the increase resulting from higher depreciation expense on new equipment,
an increase in branch rent expense primarily resulting from common area maintenance adjustments on some leased properties and
equipment maintenance costs. Also contributing to the increase in non-interest expense was a $50,000, or 24.3%, increase in marketing
expenses a result of an increase in outdoor and direct mail advertising as well as higher donations costs. Third party information
technology expense increased $43,000 primarily related to ongoing costs associated with the new online and mobile banking system
introduced in the third quarter of 2011. Partially offsetting these higher costs were reductions in FDIC insurance expense of
$114,000, or 41.3%. The decrease in FDIC premium expense reflects a reduction in the rate charged and a change in the method of
calculating the basis of the premium effective during 2011.



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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS








RESULTS OF OPERATIONS – OVERVIEW (Continued)



Total non-interest expense was $9,679,000
for the six-month period ended June 30, 2012 compared to $9,004,000 for the same period in 2011, an increase of $675,000, or 7.5%.
Salaries and benefits expense increased $379,000, or 7.9% to $5,174,000 for the six months ended June 30, 2011 compared to the
same period in 2011 with merit increases, two additional full-time equivalent employees including the Chief Information and Technology
Officer and an increase in medical expense being the primary factors.



Net occupancy expense increased $54,000,
or 7.0%, to $821,000 for the first half of 2012 while furniture and equipment expense increased $80,000, or 12.8%, to $703,000
for the same period. As was the case for the quarter most of the increase in net occupancy expense pertains to an increase in
rent expense resulting from adjustments to common area maintenance cost on some leased properties and scheduled rent increases
on several leased properties. The increase in furniture and equipment expense relates to a $67,000 increase in depreciation and
amortization expense on new equipment and computer software as well as higher equipment maintenance costs of $24,000.



Marketing expense increased $76,000, or
19.9%, to $457,000 for the first six months of 2012 with advertising expense increasing $44,000 and public relations and donations
expense increasing $38,000.



Third party services expense
increased $116,000, or 19.7%, to $704,000 for the six months ended June 30, 2012 when compared to the same period in 2011. As
discussed above most of this increase relates to ongoing costs associated with the new online and mobile banking system
introduced during the third quarter of 2011 and the outsourcing of email services to a third party provider during the second
quarter of 2011.



FDIC insurance premium expense
decreased $196,000, or 36.4%, to $342,000, when comparing the six months ended June 30, 2012 to the same period in 2011. As
noted earlier, the decrease in FDIC insurance expense reflects a reduction in the rate charged and the change in the method
of calculating the basis of the premium effective in 2011.



Other non-interest expense increased $139,000,
or 19.7%, to $845,000 for the first half of 2012 compared to the first six months of 2011. Expenses related to other real estate
owned increased $78,000 when comparing the six month periods while employee training and director’s fees increased $15,000
and $23,000, respectively during these same periods.



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





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






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



|                                         |  | Three Months Ended |        
|---------------------------------------- |  | ------------------ | -------
|                                         |  | June 30, 2012      |        
|                                         |  | Average            |        
|                                         |  | Balance            |        
|Assets                                   |  |                    |        
|Federal funds
    sold                   |  | $                  | -      
|Investment securities:                   |  |                    |        
|U.S. Government agencies                 |  |                    | 66,503 
|State and municipal                      |  |                    | 77,183 
|Mortgage-backed and CMOs                 |  |                    | 191,948
|Other debt securities                    |  |                    | 6,067  
|Equities                                 |  |                    | 3,690  
|Total
    investment securities          |  |                    | 345,391
|Loans:                                   |  |                    |        
|Commercial real estate                   |  |                    | 253,350
|Residential real estate                  |  |                    | 27,443 
|Home equity loans                        |  |                    | 50,735 
|Commercial and industrial                |  |                    | 100,585
|Indirect lease financing                 |  |                    | 11,783 
|Consumer loans                           |  |                    | 2,200  
|Tax-exempt loans                         |  |                    | 34,256 
|Total
    loans, net of unearned income* |  |                    | 480,352
|Other earning assets                     |  |                    | 15,818 
|Total
    earning assets                 |  |                    | 841,561
|Cash and due from banks                  |  |                    | 10,905 
|Allowance for loan losses                |  |                    | (9,608 
|Other assets                             |  |                    | 29,098 
|Total
    assets                         |  | $                  | 871,956
|                                         |  |                    |        
|Liabilities
    and Shareholders' Equity |  |                    |        
|Interest-bearing deposits:               |  |                    |        
|Interest-bearing demand                  |  | $                  | 99,061 
|Municipals                               |  |                    | 55,634 
|Money market                             |  |                    | 73,556 
|Savings                                  |  |                    | 189,545
|Time                                     |  |                    | 182,594
|Time of $100,000
    or more             |  |                    | 102,897
|Total
    interest-bearing deposits      |  |                    | 703,287
|Short-term borrowings                    |  |                    | 21,596 
|Long-term debt                           |  |                    | 7,932  
|Total
    interest-bearing liabilities   |  |                    | 732,815
|Non-interest-bearing deposits            |  |                    | 66,939 
|Other liabilities                        |  |                    | 2,919  
|Shareholders' equity                     |  |                    | 69,283 
|Total liabilities and                    |  |                    |        
|shareholders'
    equity                 |  | $                  | 871,956
|Net interest rate spread                 |  |                    |        
|Margin/net interest
    income           |  |                    |        



|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                                                                                                      



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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS










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





|                                         |  | Six Months Ended |        
|---------------------------------------- |  | ---------------- | -------
|                                         |  | June 30, 2012    |        
|                                         |  | Average          |        
|                                         |  | Balance          |        
|Assets                                   |  |                  |        
|Federal funds
    sold                   |  | $                | -      
|Investment securities:                   |  |                  |        
|U.S. Government agencies                 |  |                  | 66,044 
|State and municipal                      |  |                  | 76,832 
|Mortgage-backed and CMOs                 |  |                  | 190,224
|Other debt securities                    |  |                  | 6,081  
|Equities                                 |  |                  | 3,488  
|Total
    investment securities          |  |                  | 342,669
|Loans:                                   |  |                  |        
|Commercial real estate                   |  |                  | 255,035
|Residential real estate                  |  |                  | 27,298 
|Home equity loans                        |  |                  | 51,286 
|Commercial and industrial                |  |                  | 98,930 
|Indirect lease financing                 |  |                  | 11,969 
|Consumer loans                           |  |                  | 2,254  
|Tax-exempt loans                         |  |                  | 34,546 
|Total
    loans, net of unearned income* |  |                  | 481,318
|Other earning assets                     |  |                  | 14,869 
|Total
    earning assets                 |  |                  | 838,856
|Cash and due from banks                  |  |                  | 10,770 
|Allowance for loan losses                |  |                  | (9,476 
|Other assets                             |  |                  | 28,755 
|Total
    assets                         |  | $                | 868,905
|                                         |  |                  |        
|Liabilities
    and Shareholders' Equity |  |                  |        
|Interest-bearing deposits:               |  |                  |        
|Interest-bearing demand                  |  | $                | 97,445 
|Municipals                               |  |                  | 54,989 
|Money market                             |  |                  | 75,845 
|Savings                                  |  |                  | 183,288
|Time                                     |  |                  | 183,331
|Time of $100,000
    or more             |  |                  | 102,061
|Total
    interest-bearing deposits      |  |                  | 696,959
|Short-term borrowings                    |  |                  | 21,248 
|Long-term debt                           |  |                  | 14,115 
|Total
    interest-bearing liabilities   |  |                  | 732,322
|Non-interest-bearing deposits            |  |                  | 65,127 
|Other liabilities                        |  |                  | 3,020  
|Shareholders' equity                     |  |                  | 68,436 
|Total liabilities and                    |  |                  |        
|shareholders'
    equity                 |  | $                | 868,905
|Net interest rate spread                 |  |                  |        
|Margin/net interest
    income           |  |                  |        



|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                                                                                                      





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION 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 Ended       |  
|------------------------- |  | ---------------------- | ---- | - | ---------------------- | -
|                          |  | June 30, 2012 compared |      |   | June 30, 2012 compared |  
|                          |  | to June 30,
    2011   |      |   | to June 30,
    2011   |  
|                          |  |                        |      |   |                        |  
|                          |  | Total                  |      |   | Due to change in:      |  
|                          |  | Change                 |      |   | Volume                 |  
|Interest income:          |  |                        |      |   |                        |  
|Federal funds sold        |  | $                      | -    |   |                        | $
|Investment securities:    |  |                        |      |   |                        |  
|U.S. Government agencies  |  |                        | (82  | ) |                        |  
|State and municipal       |  |                        | 41   |   |                        |  
|Mortgage-backed and CMOs  |  |                        | (201 | ) |                        |  
|Other debt securities     |  |                        | 15   |   |                        |  
|Equities                  |  |                        | 8    |   |                        |  
|Loans:                    |  |                        |      |   |                        |  
|Commercial real estate    |  |                        | (501 | ) |                        |  
|Residential real estate   |  |                        | 60   |   |                        |  
|Home equity loans         |  |                        | (95  | ) |                        |  
|Commercial and industrial |  |                        | 35   |   |                        |  
|Indirect lease financing  |  |                        | (1   | ) |                        |  
|Consumer loans            |  |                        | (22  | ) |                        |  
|Tax-exempt loans          |  |                        | (8   | ) |                        |  
|Other earning assets      |  |                        | -    |   |                        |  
|Total interest income     |  |                        | (751 | ) |                        |  
|Interest expense:         |  |                        |      |   |                        |  
|Interest-bearing demand   |  |                        | (34  | ) |                        |  
|Municipals                |  |                        | (13  | ) |                        |  
|Money market              |  |                        | (18  | ) |                        |  
|Savings                   |  |                        | 15   |   |                        |  
|Time                      |  |                        | (136 | ) |                        |  
|Time of $100,000 or more  |  |                        | (22  | ) |                        |  
|Short-term borrowings     |  |                        | (32  | ) |                        |  
|Long-term debt            |  |                        | (149 | ) |                        |  
|Total interest expense    |  |                        | (389 | ) |                        |  
|Net interest income       |  | $                      | (362 | ) |                        | $





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION 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, 2012 and 2011.





|                                                   |  | For the Three
    Months |       |  | For the Six Months |  
|-------------------------------------------------- |  | ------------------------ | ----- |  | ------------------ | -
|                                                   |  | Ended June
    30,       |       |  | Ended June
    30, |  
|                                                   |  | 2012                     |       |  | 2011               |  
|Total interest income                              |  | $                        | 8,424 |  |                    | $
|Total interest expense                             |  |                          | 1,648 |  |                    |  
|Net interest income                                |  |                          | 6,776 |  |                    |  
|Tax-equivalent adjustment                          |  |                          | 523   |  |                    |  
|Net interest income (fully
    taxable-equivalent) |  | $                        | 7,299 |  |                    | $



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



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



The net interest rate spread is the difference
between average rates received on earning assets and average rates paid on interest-bearing liabilities, while the net interest
rate margin, which includes interest-free sources of funds, is net interest income expressed as a percentage of average interest-earning
assets. The Investment and Asset/Liability Management Committees work to manage and maximize the net interest margin for the Company.



Quarter to Quarter Comparison



Net interest income decreased $375,000,
or 5.2%, to $6,776,000 for the quarter ended June 30, 2012 as compared to the quarter ended June 30, 2011. On a tax-equivalent
basis, net interest income decreased $362,000, or 4.7%, from $7,661,000 for the three months ended June 30, 2011 to $7,299,000
for the same period ended June 30, 2012.



When comparing the two quarters, strong
growth in deposits and the investment of these deposits into the securities portfolio was offset by a reduction in the net interest
margin resulting in lower net interest income. Average earning assets grew by $42,053,000, or 5.3%, when comparing the second
quarter of 2012 to the same period in 2011, with average investment securities increasing $40,195,000, or 13.2%, and average loans
increasing $3,201,000, or 0.7%. On the funding side, average deposits increased $55,598,000, or 7.8%, with average transaction
accounts increasing $61,223,000, or 14.5%. The growth in transaction accounts was broad based across all product lines and all
customer types with the largest increases centered in QNB's Online eSavings product and the deposits of several local school districts
and municipalities. Offsetting a portion of this growth was a decline in average time deposits of $5,625,000, or 1.9%, when comparing
the second quarter 2012 with the same period in 2011.



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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






NET INTEREST INCOME (continued)



With the growth in earning assets occurring
in the investment portfolio, the mix of earning assets changed which contributed to a decline in the net interest margin, as investment
securities generally earn a lower yield than loans. In addition, while the economy has shown signs of improvement, issues in the
residential and commercial real estate markets persist as do high levels of unemployment. During the third quarter of 2011, the
Federal Reserve Open Market Committee announced that they were likely to leave the Federal funds rate at exceptionally low levels
through mid-2013 (subsequently extended to 2014) and that they would purchase longer-term Treasury securities in an effort to
further reduce longer-term interest rates. These actions combined with events in Europe had the impact of lowering Treasury interest
rates and flattening the yield curve as longer-term rates declined more than short-term rates. Interest rates on Treasury securities
hit historically low levels during the second quarter of 2012. This also resulted in historically low residential mortgage rates.
A low level of interest rates has been in place since 2008 and has resulted in lower yields earned on both loans and investment
securities as well as lower rates paid on deposits and borrowed funds. During the beginning of this interest rate cycle, funding
costs declined at a faster pace and to a greater degree than rates on earning assets resulting in an increasing net interest margin.
However, since the second quarter of 2011 this trend has reversed as funding costs have approached bottom while yields on earning
assets continue to reprice lower resulting in a lower net interest margin.



As a result of these historically low
interest rates, over the past year, a significant amount of higher yielding bonds with call features were called and prepayments
on mortgage-related securities increased, with these proceeds being reinvested in lower yielding investment securities. In addition,
new loans are being originated at significantly lower rates, variable rate loans are repricing lower and many customers with fixed
rates are requesting that their rates be modified lower. The net interest margin for the second quarter of 2012 was 3.49% compared
to 3.84% for the second quarter of 2011 and 3.53% for the first quarter of 2012. Also negatively impacting both the yield on earning
assets and the net interest margin was an increase in nonaccrual loans from $9,455,000 at June 30, 2011 to $16,264,000 at June
30, 2012.



The Rate-Volume Analysis tables, as presented
on a tax-equivalent basis, highlight the impact of changing rates and volumes on interest income and interest expense. Total interest
income on a tax-equivalent basis decreased $751,000, or 7.7%, to $8,947,000 for the second quarter of 2012, while total interest
expense decreased $389,000, or 19.1%, to $1,648,000. Volume growth in earning assets contributed an additional $378,000 of interest
income but was offset by a decline in interest income of $1,129,000 resulting from lower interest rates. With regard to interest
expense, lower funding costs resulted in a decline in interest expense of $309,000. The maturity and payoff of long-term debt
in April 2012 contributed to a decline in interest expense of $149,000 while volume growth in interest-bearing deposits contributed
an additional $80,000 in interest expense when comparing the two quarters.



The yield
on earning assets on a tax-equivalent basis decreased 59 basis points from 4.87% for the second quarter of 2011 to 4.28% for the
second quarter of 2012 and also declined by 13 basis points from the 4.41% reported for the first quarter of 2012.In comparison,
the rate paid on interest-bearing liabilities decreased 27 basis points from 1.17% for the second quarter of 2011 to 0.90% for
the second quarter of 2012 and decreased ten basis points when compared to 1.00% reported in the first quarter of 2012.



Interest
income on investment securities decreased $219,000 when comparing the two quarters as the 13.2% increase in average balances could
not offset the 69 basis point decline in the average yield of the portfolio. The average yield on the investment portfolio was
3.03% for the second quarter of 2012 compared with 3.72% for the second quarter of 2011.As noted previously, 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 actions by the Federal Open Market Committee noted above have
resulted in a further increase in prepay speeds and calls. The reinvestment of these funds was in securities that had lower yields
than what they replaced. The growth in the investment portfolio when comparing the three month periods was primarily in agency
issued mortgage-backed and CMO securities and tax-exempt state and municipal bonds.



Income on Government agency securities
decreased $82,000, as the 5.3% growth in average balances was offset a 60 basis point decline in the yield from 2.18% for the
second quarter of 2011 to 1.58% for the same period in 2012. Most of the bonds in the agency portfolio have call features ranging
from three months to three years, many of which were exercised as a result of the low interest
rate environment. The proceeds from these called bonds as well as liquidity from deposit growth were reinvested in securities
with significantly lower yields.









- 56 -


QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






NET INTEREST INCOME (continued)





Interest income on tax-exempt municipal
securities increased $41,000 with higher balances accounting for $126,000 of additional income. Average balances of tax-exempt
municipal securities increased $8,578,000, or 12.5%, to $77,183,000 for the second quarter of 2012. As a result of credit concerns
in the municipal market arising from issues with the insurance companies that insure the bonds and concerns over the general health
of state and municipal governments because of declining revenues and budget issues resulting from economic conditions, municipal
bond yields declined but not to the same degree as yields on other types of securities. This yield spread advantage has declined
during 2012 as supply and demand issues have reduced the yield on municipal bonds. As a result QNB expanded its purchase of municipal
bonds, primarily general obligation bonds of issuers with strong underlying credit ratings. The yield on the state and municipal
portfolio decreased 44 basis points from 5.88% for the second quarter of 2011 to 5.44% for the second quarter of 2012. This decline
in yield reduced interest income by $85,000 when comparing the two quarters.



Interest income on mortgage-backed securities
and CMOs decreased $201,000 with an increase in average balances offsetting in part the significant impact of lower rates. Average
balances increased $25,886,000, or 15.6%, to $191,948,000 when comparing the two periods and contributed $224,000 in additional
income. The yield on the mortgage-backed and CMO portfolio decreased 89 basis points from 3.47% for the second quarter of 2011
to 2.58% for the second quarter of 2012, resulting in a $425,000 reduction in interest income. This portfolio was expanded because
it provides higher yields relative to agency bonds and also provides monthly cash flow which can be used for liquidity purposes
or can be reinvested when interest rates eventually increase. With the historically low interest rate environment mortgage refinancing
activity over the past two years was significant resulting in an increase in prepayments on these securities. Since most of these
securities were purchased at a premium, prepayments result in a shorter amortization period of this premium and therefore a reduction
in income.



Income on loans decreased $532,000 to
$6,319,000 when comparing the second quarters of 2012 and 2011 with the decline in the portfolio yield being the primary reason.
The yield on the loan portfolio decreased 47 basis points to 5.29% when comparing the same periods,resulting in a reduction in interest income of $533,000. When comparing the two quarters average balances increased 0.7%.
Prior to the third quarter of 2011, QNB was able to minimize the decline in the portfolio yield by implementing interest rate
floors on some variable rate commercial loans and home equity lines of credit and by maintaining its pricing structure. However,
since the third quarter of 2011, as a result of the decline in market rates and an increase in competition for quality loans,
QNB lowered the rates offered on new loans and reduced rates on some existing loans.



The largest category of the loan portfolio
is commercial real estate loans. This category of loans includes commercial purpose loans secured by either commercial properties
such as office buildings, factories, warehouses, medical facilities and retail establishments, or residential real estate, usually
the residence of the business owner. The category also includes construction and land development loans. Income on commercial
real estate loans decreased $501,000 and was impacted by both the decline in yield and a decrease in average balances. The yield
on commercial real estate loans was 5.37% for the second quarter of 2012, a decrease of 58 basis points from the 5.95% reported
for the second quarter of 2011. Average balances decreased $8,629,000, or 3.3%, to $253,350,000, for the three months ended June
30, 2012 compared with the same quarter in 2011.



Income on commercial and industrial loans,
the second largest category, increased $35,000 with the positive impact from the growth in balances being partially offset by
the decline in the yield. Average commercial and industrial loans increased $11,412,000, or 12.8%, to $100,585,000 for the second
quarter of 2012, contributing an additional $143,000 in interest income. The average yield on these loans decreased 43 basis points
to 4.69% resulting in a decrease in income of $108,000. Many of the loans in this category are indexed to the prime interest rate
and have floors. Since the prime rate did not change over the past year the yield on this portfolio did not decline to the same
degree as some other categories.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






NET INTEREST INCOME (continued)



Income on home equity loans declined by
$95,000 when comparing the second quarter of 2012 and 2011. During this same time period average home equity loans decreased $5,139,000,
or 9.2%, to $50,735,000, while the yield on the home equity portfolio decreased 26 basis points to 4.51%. 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.



Given the low yields on alternative investment
securities management decided to retain some 15 year mortgages to borrowers with high credit scores and low loan to value ratios.
As a result, average residential mortgage loans secured by first lien 1-4 family residential mortgages increased by $4,117,000,
or 17.6%, to $27,443,000 for the second quarter of 2012. During this same period the average yield on the portfolio increased
by eight basis points to 5.43% for the second quarter of 2012. The net result was an additional $60,000 in interest income. During
the second quarter of 2012, $33,000 of interest income was recognized on the payoff of a nonaccrual loan. The yield on this portfolio
would have been 4.94% excluding the recognition of this nonaccrual interest compared to 5.35% for the second quarter of 2011.



For the most part, earning assets are
funded by deposits, which increased on average by $55,598,000, or 7.8%, to $770,226,000, when comparing the second quarters of
2012 and 2011. While total income on earning assets on a tax-equivalent basis decreased $751,000
when comparing the second quarter of 2012 to the second quarter of 2011, total interest expense declined $389,000. Interest expense
on total deposits decreased $208,000 while interest expense on borrowed funds decreased $181,000 when comparing the two quarters.
The rate paid on interest-bearing liabilities decreased 27 basis points from 1.17% for the second quarter of 2011 to 0.90% for
the second quarter of 2012. During this same period, the rate paid on interest-bearing deposits decreased 20 basis points from
1.07% to 0.87%.



The growth in deposits when comparing
the second quarter of 2012 with the second quarter of 2011 was not centered in time deposits but in accounts with greater liquidity,
such as interest-bearing demand, interest-bearing municipal accounts, and savings deposits. Average interest-bearing demand accounts
increased $10,665,000, or 12.1%, to $99,061,000 for the second quarter of 2012 compared to the second quarter of 2011; however,
interest expense on interest-bearing demand accounts decreased $34,000 to $78,000 for the second quarter of 2012 as the average
rate paid decreased from 0.51% for the second quarter of 2011 to 0.32% for the second quarter of 2012. The reduction in the cost
of funds reflects the exceptionally low interest rate environment over the past year and the historic lows reached by Treasury
rates. Included in this category is QNB-Rewards checking, a high-rate checking account product. The decrease in interest expense
and the average rate paid on interest-bearing demand accounts is primarily the result of a reduction in the rate paid on QNB-Rewards
checking. The rate paid on this account was 2.05% on balances up to $25,000 and 0.75% for balances over $25,000 for the months
of April and May 2011. In June 2011 these rates were reduced to 1.75% on balances up to $25,000 and 0.50% for balances over $25,000.
This compares to rates of 1.25% on balances up to $25,000 and 0.50% for balances over $25,000 for the second quarter of 2012.
In order to receive the high rate a customer must receive an electronic statement, have one direct deposit or other ACH transaction
and have at least 12 check card purchase transactions post and clear per statement cycle. For the second quarter of 2012, the
average balance in this product was $29,693,000 and the related interest expense was $68,000 for an average yield of 0.93%. In
comparison, the average balance of the QNB-Rewards accounts for the second quarter of 2011 was $27,205,000 with a related interest
expense of $104,000 and an average rate paid of 1.53%. Even with the reduction in the rates paid on the QNB-Rewards product, the
yield of 1.25% for the first $25,000 and 0.50% on balances over $25,000, assuming qualifications are met, is still an attractive
rate relative to competitors’ offerings as well as other QNB products. This product also generates fee income through the
use of the check card. The average balance of other interest-bearing demand accounts included in this category increased from
$61,191,000 for the second quarter of 2011 to $69,368,000 for the second quarter of 2012. The average rate paid on these balances
was 0.05% for both three month periods.



Interest expense on municipal interest-bearing
demand accounts decreased $13,000 to $81,000 for the second quarter of 2012. The decrease in interest expense was the result of
the decline in the rate paid offsetting the increase in average balances. The average balance of municipal interest-bearing demand
accounts increased $7,495,000, or 15.6%, while the average interest rate paid on these accounts decreased from 0.79% for the second
quarter of 2011 to 0.59% for the second quarter of 2012. Most of these accounts are tied directly to the Federal funds rate with
most having rate floors between 0.25% and 0.75%. QNB was successful in increasing their relationships with several of these customers
over the past year, accounting for the increase in balances. It is anticipated that these balances will increase during the third
quarter of 2012 as a result of seasonal tax deposits.



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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS








NET INTEREST INCOME (continued)



Average money market accounts increased
$4,202,000, or 6.1%, to $73,556,000 for the second quarter of 2012 compared with the same period in 2011. When comparing these
same periods interest expense on money market accounts decreased $18,000 to $66,000 and the average interest rate paid declined
12 basis points to 0.36% for the second quarter of 2012. The decline in interest expense and the rate paid is a function of the
overall decline in market rates.



During the second quarter of 2009 QNB
introduced an online 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 $146,462,000 at June 30, 2012. As market rates declined, the eSavings
yield was also reduced and was 0.75% at June 30, 2012. The average yield paid on these accounts was 0.85% for the second quarter
of 2012 compared with a yield of 1.10% for the second quarter of 2011. The average balance of this product was $140,847,000 for
the second quarter of 2012 compared to $100,045,000 for the second quarter of 2011 and contributed to the $36,677,000, or 24.0%,
increase in total average savings accounts when comparing the two quarters. Traditional statement savings accounts, passbook savings
and club accounts are also included in the savings category; however, experienced little change when comparing the second quarter
2012 average to the same 2011 quarter. The average rate paid on total savings accounts decreased 12 basis points from 0.79% for
the second quarter of 2011 to 0.67% for the second quarter of 2012 while interest expense increased 5.0% from $300,000 to $315,000
over the same period.



The repricing of time deposits at lower
rates has had the greatest impact on total interest expense when comparing the two quarters. Total interest expense on time deposits
decreased $158,000, or 13.8%, to $987,000 for the second quarter of 2012. Average total time deposits decreased by $5,625,000,
or 1.9%, to $285,491,000 for the second quarter of 2012. 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 2011 and the first six months of 2012 a significant amount of time deposits have repriced lower as rates have declined.
The average rate paid on time deposits decreased from 1.58% to 1.39% when comparing the second quarter of 2011 to the same period
in 2012.



Approximately $163,487,000, or 57.4%,
of time deposits at June 30, 2012 will reprice or mature over the next 12 months. The average rate paid on these time deposits
is approximately 0.96%. 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 may continue to decline slightly in the near term as higher costing time
deposits are repriced lower. However, given the short-term nature of these deposits interest expense could increase if short-term
time deposit rates were to increase suddenly.



Short-term borrowings are primarily comprised
of sweep accounts structured as repurchase agreements with our commercial customers. Interest expense on short-term borrowings
decreased from $58,000 for the second quarter of 2011 to $26,000 for the second quarter of 2012. When comparing these same periods
average balances decreased from $26,560,000 to $21,596,000 while the average rate paid declined from 0.88% to 0.49%.



Interest expense on long-term debt decreased
from $244,000 for the second quarter of 2011 to $95,000 for the same period in 2012. In April 2012, $15,000,000 of debt at a rate
of 4.75% matured and was repaid. Average long-term debt was $7,932,000 for the second quarter of 2012 compared with $20,305,000
for the second quarter of 2011. The average rate paid for both periods was 4.75%.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS








NET INTEREST INCOME (continued)



SixMonth Comparison



For the six-month period ended June 30,
2012 tax-equivalent net interest income decreased $493,000, or 3.3%. Average earning assets increased $49,471,000, or 6.3%, to
$838,856,000 with average investment securities and loans increasing 15.0% and 0.9%, respectively. Average total deposits increased
$56,284,000, or 8.0%, to $762,086,000 for the six-month period ended June 30, 2012 compared to the same period in 2011. The net
interest margin on a tax-equivalent basis was 3.51% for the six-month period ended June 30, 2012 compared with 3.87% for the same
period in 2011.



Total interest income on a tax-equivalent
basis decreased $1,193,000, from $19,305,000 to $18,112,000, when comparing the six-month periods ended June 30, 2011 and June
30, 2012 as the additional interest income generated from the growth in earning assets was offset by the impact of declining yields
on those assets. Interest income increased $947,000 as a result of volume increases but declined $2,140,000 as a result of lower
yields. The analysis of the six-month comparison periods is similar to what was described in the quarterly analysis; strong deposit
growth combined with minimal loan demand has resulted in significant growth of the investment securities portfolio. These factors
when combined with the historically low interest rate environment and the repricing of earning assets has resulted in a decline
in net interest income and the net interest margin.



Average loans increased $4,392,000 to
$481,318,000 while average investment securities increased $44,769,000 when comparing the six-month periods. The yield on earning
assets decreased from 4.93% to 4.34% for the six-month periods with the yield on loans decreasing from 5.81% to 5.33% during this
time. The yield on investments decreased from 3.73% to 3.11% 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 several 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 $700,000,
from $4,175,000 for the six-month period ended June 30, 2011 to $3,475,000, for the six-month period ended June 30, 2012. Most
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 $494,000 with interest expense on time deposits declining $431,000. The average rate paid
on time deposits decreased 25 basis points to 1.40% from 1.65% when comparing the six-month periods ended June 30, 2012 and 2011.
The average balance of total time deposits declined $9,799,000, or 3.3% to $285,392,000 for the six months ended June 30, 2012
compared with the similar 2011 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 Online
eSavings product. Interest expense on interest-bearing demand deposits decreased $67,000, as the 19 basis point decrease in the
average rate paid more than offset the impact on interest expense of the $9,564,000, or 10.9%, increase in average balances. The
interest rate paid on interest-bearing demand accounts decreased from 0.52% for the first half of 2011 to 0.33% for the first
half of 2011. As discussed previously, a reduction in the rate paid on the QNB-Rewards checking account was the primary factor
for the decrease in cost of funds in this category.



Interest expense on money market accounts
declined by $41,000 to $137,000 for the six month period ended June 30 2012 as the average rate paid declined from 0.50% for the
first half of 2011 to 0.36% for the first half of 2012. The impact of lower rates on interest expense more than offset the impact
of the 6.1% increase in average balances. As noted previously much of the growth in deposits was savings accounts and more specifically
the Online eSavings product. Average savings account balances increased $38,461,000, or 26.6% to $183,288,000 while the average
rate paid decreased from 0.81% to 0.69%. The combination of these elements resulted in a $48,000 increase in interest expense
on savings accounts.







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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






NET
                                                                              INTEREST INCOME (continued)





Also contributing to the reduction in
interest expense when comparing the six-month periods was lower expense related to both short-term and long-term debt. Interest
expense on short-term borrowings declined from $113,000 for the first six months of 2011 to $53,000 for the same period in 2012
as the average rate paid declined from 0.88% for 2011 to 0.50% for 2012 and average balances declined by $4,578,000, or 17.7%.
Interest expense on long-term debt declined by $146,000, primarily the result of the repayment of $15,000,000 in April 2012 as
discussed previously.



PROVISION FOR LOAN LOSSES AND ALLOWANCE
FOR LOAN LOSSES



The provision for loan losses represents
management's determination of the amount necessary to be charged to operations to bring the allowance for loan losses to a level
that represents management’s best estimate of the known and inherent losses in the existing loan portfolio. Management believes
that it uses the best information available to make determinations about the adequacy of the allowance and that it has established
its existing allowance for loan losses in accordance with U.S. 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. Actual loan losses, net of recoveries, serve to reduce the allowance.



Management closely monitors the quality
of its loan portfolio and performs a quarterly analysis of the appropriateness of the allowance for loan losses and the level
of unallocated reserves. This analysis considers a number of relevant factors including: specific impairment reserves, historical
loan loss experience, general economic conditions, levels of and trends in delinquent and non-performing loans, levels of classified
loans, trends in the growth rate of loans and concentrations of credit.



Economic conditions over the past few
years have contributed to high rates of unemployment and a softening of the residential and commercial real estate markets. These
factors have had a negative impact on both consumers and small businesses and have contributed to higher than historical levels
of net charge-offs until the second quarter of 2012 when the Bank actually experienced net recoveries. Increases in specific reserves
and in the amount of non-performing, impaired and classified loans has also been a consequence of the influences noted previously.
These factors when combined with the inherent risk related to the significant growth in the loan portfolio prior to 2011 and continued
concerns related to economic conditions had resulted in elevated levels of the provision for loan losses and the allowance for
loan losses. The second quarter of 2012 actually resulted in net recoveries for the first time in several years and coupled with
other considerations, including only moderate growth in loans and a stabilization in the amount of non-performing loans, resulted
in no required addition to the allowance for loan losses in the quarter. Since December 31, 2008, the start of the financial crisis,
QNB has increased its allowance for loan losses from $3,836,000, or 0.95% of total loans, to $9,467,000, or 1.92% of total loans
at June 30, 2012. Over the past year the allowance for loan losses has increased steadily representing $9,241,000, or 1.89% of
total loans at December 31, 2011, and $8,850,000, or 1.86% of total loans at June 30, 2011. The allowance for loan losses at June
30, 2012 is at a level that QNB management believes is adequate as of that date based on its analysis of known and inherent losses
in the portfolio.



QNB did not record a provision for loan
losses for the second quarter of 2012 as a result of a stabilization in the amount of non-performing loans over the past several
quarters, net recoveries for the quarter ended June 30, 2012 and modest growth in outstanding loan balances. A provision for loan
losses of $450,000 was recorded in the second quarter of 2011. QNB recorded a provision for loan losses of $300,000 for the first
six months of 2012 and $1,100,000 in the first half of 2011. Net loan recoveries were $12,000 for the second quarter of 2012,
or -0.01% annualized of total average loans, compared with charge-offs of $792,000 for the second quarter of 2011, or 0.67% annualized
of total average loans. For the six month periods ended June 30, 2012 and 2011 net loan charge-offs were $73,000, or 0.03% annualized,
and $1,205,000, or 0.51% annualized, respectively.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






PROVISION FOR LOAN LOSSES AND ALLOWANCE
FOR LOAN LOSSES (continued)



The level of non-performing loans peaked
at September 30, 2011 at $21,956,000 and has stabilized over the past three quarters as referenced in the following table. At
June 30, 2012, non-performing loans totaled $20,824,000, as compared to $21,390,000 at December 31, 2011 and $11,882,000 at June
30, 2011. Non-performing loans have risen from 2.49% of total loans at June 30, 2011 to 4.23% at June 30, 2012. The largest increase
in non-performing loans from June 30, 2011 took place between the second and third quarter of 2011. It was primarily the result
of several large commercial loan relationships that had signs of financial difficulty and collateral values that were below the
carrying value of the loan. These loans were placed on non-accrual status because it is possible that all principal and interest
payments will not be received as expected. Loans on non-accrual status were $16,264,000 at June 30, 2012 compared with $18,597,000
at December 31, 2011 and $9,455,000 at June 30, 2011. In cases where there is a collateral shortfall on non-accrual loans, specific
impairment reserves have been established based on the updated collateral values even if the borrower continues to pay in accordance
with the terms of the agreement. Of the total amount of non-accrual loans at June 30, 2012, $10,823,000, or more than 66%, were
current or past due less than 30 days at quarter end.



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, 2012, December 31, 2011 and June 30, 2011 represent
0.66%, 0.58% and 0.59% of total loans, respectively.



A loan is considered impaired, based on
current information and events, if it is probable that QNB will be unable to collect the scheduled payments of principal or interest
when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment
include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.
Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management
determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration all the circumstances
surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment
record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan
basis for commercial loans and indirect lease financing loans by either the present value of expected future cash flows discounted
at the loan’s effective interest rate or the fair value of the collateral, if the loan is collateral dependent. At June
30, 2012 and December 31, 2011, the recorded investment in loans for which impairment has been identified totaled $33,932,000
and $30,368,000 of which $28,914,000 and $21,822,000, respectively, required no specific allowance for loan loss. The recorded
investment in impaired loans requiring an allowance for loan losses was $5,018,000 and $8,546,000 at June 30, 2012 and December
31, 2011, respectively. At June 30, 2012 and December 31, 2011, the related allowance for loan losses associated with these loans
was $2,540,000 and $2,065,000, respectively. Most of the loans that have been identified as impaired are collateral-dependent.
See Note 8 to the Notes to Consolidated Financial Statements for additional detail of impaired loans.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






PROVISION FOR LOAN LOSSES AND ALLOWANCE
FOR LOAN LOSSES (continued)



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





|                                                           |  | June 30, |         |   | December 31, |   |         | June 30, | 
|---------------------------------------------------------- |  | -------- | ------- | - | ------------ | - | ------- | -------- | 
|                                                           |  | 2012     |         |   | 2011         |   |         | 2011     | 
|Non-accrual loans                                          |  | $        | 16,264  |   |              | $ | 18,597  |          | 
|Loans past due 90 days or more and still accruing interest |  |          | 475     |   |              |   | 380     |          | 
|Restructured loans (not included above)                    |  |          | 4,085   |   |              |   | 2,413   |          | 
|Total non-performing loans                                 |  |          | 20,824  |   |              |   | 21,390  |          | 
|Other real estate owned and repossessed assets             |  |          | 1,151   |   |              |   | 826     |          | 
|Non-accrual investment securities                          |  |          | 2,015   |   |              |   | 1,929   |          | 
|Total non-performing
    assets                            |  | $        | 23,990  |   |              | $ | 24,145  |          | 
|                                                           |  |          |         |   |              |   |         |          | 
|Total loans (excluding loans held-for-sale):               |  |          |         |   |              |   |         |          | 
|Average total loans (YTD)                                  |  | $        | 480,455 |   |              | $ | 476,612 |          | 
|Total loans, net of unearned fees and costs                |  |          | 491,263 |   |              |   | 489,936 |          | 
|                                                           |  |          |         |   |              |   |         |          | 
|Allowance for loan losses                                  |  |          | 9,467   |   |              |   | 9,241   |          | 
|                                                           |  |          |         |   |              |   |         |          | 
|Allowance for loan losses to:                              |  |          |         |   |              |   |         |          | 
|Non-performing loans                                       |  |          | 45.47   | % |              |   | 43.20   | %        | 
|Total loans, net of unearned fees and costs                |  |          | 1.92    | % |              |   | 1.89    | %        | 
|Average total loans (YTD)                                  |  |          | 1.97    | % |              |   | 1.94    | %        | 
|                                                           |  |          |         |   |              |   |         |          | 
|Non-performing loans to total loans                        |  |          | 4.23    | % |              |   | 4.36    | %        | 
|Non-performing assets to total assets                      |  |          | 2.70    | % |              |   | 2.78    | %        | 





An analysis of loan charge-offs for the
three and six months ended June 30, 2012 compared to 2011 is as follows:





|                                                |  | For the Three
    Months |       |   | For the Six Months |  
|----------------------------------------------- |  | ------------------------ | ----- | - | ------------------ | -
|                                                |  | Ended June
    30,       |       |   | Ended June
    30, |  
|                                                |  | 2012                     |       |   | 2011               |  
|Net charge-offs (recoveries)                    |  | $                        | (12   | ) |                    | $
|                                                |  |                          |       |   |                    |  
|Annualized net charge-offs (recoveries) to:     |  |                          |       |   |                    |  
|Total loans, net of unearned fees and
    costs |  |                          | -0.01 | % |                    |  
|Average total loans (YTD)                       |  |                          | -0.01 | % |                    |  
|Allowance
    for loan losses                   |  |                          | -0.50 | % |                    |  





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






NON-INTEREST INCOME



|Non-Interest
    Income Comparison           |  |                    |       |  |             |   |       |                  |  |   |             |   |  |      |        |   |      |   |       |        | 
|-------------------------------------------- |  | ------------------ | ----- |  | ----------- | - | ----- | ---------------- |  | - | ----------- | - |  | ---- | ------ | - | ---- | - | ----- | ------ | 
|                                             |  | Three Months Ended |       |  | Change from |   |       | Six Months Ended |  |   | Change from |  
|                                             |  | June 30,           |       |  | Prior Year  |   |       | June 30,         |  |   | Prior Year  |  
|                                             |  | 2012               |       |  | 2011        |   |       | Amount           |  |   | Percent     |   |  | 2012 |        |   | 2011 |   |       | Amount | 
|Fees for services to customers               |  | $                  | 345   |  |             | $ | 347   |                  |  | $ | (2          | ) |  |      | -0.6   | % |      | $ | 684   |        | 
|ATM and debit card                           |  |                    | 367   |  |             |   | 366   |                  |  |   | 1           |   |  |      | 0.3    | % |      |   | 731   |        | 
|Bank-owned life insurance                    |  |                    | 78    |  |             |   | 80    |                  |  |   | (2          | ) |  |      | -2.5   | % |      |   | 156   |        | 
|Merchant income                              |  |                    | 101   |  |             |   | 82    |                  |  |   | 19          |   |  |      | 23.2   | % |      |   | 186   |        | 
|Net gain (loss) on investment     securities |  |                    | 141   |  |             |   | 54    |                  |  |   | 87          |   |  |      | 161.1  | % |      |   | 530   |        | 
|Net gain on sale of loans                    |  |                    | 231   |  |             |   | 18    |                  |  |   | 213         |   |  |      | 1183.3 | % |      |   | 458   |        | 
|Other                                        |  |                    | 63    |  |             |   | 123   |                  |  |   | (60         | ) |  |      | -48.8  | % |      |   | 147   |        | 
|Total                                        |  | $                  | 1,326 |  |             | $ | 1,070 |                  |  | $ | 256         |   |  |      | 23.9   | % |      | $ | 2,892 |        | 





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



Quarter to Quarter Comparison



Total non-interest income for the second
quarter of 2012 was $1,326,000, an increase of $256,000, compared to $1,070,000 for the second quarter of 2011.



Fees for services to customers were $345,000
for the second quarter of 2012, a $2,000, or 0.6%, decrease from the same period in 2011. Overdraft income, representing approximately
65% of total fees for services to customers during the second quarter of 2012, declined by $14,000. The decline in overdraft income
was partially offset by increase in service charges on checking accounts, transfer fees to protect against overdrafts, internet
banking fees and other miscellaneous fees.



Merchant income represents fees
charged to merchants for the bank’s handling of credit card or charge sales. Merchant income was $101,000 for the
second quarter of 2012, an increase of $19,000, or 23.2%, from the amount reported in the same period in 2011. The increase
in merchant income is primarily a result of an increase in the number of merchant’s using QNB services.



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, including monitoring credit
and concentration risk in the portfolio.



Net investment securities gains were $141,000
for the quarter ended June 30, 2012 compared with net gains of $54,000 for the comparable quarter in 2011. During the second quarter
of 2012 the Company sold approximately $9.3 million of mortgage backed securities and CMO’s that were purchased at a premium
and because of the decline in interest rates were seeing significant prepayments which were resulting in very low yields. The
gain recognized on the sale of these securities was $101,000. Also included in the second quarter of 2012 securities gains were
$40,000 recorded on the sale of equity securities. In the second quarter of 2011, QNB sold several CMO’s at a net gain of
$40,000 and equity securities at a gain of $14,000. There were no credit-related OTTI charges during the second quarter of 2012
or 2011.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






NON-INTEREST INCOME (Continued)



The net gain on residential mortgage sales
is directly related to the volume of mortgages sold and the timing of the sales relative to the interest rate environment. Residential
mortgage loans to be sold are identified at origination. The net gain on the sale of residential mortgage loans was $231,000 and
$18,000 for the quarters ended June 30, 2012 and 2011, respectively. This $213,000 increase in the net gain on sale of loans was
a result of an increase in the amount of residential mortgage refinancing activity and the amount of gains recorded on the sale
of these mortgages. Contributing to the increase in the gain per loan was the interest rate environment at the time of sale. In
2012, interest rates were declining during most of the first six months of the year resulting in larger gains being recorded per
sale. Proceeds from the sale of residential mortgages were $6,451,000 and $370,000 for the second quarters of 2012 and 2011, respectively.



The $60,000 decrease in other non-interest
income when comparing the two quarters is primarily the result of a decrease in mortgage servicing income and letter of credit
fees. Mortgage servicing income declined $40,000 when comparing the three months ended June 30, 2012 with the same period in 2011.
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. During the second
quarter of 2012, a $21,000 impairment charge was recorded. The timing of mortgage payments and delinquencies also impacts the
amount of servicing fees recorded. As a result of the significant decline in mortgage interest rates and the resulting increase
in refinancing activity, prepayment speeds increased. This had the impact of reducing the income on mortgage servicing as the
related servicing asset must be written off when a loan is paid in full. Letter of credit fees declined by $10,000 when comparing
the second quarter of 2012 to the same quarter in 2011. The reduction is primarily related to a large letter of credit to a commercial
customer that expired during the fourth quarter of 2011.



Six-Month Comparison



Total non-interest income for the six
month periods ended June 30, 2012 and 2011 was $2,892,000 and $2,010,000, respectively. Excluding net gains on investment securities
and loans for both periods total non-interest income was $1,904,000 and $1,942,000, a decrease of $38,000, or 1.9%.



Fees for services to customers increased
$10,000, or 1.5%, to $684,000 for the six-month period ended June 30, 2012. An increase in checking account activity fees, transfer
fees to protect against overdrafts, internet banking fees and other miscellaneous fees offset a $19,000 decline in overdraft income
when comparing the six-month periods.



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 $731,000 for the first half of 2012, an increase of $37,000, or 5.3%, from
the amount recorded during the first half of 2011. Debit card income increased $21,000, or 4.6%, to $474,000, while ATM interchange
income increased $18,000, or 8.9%, to $221,000. The increase in debit and ATM card income was a result of the continuing increased
reliance on the card as a means of paying for goods and services by both consumers and business cardholders. The higher rate of
increase in ATM PIN-based transactions is a function of some merchants recommending lower-costing PIN based transactions over
higher costing signature debit transactions as well as an increase in the amount QNB receives per transaction. Helping to contribute
to the growth is the QNB Rewards checking product, a high-yield checking account which requires, among other terms, the posting
of a minimum of twelve debit card purchase transactions per statement cycle to receive the high interest rate. The passage of
the Dodd-Frank Act could have negative implications on the amount of interchange income earned by QNB in the future. The impact
at this time is unknown.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






NON-INTEREST INCOME (Continued)



Income on bank-owned life insurance (BOLI)
represents the earnings and death benefits on life insurance policies in which the Bank is the beneficiary. Income on BOLI was
$156,000 and $190,000 for the first six months of 2012 and 2011, respectively. Included in total BOLI income for 2011 was the
recognition of a death benefit payment of $31,000 received during the first quarter on a life insurance policy in which the Bank
was the beneficiary. The insurance carriers reset the rates on these policies annually taking into consideration the interest
rate environment as well as mortality costs. The existing policies have rate floors which minimize how low the earnings rate can
go. Some of these policies are currently at their floor.



Merchant income was $186,000 for the first
six months of 2012, an increase of $42,000, or 29.2%, from the amount reported in the same period in 2011. As noted above, the
increase in merchant income is primarily a result of an increase in the number of merchant’s using QNB services.



Net gains on investment securities were
$530,000 for the first six months of 2012 compared with gains of $11,000 in 2011. Included in the 2012 securities gains were $427,000
of gains recorded on the sale of equity securities. With the outstanding performance of the U.S. equity markets in the first quarter
of 2012, QNB elected to sell some equity holdings and recognize gains. The other gains during 2012 relate to gains on the sale
of fixed income securities as discussed in the quarterly analysis above.



The net gain on the sale of residential
mortgage loans was $458,000 and $57,000 for the six months ended June 30, 2012 and 2011, respectively. As noted previously, as
a result of historically low mortgage rates, residential mortgage refinancing activity has increased significantly as has the
amount of gains recorded on the sale of these mortgages. Proceeds from the sale of residential mortgages were $11,942,000 and
$3,081,000 for the first half of 2012 and 2011, respectively.



Other non-interest income was $147,000
for the first six months of 2012, a decrease of $93,000 from the amount recorded in 2011. Similar to the quarter, a $53,000 decrease
in mortgage servicing income and a $23,000 decrease in letter of credit fees account for the majority of the difference.



NON-INTEREST EXPENSE



|Non-Interest
    Expense Comparison |  |                    |       |  |             |   |       |                  |  |   |             |   |  |      |       |   |      |   |       |        | 
|----------------------------------- |  | ------------------ | ----- |  | ----------- | - | ----- | ---------------- |  | - | ----------- | - |  | ---- | ----- | - | ---- | - | ----- | ------ | 
|                                    |  | Three Months Ended |       |  | Change from |   |       | Six Months Ended |  |   | Change from |  
|                                    |  | June 30,           |       |  | Prior Year  |   |       | June 30,         |  |   | Prior Year  |  
|                                    |  | 2012               |       |  | 2011        |   |       | Amount           |  |   | Percent     |   |  | 2012 |       |   | 2011 |   |       | Amount | 
|Salaries and employee benefits      |  | $                  | 2,548 |  |             | $ | 2,408 |                  |  | $ | 140         |   |  |      | 5.8   | % |      | $ | 5,174 |        | 
|Net occupancy                       |  |                    | 397   |  |             |   | 370   |                  |  |   | 27          |   |  |      | 7.3   | % |      |   | 821   |        | 
|Furniture and equipment             |  |                    | 373   |  |             |   | 320   |                  |  |   | 53          |   |  |      | 16.6  | % |      |   | 703   |        | 
|Marketing                           |  |                    | 256   |  |             |   | 206   |                  |  |   | 50          |   |  |      | 24.3  | % |      |   | 457   |        | 
|Third-party services                |  |                    | 365   |  |             |   | 340   |                  |  |   | 25          |   |  |      | 7.4   | % |      |   | 704   |        | 
|Telephone, postage and supplies     |  |                    | 156   |  |             |   | 158   |                  |  |   | (2          | ) |  |      | -1.3  | % |      |   | 306   |        | 
|State taxes                         |  |                    | 167   |  |             |   | 150   |                  |  |   | 17          |   |  |      | 11.3  | % |      |   | 327   |        | 
|FDIC insurance premiums             |  |                    | 162   |  |             |   | 276   |                  |  |   | (114        | ) |  |      | -41.3 | % |      |   | 342   |        | 
|Other                               |  |                    | 404   |  |             |   | 356   |                  |  |   | 48          |   |  |      | 13.5  | % |      |   | 845   |        | 
|Total                               |  | $                  | 4,828 |  |             | $ | 4,584 |                  |  | $ | 244         |   |  |      | 5.3   | % |      | $ | 9,679 |        | 





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS








NON-INTEREST EXPENSE (continued)



Quarter to Quarter Comparison



Non-interest expense is comprised of costs
related to salaries and employee benefits, net occupancy, furniture and equipment, marketing, third party services, FDIC insurance
premiums, regulatory assessments and taxes and various other operating expenses. Total non-interest expense was $4,828,000 for
the second quarter of 2012, an increase of $244,000, or 5.3%, compared to the second quarter of 2011. QNB’s overhead efficiency
ratio, which represents the percentage of each dollar of revenue that is used for non-interest expense, is calculated by taking
non-interest expense divided by net operating revenue on a tax-equivalent basis. QNB’s efficiency ratios were 56.0% and
52.5% for the three months ended June 30, 2012 and 2011, respectively, and compare favorably with Pennsylvania commercial banks
with assets between $500 million and $1 billion which had an average efficiency ratio of 66.9% for the first quarter of 2012,
the most recent period available.



Salaries and benefits is the largest component
of non-interest expense. QNB monitors, through the use of various surveys, the competitive salary and benefit information in its
markets and makes adjustments when appropriate. Salaries and benefits expense for the second quarter of 2012 was $2,548,000, an
increase of $140,000, or 5.8%, over the $2,408,000 reported in the second quarter of 2011. Salary expense increased $96,000, or
5.0%, during the period to $2,021,000. A two person increase in the number of full-time equivalent employees, including the addition
of a Chief Information & Technology Officer during the third quarter of 2011, along with promotion and merit increases contributed
to the increase in salary expense. Comparing the two quarters, benefits expense increased $44,000, or 9.1%, to $527,000. Medical
related expenses increased $61,000 when comparing the two periods. In 2012, QNB switched from a premium based indemnity plan to
a self-funded plan offered through the Pennsylvania Banker’s Association. Claims during 2012 have been higher than what
was experienced in 2011. Included in second quarter 2011 benefits expense was the payment of $28,000 in relocation costs for the
Chief Operating Officer.



Net occupancy expense increased $27,000,
or 7.3%, to $397,000 for the second quarter of 2012 while furniture and equipment expense increased $53,000, or 16.6%, to $373,000
for the same period. Rent expense increased $14,000 which relates principally to higher ongoing common area maintenance costs
on some leased properties and scheduled increases in rent at several leased locations. Also contributing to the increase in net
occupancy expense was a $9,000, or 18.0%, increase in building repairs and maintenance costs. The increase in furniture and equipment
expense relates primarily to a $48,000 increase in depreciation and amortization expense on new equipment and computer software.



Marketing expense increased $50,000, or
24.3%, to $256,000 for the quarter ended June 30, 2012. Advertising expense increased $43,000 primarily a result of increased
use of outdoor and direct mail advertising.



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 $25,000, or
7.4%, to $365,000 for the three months ended June 30, 2012 when compared to the same period in 2011. The largest portion of the
increase related to third party IT services for ongoing costs associated with the new online and mobile banking system introduced
in the third quarter of 2011. Partially offsetting this increase was a reduction in consulting expenses. During the second quarter
of 2011 an executive search firm was used to hire a Chief Information and Technology Officer.



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 $167,000 for the second quarter of 2012, an increase of $17,000 compared to the same
period in 2011. The Bank’s Pennsylvania Shares Tax was $158,000 for the second quarter of 2012, an increase of $10,000 resulting
from an increase in the Bank’s equity. The Company’s capital stock tax increased $7,000 when comparing the two quarters.



FDIC insurance premium expense decreased
$114,000, or 41.3%, to $162,000, when comparing the second quarter of 2012 to 2011. The decrease in FDIC insurance expense reflects
a reduction in the rate charged and the change in the method of calculating the basis of the premium effective in 2011.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






NON-INTEREST EXPENSE (continued)



Other non-interest expense increased $48,000,
or 13.5%, to $404,000 for the second quarter of 2012. The majority of the increase relates to expenses associated with other real
estate owned including taxes, insurance and maintenance costs related to the properties held by the Bank., employee training and
director’s fees.



Six-Month Comparison



Total non-interest expense was $9,679,000
for the six-month period ended June 30, 2012 compared to $9,004,000 for the same period in 2011, an increase of $675,000, or 7.5%.



Salaries and benefits expense increased
$379,000, or 7.9%, to $5,174,000 for the six months ended June 30, 2012 compared to the same period in 2011. Salary expense increased
$271,000, or 7.2%, during the period to $4,056,000. Similar to the quarter, a four person increase in full-time equivalent employees,
including the hiring of a Chief Information and Technology Officer, as well as normal merit increases contributed to the increase
in salary expense. Comparing the six month periods, benefits expense increased $108,000, or 10.7%, to $1,118,000. Of this increase
in benefits expense medical related benefits contributed $89,000 as discussed in the quarterly review. Payroll related tax expense
increased $28,000 and retirement plan expense increased $26,000, when comparing the six-month periods, both a function of higher
salary expense. Included in 2011 benefits expense was $32,000 in relocation costs for the Chief Operating Officer.



Net occupancy expense increased $54,000,
or 7.0%, to $821,000 for the first half of 2012 while furniture and equipment expense increased $80,000, or 12.8%, to $703,000
for the same period. As was the case for the quarter most of the increase in net occupancy expense pertains to an increase in
rent expense resulting from adjustments to common area maintenance costs on some leased properties and scheduled rent increases
on several leased properties. The increase in furniture and equipment expense relates to a $67,000 increase in depreciation and
amortization expense on new equipment and computer software as well as higher equipment maintenance costs of $24,000.



Marketing expense increased $76,000, or
19.9% to $457,000 for the first six months of 2012. As was the case for the quarter, advertising expense increased $44,000 while
public relations and donations expense increased $38,000. QNB contributes to many not-for-profit organizations and clubs and sponsors
many local events in the communities it serves.



Third party services expense increased
$116,000, or 19.7%, to $704,000 for the six months ended June 30, 2012 when compared to the same period in 2011. As discussed
above most of this increase relates to ongoing costs associated with the

new online and mobile banking system introduced
during the third quarter of 2011 and the outsourcing of email services to a third party provider during the second quarter of
2011.



State tax expense was $327,000 for the
first half of 2012, an increase of $27,000 compared to the same period in 2011. The Bank’s Pennsylvania Shares Tax was $317,000
for the first six months of 2012, an increase of $21,000 resulting from an increase in the Bank’s equity. The Company’s
capital stock tax increased $6,000 when comparing the same periods.



FDIC insurance premium expense decreased
$196,000, or 36.4%, to $342,000, when comparing the six months ended

June 30, 2012 to the same period in 2011.
As noted earlier, the decrease in FDIC insurance expense reflects a reduction in the rate charged and the change in the method
of calculating the basis of the premium effective in 2011.



Other non-interest expense increased $139,000,
or 19.7%, to $845,000 for the first half of 2012 compared to the first six months of 2011. Expenses related to other real estate
owned increased $78,000 when comparing the six month periods while employee training and director’s fees increased $15,000
and $23,000, respectively, during these same periods.



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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS








INCOME TAXES



QNB utilizes an asset and liability approach
for financial accounting and reporting of income taxes. As of June 30, 2012, QNB’s net deferred tax asset was $1,220,000.
The primary components of deferred taxes are a deferred tax asset of $3,219,000 relating to the allowance for loan losses, a deferred
tax asset of $121,000 generated by OTTI charges on equity securities and a deferred tax asset of $435,000 related to OTTI charges
on trust preferred securities. Partially offsetting these deferred tax assets was a deferred tax liability of $2,391,000 resulting
from unrealized gains on available-for-sale securities. As of June 30, 2011, QNB’s net deferred tax asset was $1,668,000.
The primary components of deferred taxes at June 30, 2011 are a deferred tax asset of $3,009,000 relating to the allowance for
loan losses, a deferred tax asset of $188,000 generated by OTTI charges on equity securities and a deferred tax asset of $435,000
related to OTTI charges on trust preferred securities. Partially offsetting these deferred tax assets was a deferred tax liability
of $1,603,000 resulting from unrealized gains on available-for-sale securities.



The realizability of deferred tax assets
is dependent upon a variety of factors, including the generation of future taxable income, the existence of taxes paid and recoverable,
the reversal of deferred tax liabilities and tax planning strategies. 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 $769,000, or 23.5%, for the three-month period ended June 30, 2012, and $752,000, or 23.6%, for the same period
in 2011. For the six-month periods ended June 30, 2012 and 2011 applicable income taxes and the effective tax rates were $1,519,000,
or 23.4% and $1,368,000, or 22.7%, respectively.



FINANCIAL CONDITION ANALYSIS



The following balance sheet analysis compares
average balance sheet data for the six months ended June 30, 2012 and 2011, as well as the period ended balances as of June 30,
2012 and December 31, 2011.



Average earning assets for the six-month
period ended June 30, 2012 increased $49,471,000, or 6.3%, to $838,856,000 from $789,385,000 for the six months ended June 30,
2011. The mix of earning assets has changed somewhat when comparing the two periods. Average loans increased $4,392,000, or 0.9%,
while average investment securities increased $44,769,000, or 15.0%. Average loans represented 57.4% of earning assets for the
first six months of 2012, while average investment securities represented 40.9% of earning assets for the same period. This compares
to 60.4% and 37.7%, respectively, for the first six months of 2011. Given the lack of loan demand and the relatively low yield
of 0.25% on interest-bearing deposits at the Federal Reserve Bank, the decision was made to try and stay as fully invested as
possible, while still retaining adequate liquidity.



QNB’s primary business is accepting
deposits and making loans to meet the credit needs of the communities it serves. Loans are the most significant component of earning
assets and growth in loans to small businesses and residents of these communities has been a primary focus of QNB. Inherent within
the lending function is the evaluation and acceptance of credit risk and interest rate risk. QNB manages credit risk associated
with its lending activities through portfolio diversification, underwriting policies and procedures and loan monitoring practices.
Total loans increased 3.3% between June 30, 2011 and June 30, 2012 but only 0.3% since December 31, 2011. Loan growth which had
been strong for 2009 and most of 2010, slowed significantly beginning in the fourth quarter of 2010. As a result of economic conditions
both in the United States and in Europe, as well as political and tax uncertainty in Washington D.C. businesses appear to be holding
off investing in new equipment or any other type of financing and are paying down their lines with excess cash. Despite the lack
of demand QNB is committed to make credit available to its customers.



Average total commercial loans increased
$7,339,000 when comparing the first six months of 2012 to the first six months of 2011. Most of the 1.9% growth in average commercial
loans was in commercial and industrial loans, which increased $11,451,000, or 13.1%, to $98,930,000. 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 loans secured by real estate, either commercial or residential properties decreased
$7,101,000, or 2.7%, when comparing the average balances for the six month periods while average tax-exempt loans to state and
municipal organizations increased $2,989,000, or 9.5%, over the same time period.



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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS








FINANCIAL CONDITION ANALYSIS (continued)



Average residential real estate loans
increased $3,936,000, or 16.8%, to $27,298,000 for the first six months of 2012 as historically low interest rates have resulted
in an increase in residential mortgage activity. Of this increase $1,579,000 represents adjustable rate loans while the remainder
of the growth is in fixed rate loans primarily loans with a 15 year maturity, low loan-to-values and excellent credit. QNB sells
most of its fixed rate originations to Freddie Mac.



Average home equity loans continue to
decline with average balances decreasing from $56,385,000 for the first half of 2011 to $51,286,000 for the first six months of
2012. 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 the prime rate.



Total investment securities were $359,081,000
at June 30, 2012 and $349,418,000 at December 31, 2011. Despite the level of activity during the first six months of the year
the composition of the portfolio is little changed since December 31, 2011.



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 investment portfolios. QNB
does not own any non-agency mortgage security or CDO 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 or bank holding companies, 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 $3,609,000 and a fair value of
$2,015,000 at June 30, 2012. There was no credit-related other-than-temporary impairment charge in the first half of 2012 or 2011.
It is possible that future calculations could require recording additional other-than-temporary impairment charges through earnings.
For additional detail on these securities see Note 7 Investment Securities and Note 9 Fair Value Measurements and Disclosures.



For the most part, earning assets are
funded by deposits. Total average deposits increased $56,284,000, or 8.0%, to $762,086,000 for the first six months of 2012 compared
to the first six months of 2011. 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.



Most of the increase in average deposits
was in savings accounts which increased $38,461,000, or 26.6%, to $183,288,000 for the first half of 2012. The growth in savings
accounts is largely due to the success of QNB’s newest deposit product, Online eSavings. Average non-interest bearing demand
accounts increased $2,703,000, or 4.3%, when comparing the six month periods with growth in personal accounts being the primary
contributor. Average interest-bearing demand and municipal accounts increased $9,564,000, or 10.9%, and $10,967,000, or 24.9%,
respectively, when comparing the first six months of 2012 and 2011. Business accounts and Select 50 accounts were the primary
contributors to the growth of the interest-bearing demand accounts while the growth in relationships with a couple of school districts
contributed to the increase in municipal balances. Total average time deposits decreased $9,799,000, or 3.3%, when comparing the
two six-month periods as customers were looking for the liquidity of transaction accounts including the eSavings product.



Total assets at June 30, 2012 were $890,136,000
compared with $868,804,000 at December 31, 2011, an increase of $21,332,000, or 2.5%. Total investment securities increased $9,663,000
and cash and cash equivalents increased $9,708,000 when comparing December 31, 2011 to June 30, 2012. Total loans increased $1,327,000,
or 0.3%, to $491,263,000 at June 30, 2012. As discussed previously the demand for loans by businesses and consumers has slowed
dramatically.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS








FINANCIAL CONDITION ANALYSIS (continued)



On the liability side, total deposits
increased by $30,295,000, or 4.0%, since year-end. Similar to prior periods, the growth was centered in lower-cost core deposits,
including savings accounts which increased $27,823,000, or 16.6%, to $195,456,000. The increase in savings accounts is attributable
to the Online eSavings product whose balances increased from $117,871,000 at December 31, 2011 to $146,462,000 at June 30, 2012.
The rate on this account has been reduced during the first half of the year from 1.00% at December 31, 2011 to 0.75% as of June
30, 2012. Money market accounts decreased $8,634,000, or 10.8%, from $79,856,000 at December 31, 2011 to $71,222,000 at June 30,
2012. The decrease was primarily in business accounts which decreased by $8,116,000. These deposits can be volatile depending
on the timing of deposits and withdrawals. Time deposits decreased slightly by $27,000 from $285,024,000 at December 31, 2011
to $284,997,000 at June 30, 2012 as customers continue to look for liquidity in anticipation of rising interest rates.



Short-term borrowings increased $2,549,000
from $24,021,000 at December 31, 2011 to $26,570,000 at June 30, 2012. The majority of these balances are commercial sweep accounts
which are also volatile based on businesses receipt and disbursement of funds.



Long-term debt declined $15,006,000 from
$20,299,000 at December 31, 2011. In April 2012, at maturity, $15,000,000 of repurchase agreements at a weighted average rate
of 4.75% were repaid.



LIQUIDITY



Liquidity represents an institution’s
ability to generate cash or otherwise obtain funds at reasonable rates to satisfy demand for loans and deposit withdrawals. QNB
attempts to manage its mix of cash and interest-bearing balances, Federal funds sold and investment securities in an attempt 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, 2012, the Bank had a maximum borrowing capacity with the FHLB of approximately
$203,930,000. The maximum borrowing capacity changes as a function of qualifying collateral assets. QNB has no outstanding borrowings
with the FHLB at June 30, 2012. In addition, the Bank maintains two unsecured Federal funds lines with two correspondent banks
totaling $18,000,000. At June 30, 2012, 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. As part of its contingency funding plan QNB successfully
tested its ability to borrow from these sources during the third quarter of 2011.



Total cash and cash equivalents, available-for-sale
investment securities and loans held-for-sale totaled $379,646,000 and $359,581,000 at June 30, 2012 and December 31, 2011, respectively.
The increase in liquid sources is primarily the result of a $7,219,000 increase in interest-bearing cash at the Federal Reserve
Bank and a $10,703,000 increase in available-for-sale investment securities. This source of liquidity was primarily funded from
an increase in total deposits. The sources and level of liquidity maintained should be adequate to meet normal fluctuations in
loan demand or 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.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS






LIQUIDITY (continued)



Approximately $122,720,000 and $158,189,000
of available-for-sale securities at June 30, 2012 and December 31, 2011, respectively, were pledged as collateral for repurchase
agreements and deposits of public funds.



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 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. During the third quarter of 2011, QNB began offering Insured Cash Sweep (ICS), a product similar to CDARS, but one
that provides liquidity like a money market or savings account.





CAPITAL ADEQUACY



A strong capital position is fundamental
to support continued growth and profitability and to serve the needs of depositors. QNB's shareholders' equity at June 30, 2012
was $74,679,000, or 8.39% of total assets, compared to shareholders' equity of $70,841,000, or 8.15% of total assets, at December
31, 2011. Shareholders’ equity at June 30, 2012 and December 31, 2011 included a positive adjustment of $4,641,000 and $4,665,000,
respectively, related to unrealized holding gains, net of taxes, on investment securities available-for-sale. Without these adjustments,
shareholders' equity to total assets would have been 7.91% and 7.66% at June 30, 2012 and December 31, 2011, respectively.

Average shareholders' equity and average
total assets were $68,436,000 and $868,905,000 for the first six months of 2012, an increase of 7.8% and 3.3%, respectively, from
the averages for the year ended December 31, 2011. The ratio of average total equity to average total assets was 7.88% for the
first six months of 2012 compared to 7.55% for all of 2011.



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 allowable portion of the allowance for loan losses which is limited to 1.25% of risk-weighted assets 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.





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QNB CORP. AND SUBSIDIARYMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS




CAPITAL ADEQUACY (continued)



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





|Capital Analysis                             |  | June
    30, 2012 |         |   | December
    31, 2011 |  
|-------------------------------------------- |  | ----------------- | ------- | - | --------------------- | -
|Tier I                                       |  |                   |         |   |                       |  
|Shareholder's equity                         |  | $                 | 74,679  |   |                       | $
|Net unrealized securities gains              |  |                   | (4,641  | ) |                       |  
|Total Tier I risk-based capital              |  | $                 | 70,038  |   |                       | $
|                                             |  |                   |         |   |                       |  
|Tier II                                      |  |                   |         |   |                       |  
|Allowable portion: Allowance for loan losses |  | $                 | 7,360   |   |                       | $
|Unrealized gains on equity
    securities    |  |                   | 100     |   |                       |  
|Total risk-based capital                     |  | $                 | 77,498  |   |                       | $
|Risk-weighted assets                         |  | $                 | 586,705 |   |                       | $
|Average assets                               |  | $                 | 871,956 |   |                       | $



|                                                   |  |               |       |   |                       | 
|-------------------------------------------------- |  | ------------- | ----- | - | --------------------- | 
|Capital Ratios                                     |  | June 30, 2012 |       |   | December 31,
    2011 | 
|Tier I capital/risk-weighted assets                |  |               | 11.94 | % |                       | 
|Total risk-based capital/risk-weighted assets      |  |               | 13.21 | % |                       | 
|Tier I capital/average
    assets (leverage ratio) |  |               | 8.03  | % |                       | 



The minimum regulatory capital ratios
are 4.00% for Tier I, 8.00% for the total risk-based capital and 4.00% for leverage. All capital ratios have improved from December
31, 2011 to June 30, 2012.



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
$422,000 to capital during first half of 2012.



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, 2012, 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.



Continuing to impact risk-weighted assets
is an additional $26,172,000 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 $3,609,000
at June 30, 2012, regulatory guidance required an additional $26,172,000 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, 2012. The other three 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, 2012 and December 31, 2011, 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%.





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ITEM 3.	QUANTITATIVE AND QUALITATIVE
DISCLOSURES 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.



- 74 -









QNB CORP. AND SUBSIDIARY



PART II. OTHER INFORMATION



JUNE 30, 2012



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, 2011.



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



|Period                               |  | Total
    Number 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 Plan | 
|------------------------------------ |  | ------------------------------------ | - |  | -------------------------------- |  | - | ----------------------------------------------------------------------- |  |  | --------------------------------------------------------------------- | 
|                                     |  |                                      |   |  |                                  |  |   |                                                                         |  |  |                                                                       | 
|April 1, 2012 through April 30, 2012 |  |                                      | - |  |                                  |  | - |                                                                         |  |  | -                                                                     | 
|May 1, 2012 through May 31, 2012     |  |                                      | - |  |                                  |  | - |                                                                         |  |  | -                                                                     | 
|June 1, 2012 through June 30, 2012   |  |                                      | - |  |                                  |  | - |                                                                         |  |  | -                                                                     | 
|Total                                |  |                                      | - |  |                                  |  | - |                                                                         |  |  | -                                                                     | 



| | (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.	Mine Safety Disclosures



None.



Item 5.	Other Information



None.



- 75 -









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 Chief Executive Officer                                                                                                                          
|              |                                                                                                                                                                               
|Exhibit 31.2  | Section 302 Certification of Chief Financial Officer                                                                                                                          
|              |                                                                                                                                                                               
|Exhibit 32.1  | Section 906 Certification of Chief Executive Officer                                                                                                                          
|              |                                                                                                                                                                               
|Exhibit 32.2  | Section 906 Certification of Chief Financial Officer                                                                                                                          
|              |                                                                                                                                                                               







- 76 -









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 10, 2012 |  | By: | /s/ Thomas J. Bisko    
|                     |  |     | Thomas J. Bisko        
|                     |  |     | Chief Executive Officer
|                     |  |     |                        
|                     |  |     |                        
|Date:August 10, 2012 |  | By: | /s/ Bret H. Krevolin   
|                     |  |     | Bret H. Krevolin       
|                     |  |     | Chief Financial Officer







- 77 -