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 endedMarch
31, 2010


OR


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





For the
transition period from to





Commission
file number 0-17706





QNB Corp.





(Exact
Name of Registrant as Specified in Its Charter)





Pennsylvania
            23-2318082(State or Other Jurisdiction of Incorporation or Organization)
            (I.R.S. Employer Identification No.)





15 North Third Street, 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 requiredto filesuch reports), and (2) has
been subject to such filing requirements for the past 90
days.  YesþNo ̈





Indicate by check mark whether the
registrant has submitted electronically and posted on its corporate Web site, if
any, every Interactive Data File required to be submitted and posted pursuant to
Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12
months (or for such shorter period that the registrant was required to submit
and post such files).  Yes ̈No ̈





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


Large
      accelerated filer   ̈
                  Accelerated filer ̈Non-accelerated
      filer   ̈
                  Smaller
      Reporting Company þ




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





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





Class
            
            Outstanding at May 12, 2010Common Stock, par value $0.625
            
            3,098,805





QNB
CORP. AND SUBSIDIARY


FORM
10-Q


QUARTER
ENDED MARCH 31, 2010





INDEX





PAGEPART
      I - FINANCIAL INFORMATIONITEM
      1.
                    CONSOLIDATED
      FINANCIAL STATEMENTS (Unaudited)Consolidated
      Balance Sheets at March 31, 2010 and December 31, 2009
                    3Consolidated
      Statements of Income for the Three Months Ended March 31, 2010 and
      2009
                    4Consolidated
      Statement of Shareholders’ Equity for the Three Months Ended March 31,
      2010
                    5Consolidated
      Statements of Cash Flows for the Three Months Ended March 31, 2010 and
      2009
                    6Notes
      to Consolidated Financial Statements
                    7ITEM
      2.
                    MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                    26ITEM
      3.
                    QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT
      MARKET
      RISK
                    50ITEM
      4.
                    CONTROLS
      AND PROCEDURES
                    50PART
      II - OTHER INFORMATIONITEM
      1.
                    LEGAL
      PROCEEDINGS
                    51ITEM
      1A.
                    RISK
      FACTORS
                    51ITEM
      2.
                    UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
                    51ITEM
      3.
                    DEFAULTS
      UPON SENIOR SECURITIES
                    51ITEM
      4.
                    (REMOVED
      AND RESERVED)
                    51ITEM
      5.
                    OTHER
      INFORMATION
                    51ITEM
      6.
                    EXHIBITS
                    52SIGNATURESCERTIFICATIONS







QNB Corp. and SubsidiaryCONSOLIDATED
      BALANCE SHEETS
 
 (in
      thousands, except share data)(unaudited)March
      31,
                                
                                
                                December
      31,2010
                                
                                
                                2009AssetsCash
      and due from banks
                                
                                $
                                10,519
                                
                                
                                $
                                8,841Interest-bearing
      deposits in banks
                                
                                
                                17,680
                                
                                
                                
                                22,158Total
      cash and cash equivalents
                                
                                
                                28,199
                                
                                
                                
                                30,999Investment
      securitiesAvailable-for-sale
      (amortized cost $259,691 and $254,251)
                                
                                
                                263,257
                                
                                
                                
                                256,862Held-to-maturity
      (fair value $2,961 and $3,471)
                                
                                
                                2,847
                                
                                
                                
                                3,347Restricted
      investment in bank stocks
                                
                                
                                2,291
                                
                                
                                
                                2,291Loans
      held-for-sale
                                
                                
                                –
                                
                                
                                
                                534Loans
      receivable
                                
                                
                                456,217
                                
                                
                                
                                449,421Allowance
      for loan losses
                                
                                
                                (6,357
                                )
                                
                                
                                (6,217
                                )Net
      loans
                                
                                
                                449,860
                                
                                
                                
                                443,204Bank-owned
      life insurance
                                
                                
                                9,178
                                
                                
                                
                                9,109Premises
      and equipment, net
                                
                                
                                6,255
                                
                                
                                
                                6,248Accrued
      interest receivable
                                
                                
                                2,913
                                
                                
                                
                                2,848Other
      assets
                                
                                
                                6,081
                                
                                
                                
                                6,984Total
      assets
                                
                                $
                                770,881
                                
                                
                                $
                                762,426LiabilitiesDepositsDemand,
      non-interest bearing
                                
                                $
                                55,537
                                
                                
                                $
                                53,930Interest-bearing
      demand
                                
                                
                                118,865
                                
                                
                                
                                120,554Money
      market
                                
                                
                                79,485
                                
                                
                                
                                70,165Savings
                                
                                
                                83,855
                                
                                
                                
                                68,358Time
                                
                                
                                216,936
                                
                                
                                
                                215,155Time
      of $100,000 or more
                                
                                
                                107,693
                                
                                
                                
                                105,941Total
      deposits
                                
                                
                                662,371
                                
                                
                                
                                634,103Short-term
      borrowings
                                
                                
                                21,831
                                
                                
                                
                                28,433Long-term
      debt
                                
                                
                                25,000
                                
                                
                                
                                35,000Accrued
      interest payable
                                
                                
                                1,405
                                
                                
                                
                                1,565Other
      liabilities
                                
                                
                                2,050
                                
                                
                                
                                6,899Total
      liabilities
                                
                                
                                712,657
                                
                                
                                
                                706,000Shareholders'
      EquityCommon
      stock, par value $0.625 per share;authorized
      10,000,000 shares; 3,263,374 shares and 3,257,794 shares
      issued;3,098,805
      and 3,093,225 shares outstanding
                                
                                
                                2,040
                                
                                
                                
                                2,036Surplus
                                
                                
                                10,301
                                
                                
                                
                                10,221Retained
      earnings
                                
                                
                                46,005
                                
                                
                                
                                44,922Accumulated
      other comprehensive income, net
                                
                                
                                2,354
                                
                                
                                
                                1,723Treasury
      stock, at cost; 164,569 shares
                                
                                
                                (2,476
                                )
                                
                                
                                (2,476
                                )Total
      shareholders' equity
                                
                                
                                58,224
                                
                                
                                
                                56,426Total
      liabilities and shareholders' equity
                                
                                $
                                770,881
                                
                                
                                $
                                762,426
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 3
-
  QNB
      Corp. and SubsidiaryCONSOLIDATED
      STATEMENTS OF INCOME
 
 (in
      thousands, except share data)(unaudited)Three
      Months Ended March 31,
                      
                      2010
                      
                      
                      2009Interest
      IncomeInterest
      and fees on loans
                      
                      $
                      6,359
                      
                      
                      $
                      5,913Interest
      and dividends on investment securities:Taxable
                      
                      
                      1,874
                      
                      
                      
                      2,202Tax-exempt
                      
                      
                      585
                      
                      
                      
                      509Interest
      on Federal funds sold
                      
                      
                      –
                      
                      
                      
                      1Interest
      on interest-bearing balances and other interest income
                      
                      
                      10
                      
                      
                      
                      1Total
      interest income
                      
                      
                      8,828
                      
                      
                      
                      8,626Interest
      ExpenseInterest
      on depositsInterest-bearing
      demand
                      
                      
                      222
                      
                      
                      
                      154Money
      market
                      
                      
                      166
                      
                      
                      
                      164Savings
                      
                      
                      141
                      
                      
                      
                      28Time
                      
                      
                      1,272
                      
                      
                      
                      1,849Time
      of $100,000 or more
                      
                      
                      636
                      
                      
                      
                      920Interest
      on short-term borrowings
                      
                      
                      53
                      
                      
                      
                      56Interest
      on long-term debt
                      
                      
                      314
                      
                      
                      
                      374Total
      interest expense
                      
                      
                      2,804
                      
                      
                      
                      3,545Net
      interest income
                      
                      
                      6,024
                      
                      
                      
                      5,081Provision
      for loan losses
                      
                      
                      700
                      
                      
                      
                      600Net
      interest income after provision for loan losses
                      
                      
                      5,324
                      
                      
                      
                      4,481Non-Interest
      IncomeTotal
      other-than-temporary impairment losses on investment
      securities
                      
                      
                      (185
                      )
                      
                      
                      (390
                      )Less:
      Portion of loss recognized in other comprehensive income (before
      taxes)
                      
                      
                      27
                      
                      
                      
                      –Net
      other-than-temporary impairment losses on investment
      securities
                      
                      
                      (158
                      )
                      
                      
                      (390
                      )Net
      gain on sale of investment securities
                      
                      
                      294
                      
                      
                      
                      136Net
      gain (loss) on investment securities
                      
                      
                      136
                      
                      
                      
                      (254
                      )Fees
      for services to customers
                      
                      
                      405
                      
                      
                      
                      395ATM
      and debit card
                      
                      
                      271
                      
                      
                      
                      228Bank-owned
      life insurance
                      
                      
                      64
                      
                      
                      
                      71Mortgage
      servicing fees
                      
                      
                      32
                      
                      
                      
                      36Net
      gain on sale of loans
                      
                      
                      75
                      
                      
                      
                      168Other
                      
                      
                      149
                      
                      
                      
                      89Total
      non-interest income
                      
                      
                      1,132
                      
                      
                      
                      733Non-Interest
      ExpenseSalaries
      and employee benefits
                      
                      
                      2,137
                      
                      
                      
                      2,078Net
      occupancy
                      
                      
                      369
                      
                      
                      
                      353Furniture
      and equipment
                      
                      
                      282
                      
                      
                      
                      296Marketing
                      
                      
                      161
                      
                      
                      
                      175Third
      party services
                      
                      
                      273
                      
                      
                      
                      230Telephone,
      postage and supplies
                      
                      
                      157
                      
                      
                      
                      149State
      taxes
                      
                      
                      140
                      
                      
                      
                      135FDIC
      insurance premiums
                      
                      
                      254
                      
                      
                      
                      193Other
                      
                      
                      345
                      
                      
                      
                      320Total
      non-interest expense
                      
                      
                      4,118
                      
                      
                      
                      3,929Income
      before income taxes
                      
                      
                      2,338
                      
                      
                      
                      1,285Provision
      for income taxes
                      
                      
                      512
                      
                      
                      
                      191Net
      Income
                      
                      $
                      1,826
                      
                      
                      $
                      1,094Earnings
      Per Share - Basic
                      
                      $
                      0.59
                      
                      
                      $
                      0.35Earnings
      Per Share - Diluted
                      
                      $
                      0.59
                      
                      
                      $
                      0.35Cash
      Dividends Per Share
                      
                      $
                      0.24
                      
                      
                      $
                      0.24
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 4
-
  QNB
      Corp. and SubsidiaryCONSOLIDATED
      STATEMENT OF SHAREHOLDERS'
EQUITY
 
 Accumulated(in
      thousands, except share data)
                                            
                                            Number
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            Other(unaudited)
                                            
                                            of
      Shares
                                            
                                            
                                            Common
                                            
                                            
                                            
                                            
                                            
                                            Retained
                                            
                                            
                                            Comprehesive
                                            
                                            
                                            TreasuryOutstanding
                                            
                                            
                                            Stock
                                            
                                            
                                            Surplus
                                            
                                            
                                            Earnings
                                            
                                            
                                            Income
                                            
                                            
                                            Stock
                                            
                                            
                                            TotalBalance,
      December 31, 2009
                                            
                                            
                                            3,093,225
                                            
                                            
                                            $
                                            2,036
                                            
                                            
                                            $
                                            10,221
                                            
                                            
                                            $
                                            44,922
                                            
                                            
                                            $
                                            1,723
                                            
                                            
                                            $
                                            (2,476
                                            )
                                            
                                            $
                                            56,426Comprehensive
      income:Net
      Income
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            1,826
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            1,826Other
      comprehensive income
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            631
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            631Total
      comprehensive income
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            
                                            2,457Cash
      dividends paid($0.24
      per share)
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            (743
                                            )
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            (743
                                            )Stock
      issued in connection with dividend reinvestmentand
      stock purchase plan
                                            
                                            
                                            4,360
                                            
                                            
                                            
                                            3
                                            
                                            
                                            
                                            71
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            74Stock
      issued for options exercised
                                            
                                            
                                            1,220
                                            
                                            
                                            
                                            1
                                            
                                            
                                            
                                            (1
                                            )
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –Stock-based
      compensation expense
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            10
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            –
                                            
                                            
                                            
                                            10Balance,
      March 31, 2010
                                            
                                            
                                            3,098,805
                                            
                                            
                                            $
                                            2,040
                                            
                                            
                                            $
                                            10,301
                                            
                                            
                                            $
                                            46,005
                                            
                                            
                                            $
                                            2,354
                                            
                                            
                                            $
                                            (2,476
                                            )
                                            
                                            $
                                            58,224
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 5
-
  QNB
      Corp. and SubsidiaryCONSOLIDATED
      STATEMENTS OF CASH FLOWS
 
 (in
      thousands,(unaudited)Three
      Months Ended March 31,
                                              
                                              2010
                                              
                                              
                                              2009Operating
      ActivitiesNet
      income
                                              
                                              $
                                              1,826
                                              
                                              
                                              $
                                              1,094Adjustments
      to reconcile net income to net cash provided by operating
      activitiesDepreciation
      and amortization
                                              
                                              
                                              198
                                              
                                              
                                              
                                              219Provision
      for loan losses
                                              
                                              
                                              700
                                              
                                              
                                              
                                              600Net
      (gains) losses on investment securities available-for-sale
                                              
                                              
                                              (136
                                              )
                                              
                                              
                                              254Net
      loss on sale of repossessed assets
                                              
                                              
                                              3
                                              
                                              
                                              
                                              45Net
      gain on sale of loans
                                              
                                              
                                              (75
                                              )
                                              
                                              
                                              (168
                                              )Proceeds
      from sales of residential mortgages
                                              
                                              
                                              2,313
                                              
                                              
                                              
                                              7,685Originations
      of residential mortgages held-for-sale
                                              
                                              
                                              (1,704
                                              )
                                              
                                              
                                              (10,599
                                              )Income
      on bank-owned life insurance
                                              
                                              
                                              (64
                                              )
                                              
                                              
                                              (71
                                              )Life
      insurance premiums
                                              
                                              
                                              (5
                                              )
                                              
                                              
                                              (5
                                              )Stock-based
      compensation expense
                                              
                                              
                                              10
                                              
                                              
                                              
                                              13Deferred
      income tax benefit
                                              
                                              
                                              (11
                                              )
                                              
                                              
                                              (250
                                              )Net
      increase in income taxes payable
                                              
                                              
                                              422
                                              
                                              
                                              
                                              442Net
      (increase) decrease in accrued interest receivable
                                              
                                              
                                              (65
                                              )
                                              
                                              
                                              60Amortization
      of mortgage servicing rights and change in valuation
    allowance
                                              
                                              
                                              19
                                              
                                              
                                              
                                              7Net
      amortization (accretion) of premiums and discounts on investment
      securities
                                              
                                              
                                              174
                                              
                                              
                                              
                                              (63
                                              )Net
      (decrease) increase in accrued interest payable
                                              
                                              
                                              (160
                                              )
                                              
                                              
                                              366Decrease
      in other assets
                                              
                                              
                                              488
                                              
                                              
                                              
                                              767Decrease
      in other liabilities
                                              
                                              
                                              (208
                                              )
                                              
                                              
                                              (233
                                              )Net
      cash provided by operating activities
                                              
                                              
                                              3,725
                                              
                                              
                                              
                                              163Investing
      ActivitiesProceeds
      from maturities and calls of investment securitiesavailable-for-sale
                                              
                                              
                                              37,123
                                              
                                              
                                              
                                              22,984held-to-maturity
                                              
                                              
                                              500
                                              
                                              
                                              
                                              –Proceeds
      from sales of investment securitiesavailable-for-sale
                                              
                                              
                                              2,030
                                              
                                              
                                              
                                              6,164Purchase
      of investment securitiesavailable-for-sale
                                              
                                              
                                              (49,628
                                              )
                                              
                                              
                                              (32,726
                                              )Net
      increase in loans
                                              
                                              
                                              (7,413
                                              )
                                              
                                              
                                              (14,099
                                              )Net
      purchases of premises and equipment
                                              
                                              
                                              (205
                                              )
                                              
                                              
                                              (129
                                              )Proceeds
      from sale of repossessed assets
                                              
                                              
                                              71
                                              
                                              
                                              
                                              236Net
      cash used by investing activities
                                              
                                              
                                              (17,522
                                              )
                                              
                                              
                                              (17,570
                                              )Financing
      ActivitiesNet
      increase in non-interest bearing deposits
                                              
                                              
                                              1,607
                                              
                                              
                                              
                                              2,148Net
      increase in interest-bearing non-maturity deposits
                                              
                                              
                                              23,128
                                              
                                              
                                              
                                              3,977Net
      increase in time deposits
                                              
                                              
                                              3,533
                                              
                                              
                                              
                                              17,834Net
      decrease in short-term borrowings
                                              
                                              
                                              (6,602
                                              )
                                              
                                              
                                              (4,841
                                              )Repayments
      of long-term debt
                                              
                                              
                                              (10,000
                                              )
                                              
                                              
                                              –Cash
      dividends paid, net of reinvestment
                                              
                                              
                                              (710
                                              )
                                              
                                              
                                              (746
                                              )Purchase
      of treasury stock
                                              
                                              
                                              –
                                              
                                              
                                              
                                              (866
                                              )Proceeds
      from issuance of common stock
                                              
                                              
                                              41
                                              
                                              
                                              
                                              5Net
      cash provided by financing activites
                                              
                                              
                                              10,997
                                              
                                              
                                              
                                              17,511(Decrease)
      increase in cash and cash equivalents
                                              
                                              
                                              (2,800
                                              )
                                              
                                              
                                              104Cash
      and cash equivalents at beginning of year
                                              
                                              
                                              30,999
                                              
                                              
                                              
                                              16,451Cash
      and cash equivalents at end of period
                                              
                                              $
                                              28,199
                                              
                                              
                                              $
                                              16,555Supplemental
      Cash Flow DisclosuresInterest
      paid
                                              
                                              $
                                              2,964
                                              
                                              
                                              $
                                              3,179Income
      taxes paid
                                              
                                              
                                              100
                                              
                                              
                                              
                                              –Non-Cash
      TransactionsTransfer
      of loans to other real estate owned and repossessed assets
                                              
                                              
                                              57
                                              
                                              
                                              
                                              400
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 6
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




1.
BASIS OF PRESENTATION





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





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





The
unaudited consolidated financial statements reflect all adjustments which, in
the opinion of management, are necessary for a fair presentation of the results
of operations for the interim periods and are of a normal and recurring nature.
Certain items in the 2009 consolidated financial statements have been
reclassified to conform to the 2010 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 March 31, 2010, for items that should potentially be
recognized or disclosed in these financial statements.





2.
RECENT ACCOUNTING PRONOUNCEMENTS





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





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


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


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


- 7
-


QNB
CORP. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




2.
RECENT ACCOUNTING PRONOUNCEMENTS (Continued)





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


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


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





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





The FASB
has issued ASU 2010-09, Subsequent Events (Topic 855):
Amendments to Certain Recognition and Disclosure Requirements. The
amendments in the ASU remove the requirement for an SEC filer to disclose a date
through which subsequent events have been evaluated in both issued and revised
financial statements. Revised financial statements include financial statements
revised as a result of either correction of an error or retrospective
application of U.S. GAAP. The FASB also clarified that if the financial
statements have been revised, then an entity that is not an SEC filer should
disclose both the date that the financial statements were issued or available to
be issued and the date the revised financial statements were issued or available
to be issued. The FASB believes these amendments remove potential conflicts with
the SEC’s literature. All of
the amendments in the ASU were effective upon issuance on February 24,
2010.





3.
STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY





QNB
sponsors stock-based compensation plans, administered by a committee, under
which both qualified and non-qualified stock options may be granted periodically
to certain employees. Compensation cost has been measured using the fair value
of an award on the grant date and is recognized over the service period, which
is usually the vesting period.





Stock-based
compensation expense was approximately $10,000 and $13,000 for the three months
ended March 31, 2010 and 2009, respectively. As of March 31, 2010, there was
approximately $76,000 of unrecognized compensation cost related to unvested
share-based compensation awards granted that is expected to be recognized over
the next 34 months.





Options
are granted to certain employees at prices equal to the market value of the
stock on the date the options are granted. The 1998 Plan authorizes the issuance
of 220,500 shares. The time period during which any option is exercisable under
the Plan is determined by the committee but shall not commence before the
expiration of six months after the date of grant or continue beyond the
expiration of ten years after the date the option is awarded. The granted
options vest ratably over a three-year period. As of March 31, 2010, there were
225,058 options granted, 14,844 options forfeited, 81,050 options exercised and
129,164 options outstanding under this Plan. The 1998 Plan expired on March 10,
2008, therefore no further options can be granted under this Plan.





The 2005
Plan authorizes the issuance of 200,000 shares. The terms of the 2005 Plan are
identical to the 1998 Plan, except options expire five years after the grant
date. As of March 31, 2010, there were 80,700 options granted, 8,500 options
forfeited and 72,200 options outstanding under this Plan. The 2005 Plan expires
March 15, 2015.





The fair
value of each option is amortized into compensation expense on a straight-line
basis between the grant date for the option and each vesting date. QNB estimated
the fair value of stock options on the date of the grant using the Black-Scholes
option pricing model. The model requires the use of numerous assumptions, many
of which are highly subjective in nature.


- 8
-


QNB
CORP. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)


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





The
following assumptions were used in the option pricing model in determining the
fair value of options granted during the three months ended March
31:





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





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





The fair
market value of options granted in 2010 and 2009 was $2.50 and $2.17,
respectively.





Stock
option activity during the three months ended March 31, 2010 is as
follows:





Number
                        of Options
                      
                      
                      Weighted
                        Average
                        Exercise Price
                      
                      
                      Weighted
                        Average
                        Remaining
                        Contractual
                        Term (in yrs.)
                      
                      
                      Aggregate
                        Intrinsic
                        ValueOutstanding
      at January 1, 2010
                      
                      
                      200,802
                      
                      
                      $
                      21.36Exercised
                      
                      
                      (5,292
                      )
                      
                      
                      13.09Forfeited
                      
                      
                      (11,146
                      )
                      
                      
                      19.11Granted
                      
                      
                      17,000
                      
                      
                      
                      17.25Outstanding
      at March 31, 2010
                      
                      
                      201,364
                      
                      
                      $
                      21.36
                      
                      
                      
                      2.7
                      
                      
                      $
                      280Exercisable
      at March 31, 2010
                      
                      
                      152,714
                      
                      
                      $
                      22.32
                      
                      
                      
                      2.4
                      
                      
                      $
                      219





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 first quarter of 2010. As of March 31, 2010, 57,883 shares were
repurchased under this authorization at an average price of $16.97 and a total
cost of $982,000.


- 9
-




QNB
CORP. AND SUBSIDIARY




NOTES
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 Ended March 31,
                    
                    2010
                    
                    
                    2009Numerator
      for basic and diluted earnings per share - net income
                    
                    $
                    1,826
                    
                    
                    $
                    1,094Denominator
      for basic earnings per share - weighted average shares
      outstanding
                    
                    
                    3,094,534
                    
                    
                    
                    3,113,730Effect
      of dilutive securities - employee stock options
                    
                    
                    7,969
                    
                    
                    
                    12,953Denominator
      for diluted earnings per share - adjusted weighted average shares
      outstanding
                    
                    
                    3,102,503
                    
                    
                    
                    3,126,683Earnings
      per share-basic
                    
                    $
                    0.59
                    
                    
                    $
                    0.35Earnings
      per share-diluted
                    
                    $
                    0.59
                    
                    
                    $
                    0.35





There
were 147,300 and 141,600 stock options that were anti-dilutive for the
three-month periods ended March 31, 2010 and 2009, 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 March 31, 2010 and 2009:





Before-Tax
                          Amount
                        
                        
                        Tax
                          Expense
                          (Benefit)
                        
                        
                        Net-of-Tax
                          AmountThree Months Ended March 31,
      2010Unrealized
      gains (losses) on securitiesUnrealized
      holding gains arising during the period
                        
                        $
                        1,118
                        
                        
                        $
                        (380
                        )
                        
                        $
                        738Unrealized
      losses related to factors other than credit arising during the
      period
                        
                        
                        (27
                        )
                        
                        
                        9
                        
                        
                        
                        (18
                        )Reclassification
      adjustment for gains included in net income
                        
                        
                        (294
                        )
                        
                        
                        100
                        
                        
                        
                        (194
                        )Reclassification
      adjustment for OTTI losses included in net income
                        
                        
                        158
                        
                        
                        
                        (53
                        )
                        
                        
                        105Comprehensive
      income:
                        
                        $
                        955
                        
                        
                        $
                        (324
                        )
                        
                        $
                        631Three Months Ended March 31,
      2009Unrealized
      gains on securitiesUnrealized
      holding gains arising during the period
                        
                        $
                        287
                        
                        
                        $
                        (98
                        )
                        
                        $
                        189Reclassification
      adjustment for gains included in net income
                        
                        
                        (136
                        )
                        
                        
                        46
                        
                        
                        
                        (90
                        )Reclassification
      adjustment for OTTI losses included in net income
                        
                        
                        390
                        
                        
                        
                        (132
                        )
                        
                        
                        258Comprehensive
      income:
                        
                        $
                        541
                        
                        
                        $
                        (184
                        )
                        
                        $
                        357


- 10
-


QNB
CORP. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




7.
INVESTMENT SECURITIES





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





Available-for-SaleMarch
      31, 2010


Gross
                              
                              
                              GrossAggregate
                              
                              
                              unrealized
                              
                              
                              unrealized holding lossesfair
                              
                              
                              holding
                              
                              
                              Non-credit
                              
                              
                              
                              
                              
                              Amortizedvalue
                              
                              
                              gains
                              
                              
                              OTTI
                              
                              
                              Other
                              
                              
                              costU.S.
      Treasury
                              
                              $
                              5,022
                              
                              
                              $
                              10
                              
                              
                              
                              -
                              
                              
                              $
                              1
                              
                              
                              $
                              5,013U.S.
      Government agencies
                              
                              
                              58,009
                              
                              
                              
                              306
                              
                              
                              
                              -
                              
                              
                              
                              94
                              
                              
                              
                              57,797State
      and municipal securities
                              
                              
                              54,823
                              
                              
                              
                              1,327
                              
                              
                              
                              -
                              
                              
                              
                              152
                              
                              
                              
                              53,648U.S.
      Government agencies and sponsored enterprises (GSEs) -
      residential
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              
                              -Mortgage-backed
      securities
                              
                              
                              71,796
                              
                              
                              
                              2,449
                              
                              
                              
                              -
                              
                              
                              
                              110
                              
                              
                              
                              69,457Collateralized
      mortgage obligations (CMOs)
                              
                              
                              68,753
                              
                              
                              
                              2,072
                              
                              
                              
                              -
                              
                              
                              
                              47
                              
                              
                              
                              66,728Other
      debt securities
                              
                              
                              1,662
                              
                              
                              
                              80
                              
                              
                              $
                              2,218
                              
                              
                              
                              561
                              
                              
                              
                              4,361Equity
      securities
                              
                              
                              3,192
                              
                              
                              
                              505
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              2,687Total
      investment securities available-for-sale
                              
                              $
                              263,257
                              
                              
                              $
                              6,749
                              
                              
                              $
                              2,218
                              
                              
                              $
                              965
                              
                              
                              $
                              259,691


December
      31, 2009


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





The
amortized cost and estimated fair value of securities available-for-sale by
contractual maturity at March 31, 2010 are shown in the following table.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties. Securities are assigned to categories based on contractual
maturity except for mortgage-backed securities and CMOs which are based on the
estimated average life of these securities.





Aggregate
                  
                  
                  Amortizedfair value
                  
                  
                  costDue
      in one year or less
                  
                  $
                  7,916
                  
                  
                  $
                  7,831Due
      after one year through five years
                  
                  
                  170,553
                  
                  
                  
                  165,881Due
      after five years through ten years
                  
                  
                  49,504
                  
                  
                  
                  48,900Due
      after ten years
                  
                  
                  32,092
                  
                  
                  
                  34,392Equity
      securities
                  
                  
                  3,192
                  
                  
                  
                  2,687Total
      investment securities available-for-sale
                  
                  $
                  263,257
                  
                  
                  $
                  259,691


- 11
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES (Continued)





Proceeds
from sales of investment securities available-for-sale were $2,030,000 and
$6,164,000 for the three months ended March 31, 2010 and 2009,
respectively.





At March
31, 2010 and December 31, 2009, investment securities available-for-sale
totaling $128,035,000 and $133,136,000, respectively, were pledged as collateral
for repurchase agreements and deposits of public funds.





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





Three months ended March 31,
      2010:Other-than-Gross
                          
                          
                          Gross
                          
                          
                          temporaryRealized
                          
                          
                          Realized
                          
                          
                          impairment
                          
                          
                          Net
      gainsGains
                          
                          
                          Losses
                          
                          
                          losses
                          
                          
                          (losses)Equity
      securities
                          
                          $
                          287
                          
                          
                          $
                          -
                          
                          
                          $
                          -
                          
                          
                          $
                          287Debt
      securities
                          
                          
                          7
                          
                          
                          
                          -
                          
                          
                          
                          (158
                          )
                          
                          
                          (151
                          )Total
                          
                          $
                          294
                          
                          
                          $
                          -
                          
                          
                          $
                          (158
                          )
                          
                          $
                          136





Three months ended March 31,
      2009:Other-than-Gross
                  
                  
                  Gross
                  
                  
                  temporaryRealized
                  
                  
                  Realized
                  
                  
                  impairment
                  
                  
                  Net
      gainsGains
                  
                  
                  Losses
                  
                  
                  losses
                  
                  
                  (losses)Equity
      securities
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  (390
                  )
                  
                  $
                  (390
                  )Debt
      securities
                  
                  
                  136
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  136Total
                  
                  $
                  136
                  
                  
                  $
                  -
                  
                  
                  $
                  (390
                  )
                  
                  $
                  (254
                  )





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





The tax
expense applicable to the net realized gains for the period ended March 31, 2010
was $46,000. The tax benefit applicable to the net realized losses for the
period ended March 31, 2009 amounted to $86,000.




- 12
-


QNB
CORP. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





7.
INVESTMENT SECURITIES (Continued)





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





The table
below presents a rollforward of the credit loss component recognized in
earnings. The credit loss component of the amortized cost represents the
difference between the present value of expected future cash flows and the
amortized cost basis of the security prior to considering credit losses. The
beginning balance represents the credit loss component for debt securities for
which OTTI occurred prior to January 1, 2010. OTTI recognized in earnings in
2010 for credit-impaired debt securities is presented as additions in two
components based upon whether the current period is the first time the debt
security was credit-impaired (initial credit impairment) or is not the first
time the debt security was credit-impaired (subsequent credit impairments). If
we sell, intend to sell or believe we will be required to sell previously
credit-impaired debt securities, the credit loss component would be reduced. 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 March
31,
                  
                  2010Balance,
      beginning of period
                  
                  $
                  1,002Additions:Initial
      credit impairments
                  
                  
                  -Subsequent
      credit impairments
                  
                  
                  158Balance,
      end of period
                  
                  $
                  1,160





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





Held-To-MaturityMarch 31, 2010
                          
                          
                          December 31, 2009Gross
                          
                          
                          Gross
                          
                          
                          
                          
                          
                          
                          
                          
                          Gross
                          
                          
                          Grossunrealized
                          
                          
                          unrealized
                          
                          
                          Aggregate
                          
                          
                          
                          
                          
                          unrealized
                          
                          
                          unrealized
                          
                          
                          AggregateAmortized
                          
                          
                          holding
                          
                          
                          holding
                          
                          
                          fair
                          
                          
                          Amortized
                          
                          
                          holding
                          
                          
                          holding
                          
                          
                          faircost
                          
                          
                          gains
                          
                          
                          losses
                          
                          
                          value
                          
                          
                          cost
                          
                          
                          gains
                          
                          
                          losses
                          
                          
                          valueState
      and municipal securities
                          
                          $
                          2,847
                          
                          
                          $
                          114
                          
                          
                          
                          -
                          
                          
                          $
                          2,961
                          
                          
                          $
                          3,347
                          
                          
                          $
                          124
                          
                          
                          $
                          -
                          
                          
                          $
                          3,471


- 13
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




7.
INVESTMENT SECURITIES (Continued)





The
amortized cost and estimated fair value of securities held-to-maturity by
contractual maturity at March 31, 2010 are shown in the following table.
Expected maturities will differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties.





Aggregate
                    
                    
                    Amortizedfair
      value
                    
                    
                    costDue
      in one year or less
                    
                    
                    -
                    
                    
                    
                    -Due
      after one year through five years
                    
                    
                    -
                    
                    
                    
                    -Due
      after five years through ten years
                    
                    $
                    2,961
                    
                    
                    $
                    2,847Due
      after ten years
                    
                    
                    -
                    
                    
                    
                    -Total
      investment securities held-to-maturity
                    
                    $
                    2,961
                    
                    
                    $
                    2,847





There
were no sales of investment securities classified as held-to-maturity during the
three months ended March 31, 2010 or 2009.





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





March 31, 2010Less than 12 months
                  
                  
                  12 months or longer
                  
                  
                  TotalNo.
      of
                  
                  
                  Fair
                  
                  
                  Unrealized
                  
                  
                  Fair
                  
                  
                  Unrealized
                  
                  
                  Fair
                  
                  
                  Unrealizedsecurities
                  
                  
                  value
                  
                  
                  losses
                  
                  
                  value
                  
                  
                  losses
                  
                  
                  value
                  
                  
                  lossesU.S.
      Treasury
                  
                  
                  2
                  
                  
                  $
                  1,004
                  
                  
                  $
                  1
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  1,004
                  
                  
                  $
                  1U.S.
      Government agencies
                  
                  
                  11
                  
                  
                  
                  13,901
                  
                  
                  
                  94
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  13,901
                  
                  
                  
                  94State
      and municipal securities
                  
                  
                  16
                  
                  
                  
                  8,366
                  
                  
                  
                  145
                  
                  
                  $
                  491
                  
                  
                  $
                  7
                  
                  
                  
                  8,857
                  
                  
                  
                  152Mortgage-backed
      securities
                  
                  
                  12
                  
                  
                  
                  17,318
                  
                  
                  
                  110
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  17,318
                  
                  
                  
                  110Collateralized
      mortgage obligations (CMOs)
                  
                  
                  3
                  
                  
                  
                  3,840
                  
                  
                  
                  47
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,840
                  
                  
                  
                  47Other
      debt securities
                  
                  
                  8
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,135
                  
                  
                  
                  2,779
                  
                  
                  
                  1,135
                  
                  
                  
                  2,779Total
                  
                  
                  52
                  
                  
                  $
                  44,429
                  
                  
                  $
                  397
                  
                  
                  $
                  1,626
                  
                  
                  $
                  2,786
                  
                  
                  $
                  46,055
                  
                  
                  $
                  3,183





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


- 14
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





7.
INVESTMENT SECURITIES (Continued)





Management
evaluates debt securities, which are comprised of U.S. Government Agencies,
state and municipalities, mortgage-backed securities, CMOs and other issuers,
for other-than-temporary impairment and considers the current economic
conditions, the length of time and the extent to which the fair value has been
less than cost, interest rates and the bond rating of each security. The
unrealized losses at March 31, 2010 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.





All of
the securities in the other debt securities category with unrealized losses
greater than twelve months as of March 31, 2010 are pooled trust preferred
security issues. QNB holds eight of these securities with an amortized cost of
$3,914,000 and a fair value of $1,135,000. All of the trust preferred securities
are available-for-sale securities and are carried at fair value.





The
following table provides additional information related to pooled trust
preferred securities as of March 31, 2010:





Deal
                            
                            Class
                            
                            Book
                              value
                            
                            
                            Fair
                              value
                            
                            
                            Unreal-
                              ized
      loss
                            
                            
                            Realized
                              OTTI
                              Credit
                              Loss
                              (YTD
                              2010)
                            
                            
                            Moody's
                              /Fitch
                              ratings
                            
                            
                            Current
                              number
                              of
      banks
                            
                            
                            Current
                              number
      of
                              insurance
                              companies
                            
                            
                            Actual
                              deferrals
      and
                              defaults
      as a %
                              of
      total
                              collateral
                            
                            
                            Total
                              performing
                              collateral
      as a
                              %
      of
                              outstanding
                              bondsPreTSL
      IV
                            
                            Mezzanine*
                            
                            $
                            243
                            
                            
                            $
                            148
                            
                            
                            $
                            (95
                            )
                            
                            $
                            -
                            
                            
                            Ca/CCC
                            
                            
                            
                            5
                            
                            
                            
                            -
                            
                            
                            
                            27.1
                            %
                            
                            
                            123.6
                            %PreTSL
      V
                            
                            Mezzanine*
                            
                            
                            216
                            
                            
                            
                            82
                            
                            
                            
                            (134
                            )
                            
                            
                            (10
                            )
                            
                            Ba3/C
                            
                            
                            
                            2
                            
                            
                            
                            -
                            
                            
                            
                            43.1
                            %
                            
                            
                            94.7
                            %PreTSL
      VI
                            
                            Mezzanine*
                            
                            
                            121
                            
                            
                            
                            100
                            
                            
                            
                            (21
                            )
                            
                            
                            -
                            
                            
                            Caa1/CC
                            
                            
                            
                            5
                            
                            
                            
                            -
                            
                            
                            
                            81.0
                            %
                            
                            
                            50.1
                            %PreTSL
      XVII
                            
                            Mezzanine
                            
                            
                            810
                            
                            
                            
                            170
                            
                            
                            
                            (640
                            )
                            
                            
                            (139
                            )
                            
                            Ca/CC
                            
                            
                            
                            47
                            
                            
                            
                            6
                            
                            
                            
                            24.5
                            %
                            
                            
                            88.1
                            %PreTSL
      XIX
                            
                            Mezzanine
                            
                            
                            987
                            
                            
                            
                            426
                            
                            
                            
                            (561
                            )
                            
                            
                            -
                            
                            
                            Ca/C
                            
                            
                            
                            52
                            
                            
                            
                            14
                            
                            
                            
                            22.1
                            %
                            
                            
                            86.3
                            %PreTSL
      XXV
                            
                            Mezzanine
                            
                            
                            766
                            
                            
                            
                            88
                            
                            
                            
                            (678
                            )
                            
                            
                            (9
                            )
                            
                            Ca/C
                            
                            
                            
                            60
                            
                            
                            
                            8
                            
                            
                            
                            31.0
                            %
                            
                            
                            78.1
                            %PreTSL
      XXVI
                            
                            Mezzanine
                            
                            
                            771
                            
                            
                            
                            121
                            
                            
                            
                            (650
                            )
                            
                            
                            -
                            
                            
                            
                            C/C
                            
                            
                            
                            54
                            
                            
                            
                            10
                            
                            
                            
                            28.3
                            %
                            
                            
                            81.3
                            %$
                            3,914
                            
                            
                            $
                            1,135
                            
                            
                            $
                            (2,779
                            )
                            
                            $
                            (158
                            )


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





The
market for these securities at March 31, 2010 is not active and markets for
similar securities are also not active. The inactivity was evidenced first by a
significant widening of the bid-ask spread in the brokered markets in which
pooled trust preferred securities trade and then by a significant decrease in
the volume of trades relative to historical levels. The new issue market is also
inactive and the market values for these securities (and any securities other
than those issued or guaranteed by U.S. Government agencies) are depressed
relative to historical levels. In today’s market, a low market price for a
particular bond may only provide evidence of a recent widening of corporate
spreads in general versus being an indicator of credit problems with a
particular issuer. Lack of liquidity in the market for trust preferred
collateralized debt obligations, credit rating downgrades and market
uncertainties related to the financial industry are factors contributing to the
impairment of these securities. Although these securities are classified as
available-for-sale, the Company has the intent to hold the securities and does
not believe it will be required to sell the securities before recovery occurs.
As illustrated in the table above, these securities are comprised mainly of
securities issued by banks, and to a lesser degree, insurance companies. QNB
owns the mezzanine tranches of these securities.


- 15
-


QNB
CORP. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




7.
INVESTMENT SECURITIES (Continued)





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 fair value
of the security and the amount of credit related impairment. In the first
quarter of 2010, $158,000 in other-than-temporary impairment charges
representing credit impairment were recognized on our pooled trust preferred
collateralized debt obligations. A discounted cash flow analysis provides the
best estimate of credit related OTTI for these securities. Additional
information related to this analysis follows:





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





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




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




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




·
            Probability
      of Default – A near-term probability of default is determined for each
      issuer based on its financial condition and is used to calculate the
      expected impact of future deferrals and defaults on the expected cash
      flows. Each issuer in the collateral pool is assigned a near-term
      probability of default based on individual performance and financial
      characteristics. Various studies suggest that the rate of bank failures
      between 1934 and 2008 were approximately 0.36%. Future deferrals on the
      individual banks in the analysis are assumed at 1% for 2011, 0.75% for
      2012 (two times historical levels) and 0.37% for 2013 and beyond
      (historical levels). Banks currently in default or deferring interest
      payments are assigned a 100% probability of default. All other banks in
      the pool are assigned a probability of default based on their unique
      credit characteristics and market
indicators.




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


- 16
-




QNB
CORP. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




7.
INVESTMENT SECURITIES (Continued)





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





Based
upon the analysis performed by management as of March 31, 2010, the expected
principal shortfall on three out of eight pooled trust preferred securities have
resulted in a $158,000 credit related other-than-temporary impairment charge in
the first quarter of 2010. This compares to $0 for the first quarter of 2009 and
a $1,002,000 credit related other-than-temporary impairment charge for the year
ended December 31, 2009.





8.
LOANS & ALLOWANCE FOR LOAN LOSSES





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





March 31, 2010
                  
                  
                  December 31, 2009Commercial
      and industrial
                  
                  $
                  102,823
                  
                  
                  $
                  104,523Construction
                  
                  
                  25,281
                  
                  
                  
                  27,567Real
      estate-commercial
                  
                  
                  184,081
                  
                  
                  
                  173,019Real
      estate-residential
                  
                  
                  129,098
                  
                  
                  
                  128,825Consumer
                  
                  
                  3,373
                  
                  
                  
                  3,702Indirect
      lease financing
                  
                  
                  11,581
                  
                  
                  
                  11,826Total
      loans
                  
                  
                  456,237
                  
                  
                  
                  449,462Net
      unearned fees
                  
                  
                  (20
                  )
                  
                  
                  (41
                  )Loans
      receivable
                  
                  $
                  456,217
                  
                  
                  $
                  449,421





Activity
in the allowance for loan losses is shown below:





Quarter
      Ended
                    
                    
                    Year
      EndedMarch 31,
                    
                    
                    December 31,2010
                    
                    
                    2009
                    
                    
                    2009Balance
      at beginning of period
                    
                    $
                    6,217
                    
                    
                    $
                    3,836
                    
                    
                    $
                    3,836Charge-offs
                    
                    
                    (599
                    )
                    
                    
                    (243
                    )
                    
                    
                    (1,934
                    )Recoveries
                    
                    
                    39
                    
                    
                    
                    27
                    
                    
                    
                    165Net
      charge-offs
                    
                    
                    (560
                    )
                    
                    
                    (216
                    )
                    
                    
                    (1,769
                    )Provision
      for loan losses
                    
                    
                    700
                    
                    
                    
                    600
                    
                    
                    
                    4,150Balance
      at end of period
                    
                    $
                    6,357
                    
                    
                    $
                    4,220
                    
                    
                    $
                    6,217


- 17
-


QNB
CORP. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)





8.
LOANS & ALLOWANCE FOR LOAN LOSSES (Continued)





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





At March 31, 2010
                      
                      At December 31, 2009Balance
                      
                      
                      Specific
                        reserve
                      
                      Balance
                      
                      
                      Specific
                        reserveRecorded
      investment in impaired loans at period-end subject to a specific reserve
      for loan losses and corresponding specific reserve
                      
                      $
                      1,289
                      
                      
                      $
                      216
                      
                      
                      $
                      1,077
                      
                      
                      $
                      528Recorded
      investment in impaired loans at period-end requiring no specific reserve
      for loan losses
                      
                      
                      4,137
                      
                      
                      
                      
                      
                      
                      
                      4,622Recorded
      investment in impaired loans at period-end
                      
                      $
                      5,426
                      
                      
                      
                      
                      
                      
                      $
                      5,699





9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES





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





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





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


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


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





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





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


- 18
-


QNB
CORP. AND SUBSIDIARY
  NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





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





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
                    PeriodMarch
      31, 2010Securities
      available-for-sale
                  
                  $
                  8,214
                  
                  
                  $
                  253,908
                  
                  
                  $
                  1,135
                  
                  
                  $
                  263,257December
      31, 2009Securities
      available-for-sale
                  
                  $
                  8,472
                  
                  
                  $
                  247,382
                  
                  
                  $
                  1,008
                  
                  
                  $
                  256,862





The Level
1 securities in the table above included all U.S. Treasury and equity securities
at both March 31, 2010 and December 31, 2009. There were no transfers in and out
of Level 1 and Level 2 fair value measurements during the period ended March 31,
2010.





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





For the Three Months Ended
                  March 31, 2010
                
                Balance at
                  December 31,
                  2009
                
                
                Total
                  Unrealized
                  Gains or
                  (Losses)
                
                
                Total
                  Realized
                  Gains or
                  (Losses)
                
                
                Purchases
                  (Sales or
                  Paydowns)
                
                
                Balance at
                  March 31,
                  2010Securities
      available-for-sale
                
                $
                1,008
                
                
                $
                286
                
                
                $
                (158
                )
                
                $
                (1
                )
                
                $
                1,135





There
were $158,000 and $0 of losses included in earnings attributable to the change
in unrealized gains or losses relating to the available-for-sale securities
above with fair value measurements utilizing significant unobservable inputs for
the periods ended March 31, 2010 and 2009, respectively.





The Level
3 securities consist of eight collateralized debt obligation securities that are
backed by trust preferred securities issued by banks, thrifts, and insurance
companies (TRUP CDOs). The market for these securities at March 31, 2010 is not
active and markets for similar securities are also not active. The inactivity
was evidenced first by a significant widening of the bid-ask spread in the
brokered markets in which TRUP CDOs 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 March 31,
      2010,


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


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


- 19
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





The Bank
is aware of several factors indicating that recent transactions of TRUP CDO
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 TRUP CDO. 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. Over the long term, the default rates are modeled to migrate to two
times the historic norms.





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





Prepayments
are modeled to take into account the disruption in the asset-backed securities
marketplace and the lack of new trust preferred issuances.





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 an estimated market discount rate ranging from 10% to
15%.





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





Quoted
      Prices in
                        Active
      Markets for
                        Identical
      Assets
                        (Level
      1)
                      
                      
                      Significant
      Other
                        Observable
      Input
                        (Level
      2)
                      
                      
                      Significant
                        Unobservable
                        Inputs
      (Level 3)
                      
                      
                      Balance
      at End of
                        PeriodMarch
      31, 2010Mortgage
      servicing rights
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      517
                      
                      
                      $
                      517Impaired
      loans, net
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,073
                      
                      
                      
                      1,073December
      31, 2009Mortgage
      servicing rights
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      519
                      
                      
                      $
                      519Impaired
      loans
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      549
                      
                      
                      
                      549Foreclosed
      assets
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      67
                      
                      
                      
                      67





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


- 20
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





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





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





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





At March
31, 2010, the Company determined that no active market existed for pooled trust
preferred securities with an amortized cost of $3,914,000 and an estimated fair
value of $1,135,000. At December 31, 2009, the Company determined that no active
market existed for pooled trust preferred securities with an amortized cost of
$4,073,000 and an estimated fair value of $1,008,000.





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





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





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





Impaired Loans (generally
carried at fair value): Impaired loans are loans, in which the Company
has measured impairment generally based on the fair value of the loan’s
collateral. Fair value is generally determined based upon independent
third-party appraisals of the properties, or discounted cash flows based upon
the expected proceeds. These assets are included as Level 3 fair values, based
upon the lowest level of input that is significant to the fair value
measurements. The fair value of impaired loans as of March 31, 2010 consists of
loan balances of $1,289,000 less a valuation allowance of $216,000. The fair
value of impaired loans as of December 31, 2009 consists of loan balances of
$1,077,000 less a valuation allowance of $528,000.





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


- 21
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





Certain
tranches of mortgage servicing rights, which are carried at lower of cost or
fair value, were written down to fair value during the quarter. The ending
valuation allowance is $5,000 at March 31, 2010.





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





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





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





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





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





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


- 22
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)




9.
FAIR VALUE MEASUREMENTS AND DISCLOSURES (Continued)





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





March 31, 2010
                    
                    
                    December 31, 2009Carrying
                    
                    
                    Estimated
                    
                    
                    Carrying
                    
                    
                    EstimatedAmount
                    
                    
                    Fair Value
                    
                    
                    Amount
                    
                    
                    Fair ValueFinancial
      AssetsCash
      and due from banks
                    
                    $
                    10,519
                    
                    
                    $
                    10,519
                    
                    
                    $
                    8,841
                    
                    
                    $
                    8,841Interest-bearing
      deposits in banks
                    
                    
                    17,680
                    
                    
                    
                    17,680
                    
                    
                    
                    22,158
                    
                    
                    
                    22,158Investment
      securities available-for-sale
                    
                    
                    263,257
                    
                    
                    
                    263,257
                    
                    
                    
                    256,862
                    
                    
                    
                    256,862Investment
      securities held-to-maturity
                    
                    
                    2,847
                    
                    
                    
                    2,961
                    
                    
                    
                    3,347
                    
                    
                    
                    3,471Restricted
      investment in bank stocks
                    
                    
                    2,291
                    
                    
                    
                    2,291
                    
                    
                    
                    2,291
                    
                    
                    
                    2,291Loans
      held-for-sale
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    534
                    
                    
                    
                    537Net
      loans
                    
                    
                    449,860
                    
                    
                    
                    429,299
                    
                    
                    
                    443,204
                    
                    
                    
                    423,036Mortgage
      servicing rights
                    
                    
                    517
                    
                    
                    
                    637
                    
                    
                    
                    519
                    
                    
                    
                    637Accrued
      interest receivable
                    
                    
                    2,913
                    
                    
                    
                    2,913
                    
                    
                    
                    2,848
                    
                    
                    
                    2,848Financial
      LiabilitiesDeposits
      with no stated maturities
                    
                    
                    337,742
                    
                    
                    
                    337,742
                    
                    
                    
                    313,007
                    
                    
                    
                    313,007Deposits
      with stated maturities
                    
                    
                    324,629
                    
                    
                    
                    326,765
                    
                    
                    
                    321,096
                    
                    
                    
                    323,437Short-term
      borrowings
                    
                    
                    21,831
                    
                    
                    
                    21,831
                    
                    
                    
                    28,433
                    
                    
                    
                    28,433Long-term
      debt
                    
                    
                    25,000
                    
                    
                    
                    26,533
                    
                    
                    
                    35,000
                    
                    
                    
                    36,559Accrued
      interest payable
                    
                    
                    1,405
                    
                    
                    
                    1,405
                    
                    
                    
                    1,565
                    
                    
                    
                    1,565





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





March 31, 2010
                        
                        December 31, 2009Notional
                        
                        
                        Estimated
                        
                        Notional
                        
                        
                        EstimatedAmount
                        
                        
                        Fair Value
                        
                        Amount
                        
                        
                        Fair ValueCommitments
      to extend credit
                        
                        $
                        105,521
                        
                        
                        $
                        -
                        
                        
                        $
                        99,119
                        
                        
                        $
                        -Standby
      letters of credit
                        
                        
                        15,107
                        
                        
                        
                        -
                        
                        
                        
                        14,071
                        
                        
                        
                        -





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.


- 23
-




QNB
CORP. AND SUBSIDIARY




NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





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





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





March 31, 2010
                  
                  
                  December 31, 2009Commitments
      to extend credit and unused lines of credit
                  
                  $
                  105,521
                  
                  
                  $
                  99,119Standby
      letters of credit
                  
                  
                  15,107
                  
                  
                  
                  14,071$
                  120,628
                  
                  
                  $
                  113,190





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





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





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





11.
REGULATORY RESTRICTIONS





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





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 March 31, 2010, that the Company and the
Bank met capital adequacy requirements to which they were subject.





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


- 24
-




QNB
CORP. AND SUBSIDIARY




NOTES
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
      LevelsActual
                      
                      
                      Adequately
      Capitalized
                      
                      
                      Well
      CapitalizedAs of March 31, 2010
                      
                      Amount
                      
                      
                      Ratio
                      
                      
                      Amount
                      
                      
                      Ratio
                      
                      
                      Amount
                      
                      
                      RatioTotal
      Risk-Based Capital (to Risk Weighted Assets)Consolidated
                      
                      $
                      62,454
                      
                      
                      
                      11.53
                      %
                      
                      $
                      43,349
                      
                      
                      
                      8.00
                      %
                      
                      
                      N/A
                      
                      
                      
                      N/ABank
                      
                      
                      58,610
                      
                      
                      
                      10.88
                      %
                      
                      
                      43,101
                      
                      
                      
                      8.00
                      %
                      
                      $
                      53,876
                      
                      
                      
                      10.00
                      %Tier
      I Capital (to Risk Weighted Assets)Consolidated
                      
                      
                      55,870
                      
                      
                      
                      10.31
                      %
                      
                      
                      21,675
                      
                      
                      
                      4.00
                      %
                      
                      
                      N/A
                      
                      
                      
                      N/ABank
                      
                      
                      52,253
                      
                      
                      
                      9.70
                      %
                      
                      
                      21,550
                      
                      
                      
                      4.00
                      %
                      
                      
                      32,326
                      
                      
                      
                      6.00
                      %Tier
      I Capital (to Average Assets)Consolidated
                      
                      
                      55,870
                      
                      
                      
                      7.45
                      %
                      
                      
                      29,982
                      
                      
                      
                      4.00
                      %
                      
                      
                      N/A
                      
                      
                      
                      N/ABank
                      
                      
                      52,253
                      
                      
                      
                      7.00
                      %
                      
                      
                      29,844
                      
                      
                      
                      4.00
                      %
                      
                      
                      37,305
                      
                      
                      
                      5.00
                      %





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


- 25
-




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




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





QNB Corp.
(herein referred to as QNB or the Company) is a bank holding company
headquartered in Quakertown, Pennsylvania. The Company, through its wholly-owned
subsidiary, QNB Bank (the Bank), has been serving the residents and businesses
of upper Bucks, northern Montgomery and southern Lehigh counties in Pennsylvania
since 1877. The Bank is a locally managed community bank that provides a full
range of commercial and retail banking and retail brokerage
services.





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





FORWARD-LOOKING
STATEMENTS





In
addition to historical information, this document contains forward-looking
statements. Forward-looking statements are typically identified by words or
phrases such as “believe,” “expect,” “anticipate,” “intend,” “estimate,”
“project” and variations of such words and similar expressions, or future or
conditional verbs such as “will,” “would,” “should,” “could,” “may” or similar
expressions. The U.S. Private Securities Litigation Reform Act of 1995 provides
safe harbor in regard to the inclusion of forward-looking statements in this
document and documents incorporated by reference.





Shareholders
should note that many factors, some of which are discussed elsewhere in this
document and in the documents that are incorporated by reference, and including
the risk factors identified in Item 1A of QNB’s 2009 Form 10-K, could affect the
future financial results of the Company and its subsidiary and could cause those
results to differ materially from those expressed in the forward-looking
statements contained or incorporated by reference in this document. These
factors include, but are not limited, to the following:


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


·
            Credit
      risk;


·
            Liquidity
      risk;


·
            Operating,
      legal and regulatory risks;


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


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


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





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


- 26
-


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





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





During
the first quarter of 2010 QNB recorded a credit-related other-than-temporary
impairment charge of $158,000 on three of its pooled trust preferred securities.
For the same period in 2009, the Company recorded an other-than-temporary
impairment charge of $390,000 related to losses in the equity securities
portfolio.





Impairment
of Restricted Investment in Bank Stocks


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





In
December 2008, the FHLB of Pittsburgh notified member banks that it was
suspending dividend payments and the repurchase of capital stock to preserve
capital. Management’s determination of whether these investments are impaired is
based on their assessment of the ultimate recoverability of their cost rather
than by recognizing temporary declines in value. The determination of whether a
decline affects the ultimate recoverability of their cost is influenced by
criteria such as (1) the significance of the decline in net assets of the FHLB
as compared to the capital stock amount for the FHLB and the
length of time this situation has persisted, (2) commitments by the FHLB to make
payments required by law or regulation and the level of such payments in
relation to the operating performance of the FHLB, and (3) the impact of
legislative and regulatory changes on institutions and, accordingly, on the
customer base of the FHLB. Management believes no impairment charge is necessary
related to the restricted stock as of March 31, 2010.


- 27
-


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


CRITICAL
ACCOUNTING POLICIES AND ESTIMATES (Continued)





Allowance
for Loan Losses


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.





- 28
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS


CRITICAL
ACCOUNTING POLICIES AND ESTIMATES (Continued)





Stock-Based
Compensation


At March
31, 2010, QNB sponsored stock-based compensation plans, administered by a board
committee, under which both qualified and non-qualified stock options may be
granted periodically to certain employees. QNB accounts for all awards granted
under stock-based compensation plans in accordance with ASC 718,
Compensation-Stock Compensation. Compensation cost has been measured using the
fair value of an award on the grant date and is recognized over the service
period, which is usually the vesting period. The fair value of each option is
amortized into compensation expense on a straight-line basis between the grant
date for the option and each vesting date. QNB estimates the fair value of stock
options on the date of the grant using the Black-Scholes option pricing model.
The model requires the use of numerous assumptions, many of which are highly
subjective in nature.





Income
Taxes


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





RESULTS
OF OPERATIONS - OVERVIEW





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





QNB
reported net income for the first quarter of 2010 of $1,826,000, or $0.59 per
share on a diluted basis. This represents a 66.9% increase in net income
compared to the same period in 2009. Net income for the first quarter of 2009
was $1,094,000, or $0.35 per share on a diluted basis.





Net
interest income increased $943,000, or 18.6%, to $6,024,000 for the first
quarter of 2010 compared to the first quarter of 2009, reflecting an increase in
interest income of $202,000, or 2.3%, and a reduction of interest expense by
$741,000, or 20.9%. The significant decrease in interest expense has been
influenced by a change in the mix of deposit types as well as the pricing of new
and reinvested time deposits at lower market rates.





The net
interest margin was 3.64% for the first quarter of 2010 compared to 3.48% for
the first quarter of 2009 and 3.42% for the fourth quarter of 2009. The increase
in the net interest margin from both the first and fourth quarters of 2009 is
mainly the result of the cost of deposits and short-term borrowings declining to
a greater degree than the yield earned on loans. Average earning assets grew
12.9% with average loans increasing 10.0% and average investment securities
increasing 13.0% when comparing the first quarter of 2010 to the same period in
2009. The growth in loans was mainly related to real estate secured commercial
loans and to a lesser degree commercial and industrial loans, while the growth
in the investment




- 29
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS




RESULTS
OF OPERATIONS – OVERVIEW (Continued)





As a
result of continued loan growth, higher than normal levels of net charge-offs
and continued concerns over current economic conditions, QNB recorded a
provision for loan losses of $700,000 in the first quarter of 2010. This
compares to provisions of $600,000 for the quarter ended March 31, 2009 and
$1,550,000 for the quarter ended December 31, 2009. Net loan charge-offs were
$560,000 for the first quarter of 2010 compared with $216,000 for the first
quarter of 2009 and $906,000 for the fourth quarter of 2009.





Total
non-performing loans, which represent loans on non-accrual status, loans past
due more than 90 days and still accruing interest, and restructured loans were
$5,895,000, or 1.29% of total loans, at March 31, 2010, compared to $743,000, or
0.18% of total loans, at March 31, 2009 and $6,102,000, or 1.36% of total loans
at December 31, 2009. Total delinquent loans, which include loans that are
thirty days or more past due, increased to 2.46% of total loans at March 31,
2010, compared with 0.83% and 2.17% of total loans at March 31, 2009 and
December 31, 2009, respectively. QNB’s non-performing loan and total delinquent
loan ratios continue to compare favorably with the average for Pennsylvania
commercial banks with assets between $500 million and $1 billion, as reported by
the FDIC using December 31, 2009 data, the most recent available. The total
non-performing loan and total delinquent loan ratios for the Pennsylvania
commercial banks noted above were 2.34% and 3.74% of total loans, respectively,
as of December 31, 2009.





QNB’s
allowance for loan losses of $6,357,000 represents 1.39% of total loans at March
31, 2010 compared to an allowance for loan losses of $4,220,000, or 1.01% of
total loans at March 31, 2009 and $6,217,000, or 1.38% of total loans at
December 31, 2009. Other real estate owned and other repossessed assets were
$51,000 at March 31, 2010 compared with $437,000 at March 31, 2009 and $67,000
at December 31, 2009.





Total
non-interest income was $1,132,000 for the first quarter of 2010, an increase of
$399,000 compared with the same period in 2009. Activity in the investment
securities portfolio is the primary reason for the increase in total
non-interest income. In the first quarter of 2010, gains primarily on the sale
of several equity securities totaling $294,000 were offset in part by a $158,000
credit-related other-than-temporary impairment (OTTI) charge on pooled trust
preferred securities resulting in a net gain of $136,000. In the first quarter
of 2009 investment securities activity resulted in a $254,000 net loss and
included a $390,000 charge related to OTTI in the carrying value of holdings in
the equity investment portfolio and $136,000 of gains realized on the sale of
several higher-yielding corporate bonds sold to reduce credit risk in the
portfolio.





Non-interest
income for the first quarter of 2010, excluding net investment securities gains,
totaled $996,000 compared to $987,000 for the first quarter of 2009, excluding
net investment securities losses. Less residential mortgage activity for the
2010 quarter resulted in gains on sales of residential mortgage loans decreasing
$93,000 to $75,000. Increases in merchant income, letter of credit fees, and ATM
and debit card income contributed $59,000 in additional non-interest income when
comparing the three-month periods. Losses on the sale of repossessed assets
decreased $42,000 when comparing the quarter ended March 31, 2010 to the same
period in 2009.





Total
non-interest expense was $4,118,000 for the first quarter of 2010, an increase
of 4.8% compared to $3,929,000 for the first quarter of 2009. The largest
contributing factor to this increase in non-interest expense was FDIC insurance
premium expense which increased $61,000, or 31.6%, to $254,000. The higher
expense is primarily the result of deposit growth and an increased assessment
rate levied on all insured institutions by the FDIC. Salary and benefit expense
increased $59,000, or 2.8%, to $2,137,000 for the first quarter of 2010
primarily as a result of normal merit increases.





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


- 30
-




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





Average
      Balances, Rate, and Interest Income and Expense Summary (Tax-Equivalent
      Basis)Three Months Ended
                                                          
                                                          March 31, 2010
                                                          
                                                          
                                                          March 31, 2009Average
                                                          
                                                          
                                                          Average
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          Average
                                                          
                                                          
                                                          AverageBalance
                                                          
                                                          
                                                          Rate
                                                          
                                                          
                                                          Interest
                                                          
                                                          
                                                          Balance
                                                          
                                                          
                                                          Rate
                                                          
                                                          
                                                          InterestAssetsFederal
      funds sold
                                                          
                                                          $
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          $
                                                          -
                                                          
                                                          
                                                          $
                                                          1,497
                                                          
                                                          
                                                          
                                                          0.20
                                                          %
                                                          
                                                          $
                                                          1Investment
      securities:U.S.
      Treasury
                                                          
                                                          
                                                          5,025
                                                          
                                                          
                                                          
                                                          0.58
                                                          %
                                                          
                                                          
                                                          7
                                                          
                                                          
                                                          
                                                          5,064
                                                          
                                                          
                                                          
                                                          1.60
                                                          %
                                                          
                                                          
                                                          20U.S.
      Government agencies
                                                          
                                                          
                                                          63,566
                                                          
                                                          
                                                          
                                                          3.40
                                                          %
                                                          
                                                          
                                                          541
                                                          
                                                          
                                                          
                                                          37,083
                                                          
                                                          
                                                          
                                                          4.77
                                                          %
                                                          
                                                          
                                                          442State
      and municipal
                                                          
                                                          
                                                          55,900
                                                          
                                                          
                                                          
                                                          6.35
                                                          %
                                                          
                                                          
                                                          887
                                                          
                                                          
                                                          
                                                          47,732
                                                          
                                                          
                                                          
                                                          6.46
                                                          %
                                                          
                                                          
                                                          771Mortgage-backed
      and CMOs
                                                          
                                                          
                                                          120,601
                                                          
                                                          
                                                          
                                                          4.29
                                                          %
                                                          
                                                          
                                                          1,292
                                                          
                                                          
                                                          
                                                          119,098
                                                          
                                                          
                                                          
                                                          5.46
                                                          %
                                                          
                                                          
                                                          1,625Corporate
      bonds (fixed and variable)
                                                          
                                                          
                                                          4,517
                                                          
                                                          
                                                          
                                                          1.24
                                                          %
                                                          
                                                          
                                                          14
                                                          
                                                          
                                                          
                                                          7,486
                                                          
                                                          
                                                          
                                                          4.66
                                                          %
                                                          
                                                          
                                                          87Money
      market mutual funds
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          3,398
                                                          
                                                          
                                                          
                                                          1.02
                                                          %
                                                          
                                                          
                                                          9Equities
                                                          
                                                          
                                                          2,830
                                                          
                                                          
                                                          
                                                          3.66
                                                          %
                                                          
                                                          
                                                          26
                                                          
                                                          
                                                          
                                                          3,466
                                                          
                                                          
                                                          
                                                          3.04
                                                          %
                                                          
                                                          
                                                          26Total
      investment securities
                                                          
                                                          
                                                          252,439
                                                          
                                                          
                                                          
                                                          4.38
                                                          %
                                                          
                                                          
                                                          2,767
                                                          
                                                          
                                                          
                                                          223,327
                                                          
                                                          
                                                          
                                                          5.34
                                                          %
                                                          
                                                          
                                                          2,980Loans:Commercial
      real estate
                                                          
                                                          
                                                          239,586
                                                          
                                                          
                                                          
                                                          6.02
                                                          %
                                                          
                                                          
                                                          3,555
                                                          
                                                          
                                                          
                                                          201,399
                                                          
                                                          
                                                          
                                                          6.28
                                                          %
                                                          
                                                          
                                                          3,117Residential
      real estate
                                                          
                                                          
                                                          24,294
                                                          
                                                          
                                                          
                                                          5.72
                                                          %
                                                          
                                                          
                                                          347
                                                          
                                                          
                                                          
                                                          24,187
                                                          
                                                          
                                                          
                                                          6.05
                                                          %
                                                          
                                                          
                                                          366Home
      equity loans
                                                          
                                                          
                                                          61,728
                                                          
                                                          
                                                          
                                                          5.08
                                                          %
                                                          
                                                          
                                                          774
                                                          
                                                          
                                                          
                                                          67,576
                                                          
                                                          
                                                          
                                                          5.25
                                                          %
                                                          
                                                          
                                                          875Commercial
      and industrial
                                                          
                                                          
                                                          80,202
                                                          
                                                          
                                                          
                                                          5.18
                                                          %
                                                          
                                                          
                                                          1,024
                                                          
                                                          
                                                          
                                                          72,024
                                                          
                                                          
                                                          
                                                          4.94
                                                          %
                                                          
                                                          
                                                          876Indirect
      lease financing
                                                          
                                                          
                                                          13,956
                                                          
                                                          
                                                          
                                                          8.45
                                                          %
                                                          
                                                          
                                                          295
                                                          
                                                          
                                                          
                                                          15,234
                                                          
                                                          
                                                          
                                                          8.43
                                                          %
                                                          
                                                          
                                                          321Consumer
      loans
                                                          
                                                          
                                                          3,574
                                                          
                                                          
                                                          
                                                          11.73
                                                          %
                                                          
                                                          
                                                          103
                                                          
                                                          
                                                          
                                                          4,275
                                                          
                                                          
                                                          
                                                          10.35
                                                          %
                                                          
                                                          
                                                          109Tax-exempt
      loans
                                                          
                                                          
                                                          27,724
                                                          
                                                          
                                                          
                                                          5.78
                                                          %
                                                          
                                                          
                                                          396
                                                          
                                                          
                                                          
                                                          25,424
                                                          
                                                          
                                                          
                                                          6.01
                                                          %
                                                          
                                                          
                                                          377Total
      loans, net of unearned income*
                                                          
                                                          
                                                          451,064
                                                          
                                                          
                                                          
                                                          5.84
                                                          %
                                                          
                                                          
                                                          6,494
                                                          
                                                          
                                                          
                                                          410,119
                                                          
                                                          
                                                          
                                                          5.97
                                                          %
                                                          
                                                          
                                                          6,041Other
      earning assets
                                                          
                                                          
                                                          16,983
                                                          
                                                          
                                                          
                                                          0.23
                                                          %
                                                          
                                                          
                                                          10
                                                          
                                                          
                                                          
                                                          3,513
                                                          
                                                          
                                                          
                                                          0.16
                                                          %
                                                          
                                                          
                                                          1Total
      earning assets
                                                          
                                                          
                                                          720,486
                                                          
                                                          
                                                          
                                                          5.22
                                                          %
                                                          
                                                          
                                                          9,271
                                                          
                                                          
                                                          
                                                          638,456
                                                          
                                                          
                                                          
                                                          5.73
                                                          %
                                                          
                                                          
                                                          9,023Cash
      and due from banks
                                                          
                                                          
                                                          9,351
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          9,814Allowance
      for loan losses
                                                          
                                                          
                                                          (6,246
                                                          )
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          (3,925
                                                          )Other
      assets
                                                          
                                                          
                                                          25,956
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          21,695Total
      assets
                                                          
                                                          $
                                                          749,547
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          $
                                                          666,040Liabilities
      and Shareholders' EquityInterest-bearing
      deposits:Interest-bearing
      demand
                                                          
                                                          $
                                                          81,793
                                                          
                                                          
                                                          
                                                          0.69
                                                          %
                                                          
                                                          
                                                          138
                                                          
                                                          
                                                          $
                                                          64,501
                                                          
                                                          
                                                          
                                                          0.49
                                                          %
                                                          
                                                          
                                                          78Municipals
                                                          
                                                          
                                                          34,314
                                                          
                                                          
                                                          
                                                          0.99
                                                          %
                                                          
                                                          
                                                          84
                                                          
                                                          
                                                          
                                                          25,611
                                                          
                                                          
                                                          
                                                          1.21
                                                          %
                                                          
                                                          
                                                          76Money
      market
                                                          
                                                          
                                                          72,172
                                                          
                                                          
                                                          
                                                          0.93
                                                          %
                                                          
                                                          
                                                          166
                                                          
                                                          
                                                          
                                                          48,064
                                                          
                                                          
                                                          
                                                          1.38
                                                          %
                                                          
                                                          
                                                          164Savings
                                                          
                                                          
                                                          74,542
                                                          
                                                          
                                                          
                                                          0.77
                                                          %
                                                          
                                                          
                                                          141
                                                          
                                                          
                                                          
                                                          44,790
                                                          
                                                          
                                                          
                                                          0.25
                                                          %
                                                          
                                                          
                                                          28Time
                                                          
                                                          
                                                          217,241
                                                          
                                                          
                                                          
                                                          2.37
                                                          %
                                                          
                                                          
                                                          1,272
                                                          
                                                          
                                                          
                                                          215,098
                                                          
                                                          
                                                          
                                                          3.49
                                                          %
                                                          
                                                          
                                                          1,849Time
      of $100,000 or more
                                                          
                                                          
                                                          106,620
                                                          
                                                          
                                                          
                                                          2.42
                                                          %
                                                          
                                                          
                                                          636
                                                          
                                                          
                                                          
                                                          105,216
                                                          
                                                          
                                                          
                                                          3.54
                                                          %
                                                          
                                                          
                                                          920Total
      interest-bearing deposits
                                                          
                                                          
                                                          586,682
                                                          
                                                          
                                                          
                                                          1.68
                                                          %
                                                          
                                                          
                                                          2,437
                                                          
                                                          
                                                          
                                                          503,280
                                                          
                                                          
                                                          
                                                          2.51
                                                          %
                                                          
                                                          
                                                          3,115Short-term
      borrowings
                                                          
                                                          
                                                          22,588
                                                          
                                                          
                                                          
                                                          0.95
                                                          %
                                                          
                                                          
                                                          53
                                                          
                                                          
                                                          
                                                          18,488
                                                          
                                                          
                                                          
                                                          1.23
                                                          %
                                                          
                                                          
                                                          56Long-term
      debt
                                                          
                                                          
                                                          27,000
                                                          
                                                          
                                                          
                                                          4.65
                                                          %
                                                          
                                                          
                                                          314
                                                          
                                                          
                                                          
                                                          35,000
                                                          
                                                          
                                                          
                                                          4.27
                                                          %
                                                          
                                                          
                                                          374Total
      interest-bearing liabilities
                                                          
                                                          
                                                          636,270
                                                          
                                                          
                                                          
                                                          1.79
                                                          %
                                                          
                                                          
                                                          2,804
                                                          
                                                          
                                                          
                                                          556,768
                                                          
                                                          
                                                          
                                                          2.58
                                                          %
                                                          
                                                          
                                                          3,545Non-interest-bearing
      deposits
                                                          
                                                          
                                                          54,109
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          50,576Other
      liabilities
                                                          
                                                          
                                                          3,533
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          4,293Shareholders'
      equity
                                                          
                                                          
                                                          55,635
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          54,403Total
      liabilities and shareholders' equity
                                                          
                                                          $
                                                          749,547
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          $
                                                          666,040Net
      interest rate spread
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          3.43
                                                          %
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          3.15
                                                          %Margin/net
      interest income
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          3.64
                                                          %
                                                          
                                                          $
                                                          6,467
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          
                                                          3.48
                                                          %
                                                          
                                                          $
                                                          5,478


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


- 31
-




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


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





Three
      Months EndedMarch
      31, 2010 comparedto
      March 31, 2009Total
                              
                              
                              Due to change in:Change
                              
                              
                              Volume
                              
                              
                              RateInterest
      income:Federal
      funds sold
                              
                              $
                              (1
                              )
                              
                              $
                              (1
                              )
                              
                              $
                              -Investment
      securities:U.S.
      Treasury
                              
                              
                              (13
                              )
                              
                              
                              -
                              
                              
                              
                              (13
                              )U.S.
      Government agencies
                              
                              
                              99
                              
                              
                              
                              315
                              
                              
                              
                              (216
                              )State
      and municipal
                              
                              
                              116
                              
                              
                              
                              132
                              
                              
                              
                              (16
                              )Mortgage-backed
      and CMOs
                              
                              
                              (333
                              )
                              
                              
                              20
                              
                              
                              
                              (353
                              )Corporate
      bonds (fixed and variable)
                              
                              
                              (73
                              )
                              
                              
                              (34
                              )
                              
                              
                              (39
                              )Money
      market mutual funds
                              
                              
                              (9
                              )
                              
                              
                              (9
                              )
                              
                              
                              -Equities
                              
                              
                              -
                              
                              
                              
                              (4
                              )
                              
                              
                              4Loans:Commercial
      real estate
                              
                              
                              438
                              
                              
                              
                              590
                              
                              
                              
                              (152
                              )Residential
      real estate
                              
                              
                              (19
                              )
                              
                              
                              1
                              
                              
                              
                              (20
                              )Home
      equity loans
                              
                              
                              (101
                              )
                              
                              
                              (75
                              )
                              
                              
                              (26
                              )Commercial
      and industrial
                              
                              
                              148
                              
                              
                              
                              100
                              
                              
                              
                              48Indirect
      lease financing
                              
                              
                              (26
                              )
                              
                              
                              (27
                              )
                              
                              
                              1Consumer
      loans
                              
                              
                              (6
                              )
                              
                              
                              (18
                              )
                              
                              
                              12Tax-exempt
      loans
                              
                              
                              19
                              
                              
                              
                              34
                              
                              
                              
                              (15
                              )Other
      earning assets
                              
                              
                              9
                              
                              
                              
                              6
                              
                              
                              
                              3Total
      interest income
                              
                              
                              248
                              
                              
                              
                              1,030
                              
                              
                              
                              (782
                              )Interest
      expense:Interest-bearing
      demand
                              
                              
                              60
                              
                              
                              
                              21
                              
                              
                              
                              39Municipals
                              
                              
                              8
                              
                              
                              
                              26
                              
                              
                              
                              (18
                              )Money
      market
                              
                              
                              2
                              
                              
                              
                              81
                              
                              
                              
                              (79
                              )Savings
                              
                              
                              113
                              
                              
                              
                              18
                              
                              
                              
                              95Time
                              
                              
                              (577
                              )
                              
                              
                              19
                              
                              
                              
                              (596
                              )Time
      of $100,000 or more
                              
                              
                              (284
                              )
                              
                              
                              13
                              
                              
                              
                              (297
                              )Short-term
      borrowings
                              
                              
                              (3
                              )
                              
                              
                              12
                              
                              
                              
                              (15
                              )Long-term
      debt
                              
                              
                              (60
                              )
                              
                              
                              (85
                              )
                              
                              
                              25Total
      interest expense
                              
                              
                              (741
                              )
                              
                              
                              105
                              
                              
                              
                              (846
                              )Net
      interest income
                              
                              $
                              989
                              
                              
                              $
                              925
                              
                              
                              $
                              64


- 32
-




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





NET
INTEREST INCOME





The
following table presents the adjustment to convert net interest income to net
interest income on a fully taxable-equivalent basis for the three-month period
ended March 31, 2010 and 2009.





For
      the Three Months Ended March 31,
                            
                            2010
                            
                            
                            2009Total
      interest income
                            
                            $
                            8,828
                            
                            
                            $
                            8,626Total
      interest expense
                            
                            
                            2,804
                            
                            
                            
                            3,545Net
      interest income
                            
                            
                            6,024
                            
                            
                            
                            5,081Tax-equivalent
      adjustment
                            
                            
                            443
                            
                            
                            
                            397Net
      interest income (fully taxable-equivalent)
                            
                            $
                            6,467
                            
                            
                            $
                            5,478





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





For
purposes of this discussion, interest income and the average yield earned on
loans and investment securities are adjusted to a tax-equivalent basis as
detailed in the tables that appear on pages 32 and 33. This adjustment to
interest income is made for analysis purposes only. Interest income is increased
by the amount of savings of Federal income taxes, which QNB realizes by
investing in certain tax-exempt state and municipal securities and by making
loans to certain tax-exempt organizations. In this way, the ultimate economic
impact of earnings from various assets can be more easily compared.





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





Net
interest income increased $943,000, or 18.6%, to $6,024,000 for the quarter
ended March 31, 2010 as compared to the quarter ended March 31, 2009. It also
represents an increase of $251,000, or 4.3%, from the $5,773,000 reported for
the fourth quarter of 2009. On a tax-equivalent basis, net interest income
increased $989,000, or 18.1%, from $5,478,000 for the three months ended March
31, 2009 to $6,467,000 for the same period ended March 31, 2010.





Several
factors contributed to the significant increase in net interest income. Strong
growth in deposits and the deployment of these deposits into commercial loans at
reasonable interest rates contributed to the growth in tax-equivalent interest
income of $248,000. Total average deposits increased $86,935,000, or 15.7%, to
$640,791,000 when comparing the three months ended March 31, 2010 and March 31,
2009. Over this same time period total average loans increased $40,945,000, or
10.0%, and total average investment securities increased $29,112,000, or 13.0%.
Another factor in the increase in net interest income was the significant
decrease in interest expense resulting from a change in the mix of deposit types
as well as the pricing of new and reinvested time deposits at lower market
rates. Interest expense declined by $741,000, or 20.9%, when comparing the two
quarters. As a result of these factors the net interest margin improved to 3.64%
for the first quarter of 2010 compared to 3.48% for the first quarter of 2009
and 3.42% for the fourth quarter of 2009.





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


- 33
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NET
INTEREST INCOME (Continued)





The yield
on earning assets on a tax-equivalent basis decreased 51 basis points from 5.73%
for the first quarter of 2009 to 5.22% for the first quarter of 2010. However,
the yield of 5.22% for the first quarter of 2010 represents an increase of five
basis points from the 5.17% reported for the fourth quarter of 2009. In
comparison, the rate paid on interest-bearing liabilities decreased 79 basis
points from 2.58% for the first quarter of 2009 to 1.79% for the first quarter
of 2010 and decreased 19 basis points when compared to 1.98% reported in the
fourth quarter of 2009.





Interest
income on investment securities decreased $213,000 when comparing the two
quarters as the increase in average balances could only partially offset the 96
basis point decline in the average yield of the portfolio. The average yield on
the investment portfolio was 4.38% for the first quarter of 2010 compared with
5.34% for the first quarter of 2009. The decline in the yield on the investment
portfolio is primarily the result of the extended period of low interest rates
which has resulted in an increase in cash flow from the investment portfolio as
prepayments speeds on mortgage-backed securities and CMOs ramped-up as did the
amount of calls of agency and municipal securities. The reinvestment of these
funds were generally in securities that had lower yields than what they
replaced. The growth in the investment portfolio was primarily in high quality
U.S. Government agency and tax-exempt State and municipal bonds. Income on
Government agency securities increased $99,000, as the 71.4% growth in average
balances was offset by a 137 basis point decline in the yield from 4.77% for the
first quarter of 2009 to 3.40% for the same period in 2010. Most of the bonds in
the agency portfolio have call features ranging from three months to five years,
many of which were exercised as a result of the low interest rate environment.
The proceeds from these called bonds were reinvested in securities with
significantly lower yields. Interest on tax-exempt municipal securities
increased $116,000 with higher balances accounting for $132,000 of additional
income. The yield on the state and municipal portfolio decreased from 6.46% for
the first quarter of 2009 to 6.35% for the first quarter of 2010. Interest
income on mortgage-backed securities and CMOs decreased $333,000 with lower
yields being the primary factor. The yield on the mortgage-backed portfolio
decreased from 5.46% to 4.29% when comparing the first quarter of 2009 and
2010.





To reduce
credit risk in the portfolio QNB has proactively sold over the past two years
corporate bonds issued by financial institutions, nonagency issued CMOs and
noninvestment grade and nonrated state and municipal bonds. These sales
generally resulted in the recording of gains but usually also resulted in the
selling of some higher yielding bonds. The corporate bond portfolio is currently
comprised primarily of pooled trust preferred securities, most of which are on
nonaccrual status.  Interest on corporate bonds declined by $73,000
with the nonaccrual status of the trust preferred securities accounting for much
of the difference. As mentioned previously, in January 2009, QNB sold $6,000,000
in corporate bonds issued by financial institutions at a gain of $136,000. The
bonds sold had an average yield of 6.89%. This also had the impact of reducing
interest income, the average balance and the average yield on the corporate bond
portfolio. The yield on the total investment portfolio is anticipated to
continue to decline as cash flow from the portfolio as well as excess liquidity
is reinvested at current market rates which are below the projected portfolio
yield at March 31, 2010 of 4.35%.





Income on
loans increased $453,000 to $6,494,000 when comparing the first quarters of 2010
and 2009 as the impact of declining interest rates was offset by the growth in
the portfolio. Average loans increased $40,945,000, or 10.0%, and contributed an
additional $605,000 in interest income. The yield on loans decreased 13 basis
points, to 5.84% when comparing the same periods, resulting in a reduction in
interest income of $152,000. Reducing the impact of the decline in interest
rates on loan yields is the structure of the loan portfolio, which has a
significant portion of fixed-rate and adjustable-rate loans with fixed-rate
terms for three to ten years. Also helping to stabilize the yield was the
implementation of interest rate floors on some variable rate commercial loans
and home equity lines of credit. The rate earned on loans has not fallen to the
degree that the rate earned on investment securities, which are more closely
tied to the treasury yield curve.




- 34
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NET
INTEREST INCOME (Continued)




Most of
the growth in the loan portfolio, both in terms of balances and interest income,
was in the category of commercial real estate loans. This category of loans
includes commercial purpose loans secured by either commercial properties such
as office buildings, factories, warehouses, medical facilities and retail
establishments, or residential real estate, usually the residence of the
business owner. The category also includes construction and land development
loans. Income on these loans
increased $438,000, with average balances increasing $38,187,000, or 19.0%, to
$239,586,000, for the three months ended March 31, 2010. The yield on commercial
real estate loans was 6.02% for the first quarter of 2010, a decline of 26 basis
points from the 6.28% reported for the first quarter of 2009. Interest on
commercial and industrial loans, the second largest category, increased $148,000
with a positive impact from both the growth in balances and the increase in the
yield. Average commercial and industrial loans increased $8,178,000, or 11.4%,
to $80,202,000 for the first quarter of 2010, contributing an additional
$100,000 in interest income. The average yield on these loans increased 24 basis
points to 5.18% resulting in an increase in income of $48,000. The
implementation of interest rate floors on loans in this category, primarily
lines of credit indexed to the prime rate, was a major factor in the improvement
in the yield.





Income on
home equity loans declined by $101,000 when comparing the first quarter of 2010
and 2009. Over this same time period average home equity loans decreased
$5,848,000, or 8.7%, to $61,728,000, while the yield on the home equity
portfolio decreased 17 basis points to 5.08%. The demand for home equity loans
has declined as home values have fallen preventing some homeowners from having
equity in their homes to borrow against while others have taken advantage of the
low interest rates on mortgages and refinanced their home equity loans into a
new mortgage. Included in the home equity portfolio are floating rate home
equity lines tied to the prime lending rate. The average balance of these loans
increased by $4,572,000, or 23.4%, to $24,080,000 for the first quarter of 2010.
In contrast, average fixed rate home equity loans declined by $10,420,000, or
21.7%, to $37,648,000. Customers who are opening home equity loans are choosing
the floating rate option indexed to prime even with a rate floor because the
rate is currently significantly lower than a fixed rate home equity
loan.





Income on
other earning assets is comprised of interest on deposits in correspondent
banks, primarily the Federal Reserve Bank and dividends on restricted
investments in bank stocks, primarily the Federal Home Loan Bank of Pittsburgh
(FHLB). Income on other earning assets increased from $1,000 for the first
quarter of 2009 to $10,000 for the first quarter of 2010. Beginning in December
2008, the Fed began paying 0.25% on balances in excess of required reserves.
With this rate being above what could be earned on selling Federal funds or
investing in AAA rated money market mutual funds excess liquidity was housed at
the Fed. The average balance held at the Federal Reserve Bank was $14,370,000
for the three months ended March 31, 2010 compared with $278,000 for the first
quarter of 2009. This resulted in interest income of $9,000 included in other
earning assets for the first quarter of 2010. In December 2008, the FHLB
notified member banks that it was suspending dividend payments to preserve
capital. There was no dividend income from the FHLB in either the first quarter
of 2010 or 2009.





For the
most part, earning assets are funded by deposits, which increased on average by
$86,935,000, or 15.7%, to $640,791,000, when comparing the first quarters of
2010 and 2009. It appears that customers continue to seek the safety of FDIC
insured deposits and the stability of a strong local community bank as opposed
to the volatility of the equity markets and the uncertainty of the larger
regional and national banks. On October 3, 2008, in response to the ongoing
economic crisis affecting the financial services industry, the Emergency
Economic Stabilization Act of 2008 was enacted which temporarily raised the
basic limit on FDIC coverage from $100,000 to $250,000 per depositor until
December 31, 2009. However, legislation was passed during the second quarter of
2009 that extended the higher coverage through December 31, 2013. In addition,
on October 13, 2008, the FDIC established a program under which the FDIC will
fully guarantee all non-interest bearing transaction accounts until December 31,
2009 (the “Transaction Account Guarantee Program”). On August 26, 2009 the FDIC
amended the program to extend the date six months until June 30, 2010 to those
institutions that do not opt out of participating. On April 19, 2010 the program
was extended again until December 31, 2010. QNB is participating in the
Transaction Account Guarantee Program. To participate in this program QNB pays a
fee of 15 basis points. These programs likely contributed to the growth in
deposits.





While
total income on earning assets on a tax-equivalent basis increased $248,000 when
comparing the first quarter of 2010 to the first quarter of 2009, total interest
expense declined $741,000. Interest expense on total deposits decreased $678,000
while interest expense on borrowed funds decreased $63,000 when comparing the
two quarters. The rate paid on interest-bearing liabilities decreased 79 basis
points from 2.58% for the first quarter of 2009 to 1.79% for the first quarter
of 2010. During this same period, the rate paid on interest-bearing deposits
decreased 83 basis points from 2.51% to 1.68%.




- 35
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NET
INTEREST INCOME (Continued)





All
categories of average deposits increased when comparing the first quarter of
2010 to the same period in 2009. Unlike prior years the growth was not centered
in time deposits but in interest-bearing demand, money market and savings
deposits, accounts with greater liquidity. Average interest-bearing demand
accounts increased $17,292,000, or 26.8%, to $81,793,000 for the three months
ended March 31, 2010 compared to the three months ended March 31, 2009. Interest
expense on interest-bearing demand accounts increased from $78,000 for the first
quarter of 2009 to $138,000 for the first quarter of 2010 while the average rate
paid increased from 0.49% to 0.69%. The increase in the average rate paid
reflects a change in the mix of accounts included in interest-bearing demand
accounts. Included in this category is  eRewards checking, a high rate
checking account introduced during the third quarter of 2008. For the first
quarter of 2009 the account paid interest of 4.01% on balances up to $25,000. As
of April 1, 2009, the yield paid on balances up to $25,000 was reduced to 3.25%.
This yield was reduced again on February 10, 2010 to 2.75%. In order to receive
the high rate a customer must receive an electronic statement, have one direct
deposit or other ACH transaction and perform at least 12 check card transactions
per statement cycle. For the first quarter of 2010, the average balance in the
product was $23,066,000 and the related interest expense was $130,000 for an
average yield of 2.28%. This lower rate than the 2.75% reflects the lower rate
paid on accounts that do not meet the qualifications or on balances in excess of
$25,000 which pay 1.01%. In comparison the average balance for the first quarter
of 2009 was $8,862,000 with a related interest expense of $70,000 and an average
rate paid of 3.22%. Even with the drop in the rate paid, it is anticipated that
this product will continue to result in the movement of balances from lower
yielding deposit accounts to this product, but will also result in obtaining new
customers and additional deposits of existing customers. This product also
generates fee income through the use of the check card.





Interest
expense on municipal interest-bearing demand accounts increased from $76,000 for
the first quarter of 2009 to $84,000 for the same period in 2010. The increase
in interest expense was the result of volume growth as the average balance of
municipal interest-bearing demand accounts increased $8,703,000, or 34.0%. The
impact on interest expense of the increase in balances was partially offset by a
decline in the average interest rate paid on these accounts from 1.21% for the
first quarter of 2009 to 0.99% for the first quarter of 2010. Most of these
accounts are tied directly to the Federal funds rate with some having rate
floors between 0.50% and 1.50%. The balances in many of these accounts are
seasonal in nature and are dependant upon the timing of the receipt of taxes and
the disbursement by the schools and municipalities.





Average
money market accounts increased $24,108,000, or 50.2%, to $72,172,000 for the
first quarter of 2010 compared with the first quarter of 2009. Despite the
significant increase in balances, interest expense on money market accounts only
increased $2,000 to $166,000 for the first quarter of 2010 compared to the first
quarter of 2009. Interest expense related to the increase in average balances
was $81,000 while the decline in the rate paid had the impact of decreasing
interest expense by $79,000. The average interest rate paid on money market
accounts was 1.38% for the first quarter of 2009 and 0.93% for the first quarter
of 2010, a decline of 45 basis points. Included in total money market balances
is the Select money market account, a higher yielding money market product that
pays a tiered rate based on account balances. With the sharp decline in
short-term interest rates, the rates paid on the Select money market account
have declined as well. The growth in balances is in both consumer and business
accounts and appears to reflect the desire for safety, liquidity and a rate
comparable with short-term time deposits.





During
the second quarter of 2009 QNB introduced an online only eSavings account to
compete with other online savings accounts. This product was introduced at a
yield of 1.85% and has been extremely successful having grown to $31,625,000 at
March 31, 2010. The eSavings yield was reduced to 1.60% on March 17, 2010. The
average balance of this product was $24,945,000 for the first quarter of 2010
and contributed to the $29,752,000, or 66.4%, increase in total average savings
accounts when comparing the first quarters of 2010 and 2009. Average statement
savings accounts also increased $4,797,000, or 11.0%, when comparing the same
periods. As a result of the eSavings product the average rate paid on savings
accounts increased 52 basis points from 0.25% for the first quarter of 2009 to
0.77% for the first quarter of 2010.




- 36
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NET
INTEREST INCOME (Continued)





While
time deposit balances did not increase significantly when comparing the two
quarters, time deposits did have the greatest impact on total interest expense
as these accounts repriced lower over the past year.  Total interest
expense on time deposits decreased $861,000, or 31.1%, to $1,908,000 for the
first quarter of 2010. Average total time deposits increased by $3,547,000, or
1.1%, to $323,861,000 for the first quarter of 2010. Similar to fixed-rate loans
and investment securities, time deposits reprice over time and, therefore, have
less of an immediate impact on costs in either a rising or falling rate
environment. Unlike loans and investment securities, however, the maturity and
repricing characteristics of time deposits tend to be shorter. Over the course
of 2009 and the first quarter of 2010 a significant amount of time deposits have
repriced lower as rates have declined. The average rate paid on time deposits
decreased from 3.51% to 2.39% when comparing the first quarter of 2009 to the
same period in 2010.





Approximately
$231,950,000, or 71.5%, of time deposits at March 31, 2010 will reprice or
mature over the next 12 months. The average rate paid on these time deposits is
approximately 2.26%. Included in this amount are $60,896,000 of time deposits
which mature during the second quarter of 2010 at an average rate of 2.84%.
Given the short-term nature of QNB’s time deposit portfolio and the current
rates being offered, it is likely that the average rate paid on time deposits
should continue to decline through the second quarter or third quarter of 2010
as higher costing time deposits are repriced lower. To date QNB has been
extremely successful in meeting the challenge of retaining these
deposits.





Contributing
to the decrease in total interest expense was a reduction in interest expense on
long-term debt of $60,000. In January 2010, $10,000,000 in FHLB advances at a
rate of 2.97% matured and were repaid resulting in the reduction in expense.
Since the rate paid on the debt that was repaid was lower than the remaining
debt the average rate paid increased from 4.27% for the first quarter of 2009 to
4.65% for the first quarter of 2010. In April, 2010 another $5,000,000 of debt
at a rate of 4.90% was repaid.





PROVISION
FOR LOAN LOSSES





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





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





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





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




- 37
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





PROVISION
FOR LOAN LOSSES (Continued)





As a
result of continued loan growth, higher than normal levels of net charge-offs
and continued concerns over current economic conditions, QNB recorded a
provision for loan losses of $700,000 in the first quarter of 2010. This
compares to provisions of $600,000 for the quarter ended March 31, 2009 and
$1,550,000 for the quarter ended December 31, 2009. Net loan charge-offs were
$560,000, or 0.50% (annualized) of average total loans for the first quarter of
2010 compared with $216,000, or 0.21% (annualized) of average total loans for
the first quarter of 2009 and $906,000, or 0.82% (annualized) of average total
loans for the fourth quarter of 2009. Of the charge-offs for the first quarter
of 2010, $350,000 relates to a commercial borrower whose loan was secured by
business assets. Indirect lease financing net charge-offs were $62,000 and
$99,000 for the first quarter of 2010 and 2009, respectively. This portfolio
includes loans to businesses in the trucking and construction industries which
were negatively impacted by the slowdown in the economy over the past 18
months.





As
referenced in the following table, the levels of non-performing and delinquent
loans have trended higher over the past year. At March 31, 2010 non-performing
loans totaled $5,895,000, as compared with $6,102,000 at December 31, 2009 and
$743,000 at March 31, 2009. When compared to total loans, non-performing loans
have risen from 0.18% at March 31, 2009 to 1.29% at March 31, 2010. However, it
does represent a slight improvement from the 1.36% reported at December 31,
2009. Despite the increase in non-performing loans over the past year QNB’s
non-performing loans to total loans ratio continues to compare favorably with
the average 2.34% of total loans for Pennsylvania commercial banks with assets
between $500 million and $1 billion as reported by the FDIC using December 31,
2009 data, the most recent available.





Delinquent
loans are considered performing loans and exclude non-accrual loans,
restructured loans and loans 90 days or more past due and still accruing
interest (all of which are considered non-performing loans). Total delinquent
loans at March 31, 2010, December 31, 2009 and March 31, 2009 represent 1.24%,
0.89% and 0.66% of total loans, respectively. The increase from December 31,
2009 primarily represents loans to one borrower.





The
allowance for loan losses was $6,357,000 and $6,217,000 at March 31, 2010 and
December 31, 2009, respectively. The ratio of the allowance to total loans was
1.39% and 1.38% at the respective period end dates. The ratio is at a level that
QNB management believes is adequate based on its analysis of known and inherent
losses in the portfolio.





A loan is
considered impaired, based on current information and events, if it is probable
that QNB will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan agreement.
Impaired loans are primarily those classified as non-accrual or restructured.
The measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the effective interest rate, except
that all collateral-dependent loans are measured for impairment based on the
fair value of the collateral. At March 31, 2010 and December 31, 2009, the
recorded investment in impaired loans totaled $5,426,000 and $5,699,000,
respectively, of which $4,137,000 and $4,622,000, respectively, required no
specific allowance for loan losses. The recorded investment in impaired loans
requiring a specific allowance for loan losses was $1,289,000 and $1,077,000 at
March 31, 2010 and December 31, 2009, respectively. At March 31, 2010 and
December 31, 2009 the related allowance for loan losses associated with these
loans was $216,000 and $528,000, respectively. Most of the loans that have been
identified as impaired are collateral-dependent.




- 38
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





PROVISION
FOR LOAN LOSSES (Continued)





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





3/31/10
                    
                    
                    12/31/09
                    
                    
                    9/30/09
                    
                    
                    6/30/09
                    
                    
                    3/31/09Non-performing
      loans
                    
                    $
                    5,895
                    
                    
                    $
                    6,102
                    
                    
                    $
                    5,199
                    
                    
                    $
                    4,203
                    
                    
                    $
                    743Non-performing
      loans to total loans
                    
                    
                    1.29
                    %
                    
                    
                    1.36
                    %
                    
                    
                    1.19
                    %
                    
                    
                    0.97
                    %
                    
                    
                    0.18
                    %Delinquent
      loans (30-89 days past due), not included above
                    
                    $
                    5,677
                    
                    
                    $
                    4,015
                    
                    
                    $
                    5,210
                    
                    
                    $
                    4,049
                    
                    
                    $
                    2,757Delinquent
      loans to total loans
                    
                    
                    1.24
                    %
                    
                    
                    0.89
                    %
                    
                    
                    1.19
                    %
                    
                    
                    0.93
                    %
                    
                    
                    0.66
                    %Total
      delinquent and non-performing loans
                    
                    $
                    11,572
                    
                    
                    $
                    10,117
                    
                    
                    $
                    10,409
                    
                    
                    $
                    8,252
                    
                    
                    $
                    3,500Total
      delinquent and non-performing loans to total loans
                    
                    
                    2.54
                    %
                    
                    
                    2.25
                    %
                    
                    
                    2.38
                    %
                    
                    
                    1.89
                    %
                    
                    
                    0.83
                    %Non-performing
      assets
                    
                    $
                    6,932
                    
                    
                    $
                    7,032
                    
                    
                    $
                    6,285
                    
                    
                    $
                    4,582
                    
                    
                    $
                    1,180Non-performing
      assets to total assets
                    
                    
                    0.90
                    %
                    
                    
                    0.92
                    %
                    
                    
                    0.86
                    %
                    
                    
                    0.64
                    %
                    
                    
                    0.17
                    %





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





March 31, 2010
                            
                            
                            December 31, 2009Loans
      past due 90 days or more and still accruing interest
                            
                            $
                            14
                            
                            
                            $
                            759Non-accrual
      loans
                            
                            
                            3,664
                            
                            
                            
                            3,086Restructured loans, not included
      above
                            
                            
                            2,217
                            
                            
                            
                            2,257Total
      non-performing loans
                            
                            $
                            5,895
                            
                            
                            $
                            6,102Other
      real estate owned and repossessed assets
                            
                            
                            51
                            
                            
                            
                            67Non-accrual pooled trust preferred
      securities
                            
                            
                            986
                            
                            
                            
                            863Total non-performing assets
                            
                            $
                            6,932
                            
                            
                            $
                            7,032Average
      total loans (YTD average)
                            
                            $
                            451,064
                            
                            
                            $
                            427,924Total
      loans, including loans held for sale
                            
                            
                            456,217
                            
                            
                            
                            449,421Allowance
      for loan losses
                            
                            
                            6,357
                            
                            
                            
                            6,217Allowance
      for loan losses to:Non-performing
      loans
                            
                            
                            107.85
                            %
                            
                            
                            101.88
                            %Total
      loans
                            
                            
                            1.39
                            %
                            
                            
                            1.38
                            %Average
      total loans
                            
                            
                            1.41
                            %
                            
                            
                            1.45
                            %Non-performing
      loans / Loans
                            
                            
                            1.29
                            %
                            
                            
                            1.36
                            %Non-performing assets /
    Assets
                            
                            
                            0.90
                            %
                            
                            
                            0.92
                            %




- 39
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





PROVISION
FOR LOAN LOSSES (Continued)





An
analysis of loan charge-offs for the three months ended March 31, 2010 compared
to 2009 is as follows:





For the Three Months Ended March
      31,
                        
                        2010
                        
                        
                        2009Net
      charge-offs
                        
                        $
                        560
                        
                        
                        $
                        216Net
      charge-offs (annualized) to:Total
      loans
                        
                        
                        0.50
                        %
                        
                        
                        0.21
                        %Average
      total loans
                        
                        
                        0.50
                        %
                        
                        
                        0.21
                        %Allowance for loan losses
                        
                        
                        35.75
                        %
                        
                        
                        20.73
                        %





NON-INTEREST
INCOME





Non-Interest IncomeComparisonChange
      from PriorYearThree
      Months Ended March 31,
                                                      
                                                      2010
                                                      
                                                      
                                                      2009
                                                      
                                                      
                                                      Amount
                                                      
                                                      
                                                      PercentFees
      for services to customers
                                                      
                                                      $
                                                      405
                                                      
                                                      
                                                      $
                                                      395
                                                      
                                                      
                                                      $
                                                      10
                                                      
                                                      
                                                      
                                                      2.5
                                                      %ATM
      and debit card
                                                      
                                                      
                                                      271
                                                      
                                                      
                                                      
                                                      228
                                                      
                                                      
                                                      
                                                      43
                                                      
                                                      
                                                      
                                                      18.9
                                                      %Bank-owned
      life insurance
                                                      
                                                      
                                                      64
                                                      
                                                      
                                                      
                                                      71
                                                      
                                                      
                                                      
                                                      (7
                                                      )
                                                      
                                                      
                                                      -9.9
                                                      %Mortgage
      servicing fees
                                                      
                                                      
                                                      32
                                                      
                                                      
                                                      
                                                      36
                                                      
                                                      
                                                      
                                                      (4
                                                      )
                                                      
                                                      
                                                      -11.1
                                                      %Net
      gain on sale of loans
                                                      
                                                      
                                                      75
                                                      
                                                      
                                                      
                                                      168
                                                      
                                                      
                                                      
                                                      (93
                                                      )
                                                      
                                                      
                                                      -55.4
                                                      %Net
      gain (loss) on investment securities
                                                      
                                                      
                                                      136
                                                      
                                                      
                                                      
                                                      (254
                                                      )
                                                      
                                                      
                                                      390
                                                      
                                                      
                                                      
                                                      153.5
                                                      %Other
                                                      
                                                      
                                                      149
                                                      
                                                      
                                                      
                                                      89
                                                      
                                                      
                                                      
                                                      60
                                                      
                                                      
                                                      
                                                      67.4
                                                      %Total
                                                      
                                                      $
                                                      1,132
                                                      
                                                      
                                                      $
                                                      733
                                                      
                                                      
                                                      $
                                                      399
                                                      
                                                      
                                                      
                                                      54.4
                                                      %





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





Total
non-interest income for the first quarter of 2010 was $1,132,000 compared to
$733,000 for the first quarter of 2009. Activity in the investment securities
portfolio is the primary reason for the increase in total non-interest
income.





Fees for
services to customers are primarily comprised of service charges on deposit
accounts. These fees increased $10,000, or 2.5%, to $405,000 when comparing the
three-month periods. Overdraft increased slightly despite QNB reducing the per
item charge for overdrafts in March by $2.00, to $35.00. A modest increase in
the volume of overdrafts was able to offset the lower charge per
item.





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 $271,000 for the first quarter
of 2010, an increase of $43,000 from the amount recorded during the first
quarter of 2009. This primarily reflects growth in ATM and debit card
transactions. Helping to contribute to the growth in debit card transactions is
the growth in the eRewards checking product, a high-yield checking account which
requires a minimum of twelve debit card transactions per statement cycle to
receive the high interest rate.




- 40
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NON-INTEREST
INCOME (Continued)





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. Mortgage servicing fees for the
three-month periods ended March 31, 2010 and 2009 were $32,000 and $36,000,
respectively. Mortgage servicing fee income is made of several components: the
fee earned for servicing the mortgage minus the amortization of the mortgage
servicing asset plus or minus the change in the valuation allowance. During the
three months ended March 31, 2009 there was a $26,000 reversal of a portion of
the valuation allowance that was recorded at December 31, 2008. Amortization
expense related to the mortgage servicing asset for the three-month periods
ended March 31, 2010 and 2009 was $18,000 and $33,000, respectively. Mortgage
refinance activity increased significantly during the first quarter of 2009 as
residential mortgage rates declined resulting in a higher amount of amortization
expense as mortgage servicing assets were written off. The average balance of
mortgages serviced for others was $80,019,000 for the first quarter of 2010
compared to $67,334,000 for the first quarter of 2009, an increase of 10.8%. The
timing of mortgage payments and delinquencies also impacts the amount of
servicing fees recorded.





The
fixed-income securities portfolio represents a significant portion of QNB’s
earning assets and is also a primary tool in liquidity and asset/liability
management. QNB actively manages its fixed income portfolio in an effort to take
advantage of changes in the shape of the yield curve 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.





Net
investment securities gains were $136,000 for the quarter ended March 31, 2010
compared to net losses of $254,000 for the comparable quarter in 2009. In the
first quarter of 2010, gains primarily on the sale of several equity securities
totaling $294,000 were offset in part by a $158,000 credit-related
other-than-temporary impairment (OTTI) charge on pooled trust preferred
securities resulting in a net gain of $136,000. In the first quarter of 2009
investment securities activity resulted in a $254,000 net loss and included a
$390,000 charge related to OTTI in the carrying value of holdings in the equity
investment portfolio and $136,000 of gains realized on the sale of several
higher-yielding corporate bonds sold to reduce credit risk in the
portfolio.





The net
gain on the sale of residential mortgage loans was $75,000 and $168,000 for the
quarters ended March 31, 2010 and 2009, respectively. This $93,000 decrease in
the net gain on sale of loans was a result of decreased refinancing activity.
Many customers who were able to refinance have already refinanced due to the low
interest rate environment that has existed for over a year. Residential mortgage
loans to be sold are identified at origination. The net gain on residential
mortgage sales is directly related to the volume of mortgages sold and the
timing of the sales relative to the interest rate environment. Included in the
gains on the sale of residential mortgages in these periods were $17,000 and
$58,000, respectively, related to the recognition of mortgage servicing assets.
Proceeds from the sale of residential mortgages were $2,313,000 and $7,685,000
for the first quarters of 2010 and 2009, respectively.





Other
income was $149,000 for the first quarter of 2010 and $89,000 for the same
period during 2009. The majority of the increase was attributable to the
following:


·
            Merchant
      income increased $10,000, or 21.3%, for the three-month period which is
      attributable to new merchant accounts being
  obtained.


·
            Letter
      of credit fee income increased
$6,000.


·
            Loss
      on sale of repossessed assets of $3,000 was $42,000 lower than the first
      quarter of 2009.





- 41
-




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


NON-INTEREST
EXPENSE





Non-Interest Expense
    ComparisonChange from PriorYearThree Months Ended March
31,
                                            
                                            2010
                                            
                                            
                                            2009
                                            
                                            
                                            Amount
                                            
                                            
                                            PercentSalaries
      and employee benefits
                                            
                                            $
                                            2,137
                                            
                                            
                                            $
                                            2,078
                                            
                                            
                                            $
                                            59
                                            
                                            
                                            
                                            2.8
                                            %Net
      occumpancy
                                            
                                            
                                            369
                                            
                                            
                                            
                                            353
                                            
                                            
                                            
                                            16
                                            
                                            
                                            
                                            4.5
                                            %Furniture
      and equipment
                                            
                                            
                                            282
                                            
                                            
                                            
                                            296
                                            
                                            
                                            
                                            (14
                                            )
                                            
                                            
                                            -4.7
                                            %Marketing
                                            
                                            
                                            161
                                            
                                            
                                            
                                            175
                                            
                                            
                                            
                                            (14
                                            )
                                            
                                            
                                            -8.0
                                            %Third-party
      services
                                            
                                            
                                            273
                                            
                                            
                                            
                                            230
                                            
                                            
                                            
                                            43
                                            
                                            
                                            
                                            18.7
                                            %Telephone,
      postage and supplies
                                            
                                            
                                            157
                                            
                                            
                                            
                                            149
                                            
                                            
                                            
                                            8
                                            
                                            
                                            
                                            5.4
                                            %State
      taxes
                                            
                                            
                                            140
                                            
                                            
                                            
                                            135
                                            
                                            
                                            
                                            5
                                            
                                            
                                            
                                            3.7
                                            %FDIC
      insurance premiums
                                            
                                            
                                            254
                                            
                                            
                                            
                                            193
                                            
                                            
                                            
                                            61
                                            
                                            
                                            
                                            31.6
                                            %Other
                                            
                                            
                                            345
                                            
                                            
                                            
                                            320
                                            
                                            
                                            
                                            25
                                            
                                            
                                            
                                            7.8
                                            %Total
                                            
                                            $
                                            4,118
                                            
                                            
                                            $
                                            3,929
                                            
                                            
                                            $
                                            189
                                            
                                            
                                            
                                            4.8
                                            %





Non-interest
expense is comprised of costs related to salaries and employee benefits, net
occupancy, furniture and equipment, marketing, third party services and various
other operating expenses. Total non-interest expense was $4,118,000 for the
first quarter of 2010, an increase of $189,000 compared to the first quarter of
2009.





Salaries
and benefits is the largest component of non-interest expense. Salaries and
benefits expense increased $59,000, or 2.8%, to $2,137,000 for the quarter ended
March 31, 2010 compared to the same quarter in 2009. Salary expense increased
$37,000, or 2.2%, during the period to $1,684,000. Also, included in salary
expense for the first quarter of 2010 and 2009, was $10,000 and $13,000,
respectively, in stock option compensation expense. Merit increases, as well as
a small increase in the average number of full-time equivalent employees
accounts for the higher salary expense. Included in salary and benefit expense
for the first quarter of 2009 were costs associated with the Chief Operating
Officer position. This position was vacant during the first quarter of 2010. The
average number of full time-equivalent employees increased by three when
comparing the first quarter of 2010 and 2009. Comparing the two quarters,
benefits expense increased $22,000, or 5.1%, to $453,000. Increases in
payroll related tax expense, including Pennsylvania unemployment taxes,
increased $8,000 and retirement plan contribution expense increased by $9,000
when comparing the two quarters. In addition, costs related to medical, dental
and life insurance premiums accounted for $12,000 of the increase.





Net
occupancy expense increased $16,000, or 4.5%, to $369,000 for the first quarter
of 2010 while furniture and equipment expense declined by $14,000, or 4.7%, to
$282,000 for the same period. Higher branch rent and building security expense
account for most of the increase in net occupancy expense while the reduction in
depreciation expense contributed to the decline in furniture and fixture
expense.





Marketing
expense decreased $14,000, to $161,000, for the quarter ended March 31, 2010.
Advertising expense was $12,000 lower in 2010 when compared to 2009. The
decrease was related to lower outdoor advertising expenses related to the
Wescosville location, which opened in the fourth quarter of 2008. During the
first quarter of 2009 there was a heightened focus on marketing in that
region.





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 $43,000 for the three months ended March 31, 2010
when comparing the same period in 2009. Total expense was $273,000 for the first
quarter of 2010 compared to $230,000 for the first quarter of 2009. The largest
portion of the increase related to the following third party
services:


·
            Legal
      expense increased by $15,000 primarily as a result of loan collection
      costs.




- 42
-




QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





NON-INTEREST
EXPENSE (Continued)





·
            Consultant
      expense increased $13,000. During the first quarter of 2010 an independent
      third party was utilized to analyze and value the Bank’s pooled trust
      preferred securities. In addition a consultant was hired for leadership
      training.


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


·
            $7,000
      of the increase relates to a new system to allow customers to open
      accounts online through a dedicated secure website and increased vendor
      costs in connection with the eRewards checking
  account.





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 $140,000 for the first quarter of 2010,
an increase of $5,000 compared to the same period in 2009. This increase was a
result of a higher shares tax of $6,000 resulting from an increase in the Bank’s
equity, partially offset by a reduction in the Company’s capital stock
tax.





FDIC
insurance premium expense increased $61,000, or 31.6%, to $254,000, when
comparing the first quarter of 2010 to 2009. The higher expense is a result of
an increased assessment rate levied on all insured institutions by the FDIC in
order to replenish the Deposit Insurance Fund which has been reduced as a result
of the recent bank failures. Strong deposit growth along with QNB’s
participation in the FDIC’s Transaction Account Guarantee Program also
contributed to the higher premiums.





Other
expense increased $25,000 to $345,000 for the first quarter of 2010. The main
contributors to the increase in this category were an $11,000 increase in
expenses related to the processing of check card transactions, an increase of
$10,000 related to charge-offs of fraudulent ATM and check card transactions and
$10,000 related to Directors’ fees. There was also an increase of $5,000 in ATM
fee refunds in connection with the eRewards checking account.. These increases
were partially offset by a decrease of $15,000 related to expenses in connection
with foreclosed real estate and repossessed assets.





INCOME
TAXES





QNB
utilizes an asset and liability approach for financial accounting and reporting
of income taxes. As of March 31, 2010, QNB’s net deferred tax asset was
$1,296,000. The primary components of deferred taxes are a deferred tax asset of
$2,161,000 relating to the allowance for loan losses, a deferred tax asset of
$269,000 generated by OTTI charges on equity securities and a deferred tax asset
of $395,000 related to OTTI charges on trust preferred securities. Partially
offsetting these deferred tax assets was a deferred tax liability of $1,212,000
resulting from unrealized gains on available-for-sale securities. As of March
31, 2009, QNB’s net deferred tax asset was $1,626,000. The primary components of
deferred taxes are a deferred tax asset of $1,435,000 relating to the allowance
for loan losses, a deferred tax asset of $513,000 generated by OTTI charges on
equity securities, and a deferred tax liability of $64,000 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 the effective tax rate were $512,000, or 21.9%, for the
three-month period ended March 31, 2010. Applicable income taxes and the
effective rate were $191,000, or 14.9%, for the three-month period ended March
31, 2009. The low effective rate for the first quarter of 2009 in comparison to
current year was predominantly a result of tax-exempt income from loans and
securities comprising a higher proportion of pre-tax income.




- 43
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS




FINANCIAL
CONDITION ANALYSIS





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





Average
earning assets for the three-month period ended March 31, 2010 increased
$82,030,000, or 12.8%, to $720,486,000 from $638,456,000 for the three months
ended March 31, 2009. The mix of earning assets changed slightly when comparing
the two periods. Average loans increased $40,945,000, or 10.0%, while average
investment securities increased $29,112,000, or 13.0%. Average loans represented
62.6% of earning assets for the first three months of 2010, while average
investment securities represented 35.0% of earning assets for the same period.
This compares to 64.2% and 35.0% for the first three months of 2009. Average
other earning assets increased $13,470,000, or 383%, when comparing these same
periods. Given the low yield on Federal funds sold and AAA rated money market
mutual funds QNB has chosen to keep excess liquidity in an interest-bearing
account at the Federal Reserve Bank that pays a higher rate than these products
and also has a zero percent risk-weighting for risk based capital
purposes.





QNB’s
primary business is accepting deposits and making loans to meet the credit needs
of the communities it serves. Loans are the most significant component of
earning assets and growth in loans to small businesses and residents of these
communities has been a primary focus of QNB. QNB has been successful in
achieving strong growth in total loans, while at the same time maintaining asset
quality. Inherent within the lending function is the evaluation and acceptance
of credit risk and interest rate risk. QNB manages credit risk associated with
its lending activities through portfolio diversification, underwriting policies
and procedures and loan monitoring practices. Total loans increased 9.4% between
March 31, 2009 and March 31, 2010 and increased 1.5% since December 31, 2009.
The growth in loans despite the economic environment reflects QNB’s commitment
to make credit available to its customers.





Average
total commercial loans increased $48,665,000 when comparing the first three
months of 2010 to the first three months of 2009. Most of the 16.3% growth in
average commercial loans was in loans secured by real estate, either commercial
or residential properties, which increased $38,187,000, or 19.0%, to
$239,586,000. Commercial and industrial loans represent commercial purpose loans
that are either secured by collateral other than real estate or unsecured. Many
of these loans are for operating lines of credit. Average commercial and
industrial loans increased $8,178,000, or 11.4%, when comparing the average
balances for the three month periods.





Average
home equity loans continue to decline with average balances decreasing from
$67,576,000 for the three months of 2009 to $61,728,000 for the first three
months of 2010. With the decline in mortgage interest rates that took place,
customers have paid down their home equity loans when they refinance their first
mortgage. The other impact of the low interest rate environment is movement from
fixed rate home equity loans to floating rate lines tied to prime rate. Fixed
rate home equity term loans declined by $10,420,000 to $37,648,000 when
comparing the three-month periods. In contrast average floating rate home equity
lines have increased by $4,572,000 comparing the same periods. The introduction
of the Equity Choice product, which allows both a floating rate line and fixed
rate carve out loans, contributed to this migration, as did the current low
interest rate on the variable rate product.





Total
investment securities were $266,104,000 at March 31, 2010 and $260,209,000 at
December 31, 2009. The composition of the portfolio changed since December
31, 2009 with agency mortgage-backed and CMO securities increasing by
$10,147,000 and $7,436,000, respectively, when comparing December 31, 2009 and
March 31, 2010. These increases were partially offset by a decrease in U.S.
Government agency bonds of $11,722,000 when comparing the same periods. The
agency bonds were callable bonds that were called due to the low interest rate
environment. The proceeds were reinvested in agency mortgage-backed and CMO
securities which will provide ongoing cash flow to invest as rates increase.
During the first quarter of 2010 QNB sold six tax-exempt State and municipal
securities, totaling approximately $938,000, resulting in a gain of $7.400. The
bonds were sold because they had become non-rated by the ratings
agencies.




- 44
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS




FINANCIAL
CONDITION ANALYSIS (Continued)





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
mortgage-backed securities portfolio and its CMO portfolio (both U.S. government
sponsored agency issued securities (FHLMC and FNMA) and non-agency issued
securities). QNB does not own any CDOs backed by subprime
mortgages.





QNB does
own CDOs in the form of pooled trust preferred securities. These securities are
comprised mainly of securities issued by banks, and to a lesser degree,
insurance companies. QNB owns the mezzanine tranches of these securities. These
securities are structured so that the senior and mezzanine tranches are
protected from defaults by over-collateralization and cash flow default
protection provided by subordinated tranches. QNB holds eight of these
securities with an amortized cost of $3,914,000 and a fair value of $1,135,000.
The market values for these securities are very depressed relative to historical
levels. A discounted cash flow analysis provides the best estimate of credit
related OTTI for these securities. During the first quarter of 2010 a $158,000
credit-related other-than-temporary impairment charge was taken on three issues.
It is possible that future calculations could require recording additional
other-than-temporary impairment charges through earnings.





For the
most part, earning assets are funded by deposits. Total average deposits
increased $86,935,000, or 15.7%, to $640,791,000 for the first three months of
2010 compared to the first three months of 2009. It appears that customers are
continuing to look for the safety of FDIC insured deposits and the stability of
a strong local community bank as opposed to the volatility of the equity markets
and the uncertainty of the larger regional and national banks.





Most of
the increase in average deposits was in categories other than time deposits
which only increased $3,547,000, or 1.1%, to $323,861,000 for the first three
months of 2010. Average interest-bearing demand and municipal accounts increased
$17,292,000, or 26.8%, and $8,703,000, or 34.0%, respectively, when comparing
the first three months of 2010 and 2009. The high yielding eRewards checking
product is the primary factor behind the growth of the interest-bearing demand
accounts. Average money market and savings account balances increased
$24,108,000, or 50.2%, and $29,752,000, or 66.4%, when comparing the same
periods. The growth in savings accounts is largely due to the success of QNB’s
newest high-rate deposit product, Online eSavings.





Total
assets at March 31, 2010 were $770,881,000 compared with $762,426,000 at
December 31, 2009, an increase of 1.1%. Impacting total assets was the repayment
of $10,000,000 in FHLB borrowings, classified as long-term debt, which matured
in January, 2010.





On the
liability side, total deposits increased by $28,268,000, or 4.5%, since
year-end. In comparison to prior periods where the growth was centered in time
deposits, the current growth reflects increases in both lower-cost core
deposits, including savings and money market accounts. Savings accounts
increased $15,497,000, or 22.7%, to $83,855,000. The increase in savings
accounts was primarily in the Online eSavings product whose balances increased
from $19,944,000 at December 31, 2009 to $31,625,000 at March 31, 2010. This
account currently yields 1.60%. Money market accounts increased $9,320,000, or
13.3%, from $70,165,000 at December 31, 2009 to $79,485,000 at March 31, 2010.
The majority of the increase was in business accounts which increased by
$8,375,000. These deposits can be volatile depending on the timing of deposits
and withdrawals.





Short-term
borrowings declined $6,602,000 from $28,433,000 at December 31, 2009 to
$21,831,000 at March 31, 2010. The majority of these balances are commercial
sweep accounts which are also volatile based on businesses receipt and
disbursement of funds. The category of other liabilities decreased from
$6,899,000 at December 31, 2009 to $2,050,000 at March 31, 2010. Included in the
December 31, 2009 balance were unsettled trades of investment securities that
settled in January 2010.




- 45
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





LIQUIDITY





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





Additional
sources of liquidity are provided by the Bank’s membership in the FHLB. At March
31, 2010, the Bank had a maximum borrowing capacity with the FHLB of
approximately $196,673,000. In January 2010 QNB repaid $10,000,000 in FHLB
borrowings at a rate of 2.97% that matured. The maximum borrowing capacity
changes as a function of qualifying collateral assets. In addition, the Bank
maintains Federal funds lines with two correspondent banks totaling $18,000,000.
At March 31, 2010, there were no outstanding borrowings under these lines.
Future availability under these lines is subject to the policies of the granting
banks and may be withdrawn.





Cash and
due from banks, interest-bearing deposits in banks, Federal funds sold,
investment securities available-for-sale and loans held-for-sale totaled
$291,456,000 and $288,395,000 at March 31, 2010 and December 31, 2009,
respectively. These sources should be adequate to meet normal fluctuations in
loan demand and deposit withdrawals. With the current low interest rate
environment, it is anticipated that the investment portfolio will continue to
provide significant liquidity as agency and municipal bonds are called and as
cash flow on mortgage-backed and CMO securities continues to be steady. In the
event that interest rates would increase the cash flow available from the
investment portfolio could decrease.





Approximately
$128,035,000 and $133,136,000 of available-for-sale securities at March 31, 2010
and December 31, 2009, respectively, were pledged as collateral for repurchase
agreements and deposits of public funds.





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





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





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 March 31,
2010 was $58,224,000, or 7.55% of total assets, compared to shareholders' equity
of $56,426,000, or 7.40% of total assets, at December 31, 2009. Shareholders’
equity at March 31, 2010 and December 31, 2009 included a positive adjustment of
$2,354,000 and $1,723,000, 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 7.25% and
7.17% at March 31, 2010 and December 31, 2009, respectively.





Average
shareholders' equity and average total assets were $55,635,000 and $749,547,000
for the first three months of 2010, an increase of 1.7% and 5.5%, respectively,
from the averages for the year ended December 31, 2009. The ratio of average
total equity to average total assets was 7.42% for the first three months of
2010 compared to 7.70% for all of 2009.




- 46
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS




CAPITAL
ADEQUACY (Continued)





QNB is
subject to various regulatory capital requirements as issued by Federal
regulatory authorities. Regulatory capital is defined in terms of Tier I capital
(shareholders’ equity excluding unrealized gains or losses on available-for-sale
debt securities and disallowed intangible assets), Tier II capital, which
includes the allowance for loan losses and a portion of the unrealized gains on
equity securities, and total capital (Tier I plus Tier II). Risk-based capital
ratios are expressed as a percentage of risk-weighted assets. Risk-weighted
assets are determined by assigning various weights to all assets and off-balance
sheet arrangements, such as letters of credit and loan commitments, based
on associated risk. Regulators have also adopted minimum Tier I leverage ratio
standards, which measure the ratio of Tier I capital to total quarterly average
assets.





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





Capital AnalysisMarch 31, 2010
                                                              
                                                              
                                                              December 31, 2009Tier
      IShareholder's
      Equity
                                                              
                                                              $
                                                              58,224
                                                              
                                                              
                                                              $
                                                              56,426Net
      unrealized securities gains
                                                              
                                                              
                                                              (2,354
                                                              )
                                                              
                                                              
                                                              (1,723
                                                              )Net unrealized losses on available-for-sale equity
      securities
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -Total
      Tier I risk-based capital
                                                              
                                                              $
                                                              55,870
                                                              
                                                              
                                                              $
                                                              54,703Tier
      IIAllowable
      portion: Allowance for loan losses
                                                              
                                                              
                                                              6,357
                                                              
                                                              
                                                              
                                                              6,217Unrealized gains on equity
      securities
                                                              
                                                              
                                                              227
                                                              
                                                              
                                                              
                                                              248Total risk-based capital
                                                              
                                                              $
                                                              62,454
                                                              
                                                              
                                                              $
                                                              61,168Risk-weighted assets
                                                              
                                                              $
                                                              541,868
                                                              
                                                              
                                                              $
                                                              531,295Average assets
                                                              
                                                              $
                                                              749,547
                                                              
                                                              
                                                              $
                                                              745,551Capital RatiosMarch 31, 2010
                                                              
                                                              
                                                              December 31, 2009Tier
      I capital/risk-weighted assets
                                                              
                                                              
                                                              10.31
                                                              %
                                                              
                                                              
                                                              10.30
                                                              %Total
      risk-based capital/risk-weighted assets
                                                              
                                                              
                                                              11.53
                                                              %
                                                              
                                                              
                                                              11.51
                                                              %Tier I capital/average assets (leverage
      ratio)
                                                              
                                                              
                                                              7.45
                                                              %
                                                              
                                                              
                                                              7.34
                                                              %





The
minimum regulatory capital ratios are 4.00% for Tier I, 8.00% for the total
risk-based capital and 4.00% for leverage. QNB had a Tier I capital ratio of
10.31% and 10.30%, a total risk-based ratio of 11.53% and 11.51% and a leverage
ratio of 7.45% and 7.34% at March 31, 2010 and December 31, 2009,
respectively.





All
capital ratios have improved slightly from December 31, 2009 as the growth rate
of capital slightly exceeded the growth rate of average and risk-weighted
assets. During the first quarter of 2010, QNB began offering a Dividend
Reinvestment and Stock Purchase Plan (the “Plan”) to provide participants a
convenient and economical method for investing cash dividends paid on the
Company’s common stock in additional shares at a discount. The Plan also allows
participants to make additional cash purchases of stock at a discount. Stock
purchases under the Plan contributed $74,000 to capital for the first quarter of
2010. The Board of Directors has authorized the repurchase of up to 100,000
shares of its common stock in open market or privately negotiated transactions.
The repurchase authorization does not bear a termination date. As of March 31,
2010, 57,883 shares were repurchased under this authorization at an average
price of $16.97 and a total cost of $982,000. There were no shares repurchased
under the plan since the first quarter of 2009.




- 47
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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





CAPITAL
ADEQUACY (Continued)





Also
impacting the regulatory capital ratios was an increase in risk-weighted assets
during the first three months of 2010. Loan growth, primarily centered in
commercial loans, accounted for virtually all of the $10,573,000 growth in
risk-weighted assets. Continuing to impact risk-weighted assets is the
$27,705,000 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
$3,914,000 at March 31, 2010, regulatory guidance required an additional
$27,705,000 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 March 31, 2010. The
other 3 pooled trust preferred securities have only one tranche remaining so the
treatment noted above does not apply.





The
Federal Deposit Insurance Corporation Improvement Act of 1991 established five
capital level designations ranging from "well capitalized" to "critically
undercapitalized." At March 31, 2010 and December 31, 2009, management believes
that the Company and the Bank met all capital adequacy requirements to which
they are subject and have met the "well capitalized" criteria which requires
minimum Tier I and total risk-based capital ratios of 6.00% and 10.00%,
respectively, and a leverage ratio of 5.00%.





INTEREST
RATE SENSITIVITY





Since the
assets and liabilities of QNB have diverse repricing characteristics that
influence net interest income, management analyzes interest sensitivity through
the use of gap analysis and simulation models. Interest rate sensitivity
management seeks to minimize the effect of interest rate changes on net interest
margins and interest rate spreads and to provide growth in net interest income
through periods of changing interest rates. QNB’s Asset/Liability Management
Committee (ALCO) is responsible for managing interest rate risk and for
evaluating the impact of changing interest rate conditions on net interest
income.





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





A
positive gap results when the amount of interest rate sensitive assets exceeds
interest rate sensitive liabilities. A negative gap results when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive assets.
Generally a positive or asset sensitive position is beneficial in a rising rate
environment while a negative gap or liability sensitive position is beneficial
in a declining rate environment.





QNB
primarily focuses on the management of the one-year interest rate sensitivity
gap. The one-year cumulative gap, which reflects QNB’s interest sensitivity over
a period of time, was a negative $97,445,000 at March 31, 2010. The cumulative
one-year gap equals -13.0% of total rate sensitive assets. This position
compares to a negative gap position of $47,997,000, or -6.5% of total rate
sensitive assets, at December 31, 2009. The increase in the negative gap
position is primarily the result of an increase in time deposits repricing over
the next twelve months.




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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





INTEREST
RATE SENSITIVITY (Continued)





QNB also
uses a simulation model to assess the impact of changes in interest rates on net
interest income. The model reflects management’s assumptions related to asset
yields and rates paid on liabilities, deposit sensitivity, and the size,
composition and maturity or repricing characteristics of the balance sheet. The
assumptions are based on the interest rate environment at period end. Management
also evaluates the impact of higher and lower interest rates by simulating the
impact on net interest income of changing rates. While management performs rate
shocks of 100, 200 and 300 basis points, it believes that, given the level of
interest rates at March 31, 2010, it is unlikely that interest rates would
decline by 200 or 300 basis points. The simulation results can be found in the
chart below.





Net
interest income declines in a falling rate environment. This result reflects
that income on earning assets would decline to a greater degree than the expense
associated with interest-bearing liabilities. In a lower rate environment, the
cash flow or repricing characteristics from both the loan and investment
portfolios would increase and be reinvested at lower rates resulting in less
income. Loan customers would likely either refinance their fixed rate loans at
lower rates or request rate reductions on their existing loans. While interest
expense on time deposits would decrease, the interest rate floors on some
municipal interest-bearing demand accounts, hypothetical interest rate floors on
interest-bearing transaction accounts, regular money market accounts and savings
accounts would prevent a reduction in interest expense on these
accounts.





In a
rising rate environment net interest income increases slightly as loans and
investments reprice more than rates on interest-bearing liabilities. The rate of
increase in net interest income declines the more rates increase because
prepayments and calls on investments and loans slow resulting in fewer amounts
repricing at higher rates. Actual results may differ from simulated results due
to various factors including time, magnitude and frequency of interest rate
changes, the relationship or spread between various rates, loan pricing and
deposit sensitivity, and asset/liability strategies.





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





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





The
nature of QNB’s current operation is such that it is not subject to foreign
currency exchange or commodity price risk. At March 31, 2010, QNB did not have
any hedging transactions in place such as interest rate swaps, caps or
floors.





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





Change in Interest Rates
                    
                    Net Interest Income
                    
                    
                    Dollar Change
                    
                    
                    % Change+300
      Basis Points
                    
                    $
                    27,145
                    
                    
                    $
                    457
                    
                    
                    
                    1.7
                    %+200
      Basis Points
                    
                    
                    27,047
                    
                    
                    
                    359
                    
                    
                    
                    1.3+100
      Basis Points
                    
                    
                    26,907
                    
                    
                    
                    219
                    
                    
                    
                    0.8Flat
      Rate
                    
                    
                    26,688
                    
                    
                    
                    -
                    
                    
                    
                    --100 Basis Points
                    
                    
                    25,864
                    
                    
                    
                    (824
                    )
                    
                    
                    (3.1
                    )




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QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





ITEM
      3.
            QUANTITATIVE
      AND QUALITATIVE DISCLOSURE ABOUT MARKET
RISK.





The
information required in response to this item is set forth in Item 2,
above.





ITEM
      4.
            CONTROLS
      AND PROCEDURES





We
maintain a system of controls and procedures designed to provide reasonable
assurance as to the reliability of the consolidated financial statements and
other disclosures included in this report, as well as to safeguard assets from
unauthorized use or disposition. We evaluated the effectiveness of the design
and operation of our disclosure controls and procedures under the supervision
and with the participation of management, including our Chief Executive Officer
and Chief Financial Officer. Based upon that evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and
procedures are effective as of the end of the period covered by this report. No
changes were made to our internal control over financial reporting during the
fiscal quarter covered by this report that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




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QNB
CORP. AND SUBSIDIARY





PART
II.  OTHER INFORMATION





MARCH
31, 2010





Item
      1.
            Legal
      Proceedings




None.





Item
      1A.
            Risk
      Factors




There
were no material changes to the Risk Factors described in Item 1A in QNB’s
Annual Report on Form 10-K for the period ended December 31, 2009.





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




Period
                    
                    TotalNumber of
                      Shares
                      Purchased
                    
                    
                    Average Price
                      Paid perShare
                    
                    
                    TotalNumber
                      ofShares
                      Purchased as
                      Part ofPublicly
                      AnnouncedPlan
                    
                    
                    Maximum
                      Number of
                      Shares thatmay
                      yet bePurchased
                      Under thePlanJanuary
      1, 2010 through January 31, 2010
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    42,117February
      1, 2010 through February 28, 2010
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    42,117March 1, 2010 through March 31,
      2010
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    42,117Total
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    42,117





(1)
            Transactions
      are reported as of settlement
dates.


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


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


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


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





Item
      3.
            Default Upon Senior
      Securities




None.





Item
      4.
            (Removed and
      Reserved)





Item
      5.
            Other
      Information




None.




- 51
-




Item
      6.
            Exhibits




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




- 52
-




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:May 17,
      2010
                                                  
                                                  
                                                  By:/s/
      Thomas J. BiskoThomas
      J. BiskoPresident/CEODate:May 17,
      2010
                                                  
                                                  
                                                  By:/s/
      Bret H. KrevolinBret
      H. KrevolinChief
      Financial
Officer