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, 2009


OR


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





For the
transition period from 
to





Commission
file number 0-17706





QNB Corp.





(Exact
Name of Registrant as Specified in Its Charter)





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





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




Not Applicable





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





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


Indicate
by check mark whether the registrant 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  ̈   No
þ





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





Class
              Outstanding
      at May 6, 2009Common
      Stock, par value $.625
              3,082,332





QNB
CORP. AND SUBSIDIARY


FORM
10-Q


QUARTER
ENDED MARCH 31, 2009





INDEX





PAGEPART I - FINANCIAL INFORMATIONITEM 1.
                CONSOLIDATED
      FINANCIAL STATEMENTS (Unaudited)Consolidated
      Balance Sheets at March 31, 2009 and December 31, 2008
                3Consolidated
      Statements of Income for the Three Months Ended March 31, 2009 and
      2008
                4Consolidated
      Statement of Shareholders’ Equity for the Three Months Ended March 31,
      2009
                5Consolidated
      Statements of Cash Flows for the Three Months Ended March 31, 2009 and
      2008
                6Notes
      to Consolidated Financial Statements
                7ITEM 2.
                MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                21ITEM 3.
                QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                49ITEM 4.
                CONTROLS
      AND PROCEDURES
                49PART II - OTHER INFORMATIONITEM 1.
                LEGAL
      PROCEEDINGS
                50ITEM 1A.
                RISK
      FACTORS
                50ITEM 2.
                UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
                50ITEM 3.
                DEFAULTS
      UPON SENIOR SECURITIES
                50ITEM 4.
                SUBMISSIONS
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                50ITEM 5.
                OTHER
      INFORMATION
                51ITEM 6.
                EXHIBITS
                51SIGNATURESCERTIFICATIONS


- 2
-


QNB
Corp. and Subsidiary
 CONSOLIDATED
BALANCE SHEETS
 
 (in thousands, except share data)
                        (unaudited)March 31,
                        2009
                      
                      
                      December 31,
                        2008AssetsCash
      and due from banks
                      
                      $
                      10,048
                      
                      
                      $
                      10,634Interest-bearing
      deposits in banks
                      
                      
                      569
                      
                      
                      
                      1,276Federal
      funds sold
                      
                      
                      5,938
                      
                      
                      
                      4,541Total
      cash and cash equivalents
                      
                      
                      16,555
                      
                      
                      
                      16,451Investment
      securitiesAvailable-for-sale
      (amortized cost $223,337 and $219,950)
                      
                      
                      223,526
                      
                      
                      
                      219,597Held-to-maturity
      (fair value $3,740 and $3,683)
                      
                      
                      3,598
                      
                      
                      
                      3,598Restricted
      investment in bank stocks
                      
                      
                      2,291
                      
                      
                      
                      2,291Loans
      held-for-sale
                      
                      
                      3,202
                      
                      
                      
                      120Loans
      receivable
                      
                      
                      417,062
                      
                      
                      
                      403,579Allowance
      for loan losses
                      
                      
                      (4,220
                      )
                      
                      
                      (3,836
                      )Net
      loans
                      
                      
                      412,842
                      
                      
                      
                      399,743Bank-owned
      life insurance
                      
                      
                      8,860
                      
                      
                      
                      8,785Premises
      and equipment, net
                      
                      
                      6,571
                      
                      
                      
                      6,661Accrued
      interest receivable
                      
                      
                      2,759
                      
                      
                      
                      2,819Other
      assets
                      
                      
                      3,740
                      
                      
                      
                      4,329Total
      assets
                      
                      $
                      683,944
                      
                      
                      $
                      664,394LiabilitiesDepositsDemand,
      non-interest bearing
                      
                      $
                      55,428
                      
                      
                      $
                      53,280Interest-bearing
      demand
                      
                      
                      91,797
                      
                      
                      
                      95,630Money
      market
                      
                      
                      50,246
                      
                      
                      
                      45,572Savings
                      
                      
                      47,142
                      
                      
                      
                      44,006Time
                      
                      
                      221,004
                      
                      
                      
                      206,336Time
      of $100,000 or more
                      
                      
                      108,132
                      
                      
                      
                      104,966Total
      deposits
                      
                      
                      573,749
                      
                      
                      
                      549,790Short-term
      borrowings
                      
                      
                      16,822
                      
                      
                      
                      21,663Long-term
      debt
                      
                      
                      35,000
                      
                      
                      
                      35,000Accrued
      interest payable
                      
                      
                      2,643
                      
                      
                      
                      2,277Other
      liabilities
                      
                      
                      1,964
                      
                      
                      
                      1,755Total
      liabilities
                      
                      
                      630,178
                      
                      
                      
                      610,485Shareholders'
      EquityCommon
      stock, par value $0.625 per share; authorized 10,000,000 shares; 3,246,901
      shares and 3,245,159 shares issued; 3,082,332 and 3,131,815 shares
      outstanding
                      
                      
                      2,029
                      
                      
                      
                      2,028Surplus
                      
                      
                      10,074
                      
                      
                      
                      10,057Retained
      earnings
                      
                      
                      44,015
                      
                      
                      
                      43,667Accumulated
      other comprehensive income (loss), net
                      
                      
                      124
                      
                      
                      
                      (233
                      )Teasury
      stock, at cost; 164,569 and 113,344 shares
                      
                      
                      (2,476
                      )
                      
                      
                      (1,610
                      )Total
      shareholders' equity
                      
                      
                      53,766
                      
                      
                      
                      53,909Total
      liabilities and shareholders' equity
                      
                      $
                      683,944
                      
                      
                      $
                      664,394
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
Statements.
  - 3
-
  QNB
Corp. and Subsidiary
 CONSOLIDATED
STATEMENTS OF INCOME
 
 (in thousands, except share data)
                      (unaudited)Three Months
      Ended March 31,
                    
                    2009
                    
                    
                    2008Interest
      IncomeInterest
      and fees on loans
                    
                    $
                    5,913
                    
                    
                    $
                    6,173Interest
      and dividends on Investment securities:Taxable
                    
                    
                    2,202
                    
                    
                    
                    2,095Tax-exempt
                    
                    
                    509
                    
                    
                    
                    462Interest
      on Federal funds sold
                    
                    
                    1
                    
                    
                    
                    42Interest
      on interest-bearing balances and other interest income
                    
                    
                    1
                    
                    
                    
                    18Total
      interest income
                    
                    
                    8,626
                    
                    
                    
                    8,790Interest
      ExpenseInterest
      on depositsInterest-bearing
      demand
                    
                    
                    154
                    
                    
                    
                    307Money
      market
                    
                    
                    164
                    
                    
                    
                    291Savings
                    
                    
                    28
                    
                    
                    
                    42Time
                    
                    
                    1,849
                    
                    
                    
                    2,210Time
      of $100,000 or more
                    
                    
                    920
                    
                    
                    
                    792Interest
      on short-term borrowings
                    
                    
                    56
                    
                    
                    
                    171Interest
      on long-term debt
                    
                    
                    374
                    
                    
                    
                    363Total
      interest expense
                    
                    
                    3,545
                    
                    
                    
                    4,176Net
      interest income
                    
                    
                    5,081
                    
                    
                    
                    4,614Provision
      for loan losses
                    
                    
                    600
                    
                    
                    
                    225Net
      interest income after provision for loan losses
                    
                    
                    4,481
                    
                    
                    
                    4,389Non-Interest
      IncomeFees
      for services to customers
                    
                    
                    395
                    
                    
                    
                    445ATM
      and debit card
                    
                    
                    228
                    
                    
                    
                    219Bank-owned
      life insurance
                    
                    
                    71
                    
                    
                    
                    106Mortgage
      servicing fees
                    
                    
                    36
                    
                    
                    
                    20Net
      (loss) gain on investment securities available-for-sale
                    
                    
                    (254
                    )
                    
                    
                    222Net
      gain on sale of loans
                    
                    
                    168
                    
                    
                    
                    32Other
                    
                    
                    89
                    
                    
                    
                    340Total
      non-interest income
                    
                    
                    733
                    
                    
                    
                    1,384Non-Interest
      ExpenseSalaries
      and employee benefits
                    
                    
                    2,078
                    
                    
                    
                    1,971Net
      occupancy
                    
                    
                    353
                    
                    
                    
                    340Furniture
      and equipment
                    
                    
                    296
                    
                    
                    
                    289Marketing
                    
                    
                    175
                    
                    
                    
                    153Third
      party services
                    
                    
                    230
                    
                    
                    
                    188Telephone,
      postage and supplies
                    
                    
                    149
                    
                    
                    
                    161State
      taxes
                    
                    
                    135
                    
                    
                    
                    130FDIC
      insurance premiums
                    
                    
                    193
                    
                    
                    
                    34Other
                    
                    
                    320
                    
                    
                    
                    277Total
      non-interest expense
                    
                    
                    3,929
                    
                    
                    
                    3,543Income
      before income taxes
                    
                    
                    1,285
                    
                    
                    
                    2,230Provision
      for income taxes
                    
                    
                    191
                    
                    
                    
                    520Net
      Income
                    
                    $
                    1,094
                    
                    
                    $
                    1,710Earnings
      Per Share - Basic
                    
                    $
                    .35
                    
                    
                    $
                    .55Earnings
      Per Share - Diluted
                    
                    $
                    .35
                    
                    
                    $
                    .54Cash
      Dividends Per Share
                    
                    $
                    .24
                    
                    
                    $
                    .23
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
Statements.
  - 4
-


QNB
Corp. and Subsidiary
 consolidated
statement of shareholders' equity
 
 AccumulatedOther(in
      thousands, except share data)
                          
                          Number
                          
                          
                          Comprehensive
                          
                          
                          Comprehensive
                          
                          
                          Common
                          
                          
                          
                          
                          
                          Retained
                          
                          
                          Treasury(unaudited)
                          
                          of Shares
                          
                          
                          Income
                          
                          
                          Income (Loss)
                          
                          
                          Stock
                          
                          
                          Surplus
                          
                          
                          Earnings
                          
                          
                          Stock
                          
                          
                          TotalBalance,
      December 31, 2008
                          
                          
                          3,131,815
                          
                          
                          
                          
                          
                          $
                          (233
                          )
                          
                          $
                          2,028
                          
                          
                          $
                          10,057
                          
                          
                          $
                          43,667
                          
                          
                          $
                          (1,610
                          )
                          
                          $
                          53,909Net
      income
                          
                          
                          —
                          
                          
                          $
                          1,094
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          1,094
                          
                          
                          
                          —
                          
                          
                          
                          1,094Other
      comprehensive income, net of taxesUnrealized
      holding gains on investment securities available-for-sale
                          
                          
                          —
                          
                          
                          
                          190
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Reclassification
      adjustment for losses included in net income
                          
                          
                          —
                          
                          
                          
                          167
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Other
      comprehensive income
                          
                          
                          —
                          
                          
                          
                          357
                          
                          
                          
                          357
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          357Comprehensive
      income
                          
                          
                          —
                          
                          
                          $
                          1,451
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Cash
      dividends paid ($.24 per share)
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (746
                          )
                          
                          
                          —
                          
                          
                          
                          (746
                          )Purchase
      of treasury stock
                          
                          
                          (51,225
                          )
                          
                          
                          
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (866
                          )
                          
                          
                          (866
                          )Stock
      issued for options exercised
                          
                          
                          1,742
                          
                          
                          
                          
                          
                          
                          
                          —
                          
                          
                          
                          1
                          
                          
                          
                          4
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          5Stock-based
      compensation expense
                          
                          
                          —
                          
                          
                          
                          
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          13
                          
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          13Balance,
      March 31, 2009
                          
                          
                          3,082,332
                          
                          
                          
                          
                          
                          
                          $
                          124
                          
                          
                          $
                          2,029
                          
                          
                          $
                          10,074
                          
                          
                          $
                          44,015
                          
                          
                          $
                          (2,476
                          )
                          
                          $
                          53,766
 
 The
accompanying notes are an integral part of the consolidated financial
statements.
  - 5
-


QNB
Corp. and Subsidiary
 consolidated
statements of cash flows
 
 (in thousands,
                                (unaudited)Three
      Months Ended March 31,
                              
                              2009
                              
                              
                              2008Operating
      ActivitiesNet
      income
                              
                              $
                              1,094
                              
                              
                              $
                              1,710Adjustments
      to reconcile net income to net cash provided by operating
      activitiesDepreciation
      and amortization
                              
                              
                              219
                              
                              
                              
                              201Provision
      for loan losses
                              
                              
                              600
                              
                              
                              
                              225Net
      losses (gains) on investment securities available-for-sale
                              
                              
                              254
                              
                              
                              
                              (222
                              )Gain
      on sale of equity investment
                              
                              
                              —
                              
                              
                              
                              (175
                              )Net
      loss on sale of repossessed assets
                              
                              
                              45
                              
                              
                              
                              1Loss
      on disposal of premises and equipment
                              
                              
                              —
                              
                              
                              
                              3Net
      gain on sale of loans
                              
                              
                              (168
                              )
                              
                              
                              (32
                              )Proceeds
      from sales of residential mortgages
                              
                              
                              7,685
                              
                              
                              
                              3,278Originations
      of residential mortgages held-for-sale
                              
                              
                              (10,599
                              )
                              
                              
                              (3,708
                              )Income
      on bank-owned life insurance
                              
                              
                              (71
                              )
                              
                              
                              (106
                              )Life
      insurance premiums
                              
                              
                              (5
                              )
                              
                              
                              (5
                              )Stock-based
      compensation expense
                              
                              
                              13
                              
                              
                              
                              14Deferred
      income tax benefit
                              
                              
                              (250
                              )
                              
                              
                              (25
                              )Net
      increase in income taxes payable
                              
                              
                              442
                              
                              
                              
                              545Net
      decrease (increase) in accrued interest receivable
                              
                              
                              60
                              
                              
                              
                              (12
                              )Amortization
      of mortgage servicing rights and change in valuation
    allowance
                              
                              
                              7
                              
                              
                              
                              23Net
      (accretion) amortization of premiums and discounts on investment
      securities
                              
                              
                              (63
                              )
                              
                              
                              (83
                              )Net
      increase in accrued interest payable
                              
                              
                              366
                              
                              
                              
                              89Decrease
      (increase) in other assets
                              
                              
                              767
                              
                              
                              
                              (417
                              )Decrease
      in other liabilities
                              
                              
                              (233
                              )
                              
                              
                              (25
                              )Net
      cash provided by operating activities
                              
                              
                              163
                              
                              
                              
                              1,279Investing
      ActivitiesProceeds
      from maturities and calls of investment securities
      available-for-sale
                              
                              
                              22,984
                              
                              
                              
                              13,728Proceeds
      from sales of investment securities available-for-sale
                              
                              
                              20,000
                              
                              
                              
                              1,122Purchase
      of investment securities available-for-sale
                              
                              
                              (46,562
                              )
                              
                              
                              (20,223
                              )Proceeds
      from sale of equity investment
                              
                              
                              —
                              
                              
                              
                              175Proceeds
      from redemption of restricted bank stock
                              
                              
                              —
                              
                              
                              
                              332Purchase
      of restricted bank stock
                              
                              
                              —
                              
                              
                              
                              (400
                              )Net
      (increase) decrease in loans
                              
                              
                              (14,099
                              )
                              
                              
                              1,133Net
      purchases of premises and equipment
                              
                              
                              (129
                              )
                              
                              
                              (166
                              )Redemption
      of bank-owned life insurance investment
                              
                              
                              —
                              
                              
                              
                              224Proceeds
      from sale of repossessed assets
                              
                              
                              236
                              
                              
                              
                              86Net
      cash used by investing activities
                              
                              
                              (17,570
                              )
                              
                              
                              (3,989
                              )Financing
      ActivitiesNet
      increase in non-interest bearing deposits
                              
                              
                              2,148
                              
                              
                              
                              3,396Net
      increase (decrease) in interest-bearing non-maturity
    deposits
                              
                              
                              3,977
                              
                              
                              
                              (6,383
                              )Net
      increase in time deposits
                              
                              
                              17,834
                              
                              
                              
                              14,155Net
      decrease in short-term borrowings
                              
                              
                              (4,841
                              )
                              
                              
                              (15,254
                              )Proceeds
      from long-term debt
                              
                              
                              —
                              
                              
                              
                              10,000Cash
      dividends paid
                              
                              
                              (746
                              )
                              
                              
                              (721
                              )Purchase
      of treasury stock
                              
                              
                              (866
                              )
                              
                              
                              —Proceeds
      from issuance of common stock
                              
                              
                              5
                              
                              
                              
                              —Net
      cash provided by financing activites
                              
                              
                              17,511
                              
                              
                              
                              5,193Increase
      in cash and cash equivalents
                              
                              
                              104
                              
                              
                              
                              2,483Cash
      and cash equivalents at beginning of year
                              
                              
                              16,451
                              
                              
                              
                              14,322Cash
      and cash equivalents at end of period
                              
                              $
                              16,555
                              
                              
                              $
                              16,805Supplemental
      Cash Flow DisclosuresInterest
      paid
                              
                              $
                              3,179
                              
                              
                              $
                              4,087Income
      taxes paid
                              
                              
                              —
                              
                              
                              
                              —Non-Cash
      transactionsTransfer
      of loans to other real estate owned and repossessed assets
                              
                              
                              400
                              
                              
                              
                              119
 
 The
accompanying notes are an integral part of the unaudited consolidated financial
statements.
  - 6
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





1.
BASIS OF PRESENTATION





The
accompanying unaudited consolidated financial statements include the accounts of
QNB Corp. (the Company) and its wholly-owned subsidiary, QNB Bank (the Bank).
The consolidated entity is referred to herein as “QNB”. 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 2008
Annual Report incorporated in the Form 10-K. Operating results for the
three-month period ended March 31, 2009 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2009.





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 2008 consolidated financial statements have been
reclassified to conform to the 2009 financial statement presentation
format.





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





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





2.
RECENT ACCOUNTING PRONOUNCEMENTS





Financial
Accounting Standards Board (FASB) Statement No. 141(R) Business Combinations was
issued in December of 2007. This Statement establishes principles and
requirements for how the acquirer of a business recognizes and measures in its
financial statements the identifiable assets acquired, the liabilities assumed,
and any non-controlling interest in the acquiree. The Statement also provides
guidance for recognizing and measuring the goodwill acquired in the business
combination and determines what information to disclose to enable users of the
financial statements to evaluate the nature and financial effects of the
business combination. This guidance became effective as of January 1, 2009 for
QNB and had no immediate impact. This new pronouncement will affect QNB’s
accounting for business combinations completed after January 1,
2009.





In
November 2008, the SEC released a proposed roadmap regarding the potential use
by U.S. issuers of financial statements prepared in accordance with
International Financial Reporting Standards (IFRS). IFRS is a comprehensive
series of accounting standards published by the International Accounting
Standards Board (“IASB”). Under the proposed roadmap, the Company may be
required to prepare financial statements in accordance with IFRS as early as
2014. The SEC will make a determination in 2011 regarding the mandatory adoption
of IFRS. The Company is currently assessing the impact that this potential
change would have on its consolidated financial statements, and it will continue
to monitor the development of the potential implementation of
IFRS.


- 7
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





2.
RECENT ACCOUNTING PRONOUNCEMENTS (Continued)





In April
2009, FASB issued FASB Staff Position (FSP) No. FAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly(FSP FAS
157-4). FASB Statement 157, Fair Value Measurements,
defines fair value as the price that would be received to sell the asset or
transfer the liability in an orderly transaction (that is, not a forced
liquidation or distressed sale) between market participants at the measurement
date under current market conditions. FSP FAS 157-4 provides additional guidance
on determining when the volume and level of activity for the asset or liability
has significantly decreased. The FSP also includes guidance on identifying
circumstances when a transaction may not be considered orderly.





FSP FAS
157-4 provides a list of factors that a reporting entity should evaluate to
determine whether there has been a significant decrease in the volume and level
of activity for the asset or liability in relation to normal market activity for
the asset or liability. When the reporting entity concludes there has been a
significant decrease in the volume and level of activity for the asset or
liability, further analysis of the information from that market is needed and
significant adjustments to the related prices may be necessary to estimate fair
value in accordance with Statement 157.





This FSP
clarifies that when there has been a significant decrease in the volume and
level of activity for the asset or liability, some transactions may not be
orderly. In those situations, the entity must evaluate the weight of the
evidence to determine whether the transaction is orderly. The FSP provides a
list of circumstances that may indicate that a transaction is not orderly. A
transaction price that is not associated with an orderly transaction is given
little, if any, weight when estimating fair value.





This FSP
is effective for interim and annual reporting periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15,
2009. An entity early adopting FSP FAS 157-4 must also early adopt FSP FAS 115-2
and FAS 124-2, Recognition and
Presentation of Other-Than-Temporary Impairments. The Company is
currently reviewing the effect this new pronouncement will have on its
consolidated financial statements.





In April
2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments(FSP FAS 115-2 and FAS 124-2). FSP FAS
115-2 and FAS 124-2 clarifies the interaction of the factors that should be
considered when determining whether a debt security is other-than-temporarily
impaired. For debt securities, management must assess whether (a) it has
the intent to sell the security and (b) it is more likely than not that it
will be required to sell the security prior to its anticipated recovery. These
steps are done before assessing whether the entity will recover the cost basis
of the investment. Previously, this assessment required management to assert it
has both the intent and the ability to hold a security for a period of time
sufficient to allow for an anticipated recovery in fair value to avoid
recognizing an other-than-temporary impairment. This change does not affect the
need to forecast recovery of the value of the security through either cash flows
or market price.





In
instances when a determination is made that an other-than-temporary impairment
exists but the investor does not intend to sell the debt security and it is not
more likely than not that it will be required to sell the debt security prior to
its anticipated recovery, FSP FAS 115-2 and FAS 124-2 changes the presentation
and amount of the other-than-temporary impairment recognized in the income
statement. The other-than-temporary impairment is separated into (a) the
amount of the total other-than-temporary impairment related to a decrease in
cash flows expected to be collected from the debt security (the credit loss) and
(b) the amount of the total other-than-temporary impairment related to all
other factors. The amount of the total other-than-temporary impairment related
to the credit loss is recognized in earnings. The amount of the total
other-than-temporary impairment related to all other factors is recognized in
other comprehensive income.


- 8
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





2.
RECENT ACCOUNTING PRONOUNCEMENTS (Continued)





This FSP
is effective for interim and annual reporting periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15,
2009. An entity early adopting FSP FAS 115-2 and FAS 124-2 must also early adopt
FSP FAS 157-4,Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly. The Company is currently reviewing the effect this new
pronouncement will have on its consolidated financial statements.





In
April 2009, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 111 (SAB 111). SAB 111 amends Topic 5.M. in the Staff
Accounting Bulletin series entitled Other Than Temporary Impairment of
Certain Investments Debt and Equity Securities. On April 9, 2009,
the FASB issued FASB Staff Position No. FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments. SAB 111 maintains the previous views
related to equity securities and amends Topic 5.M. to exclude debt securities
from its scope.





In April
2009, the FASB issued FSP No. FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments(FSP FAS 107-1 and APB 28-1). FSP FAS 107-1 and
APB 28-1 amends FASB Statement No. 107, Disclosures about Fair Value of
Financial Instruments, to require disclosures about fair value of
financial instruments for interim reporting periods of publicly traded companies
as well as in annual financial statements. This FSP also amends APB Opinion
No. 28, Interim Financial
Reporting, to require those disclosures in summarized financial
information at interim reporting periods.





This FSP
is effective for interim and annual reporting periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15,
2009. An entity early adopting FSP FAS 107-1 and APB 28-1 must also early adopt
FSP FAS 157-4,Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderlyand FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments.The Company is currently reviewing the
effect this new pronouncement will have on its consolidated financial
statements.





3.
STOCK-BASED COMPENSATION AND SHAREHOLDERS’ EQUITY





QNB
sponsors stock-based compensation plans, administered by a committee, under
which both qualified and non-qualified stock options may be granted periodically
to certain employees. QNB accounts for all awards granted under stock-based
compensation plans in accordance with Financial Accounting Standards Board
(FASB) Statement No. 123 (revised 2004), Share-Based Payment(FASB No.
123R). Compensation cost has been measured using the fair value of an award on
the grant date and is recognized over the service period, which is usually the
vesting period.





Stock-based
compensation expense was approximately $13,000 and $14,000 for the three months
ended March 31, 2009 and 2008, respectively. As of March 31, 2009, there was
approximately $82,000 of unrecognized compensation cost related to unvested
share-based compensation awards granted that is expected to be recognized over
the next 33 months.


- 9
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





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





Options
are granted to certain employees at prices equal to the market value of the
stock on the date the options are granted. The 1998 Plan authorized the issuance
of 220,500 shares. The time period during which any option is exercisable under
the Plan is determined by the committee but shall not commence before the
expiration of six months after the date of grant or continue beyond the
expiration of ten years after the date the option is awarded. The granted
options vest ratably over a three-year period. As of March 31, 2009, there were
225,058 options granted, 12,198 options forfeited, 57,019 options exercised and
155,841 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, 2009, there were 63,700 options granted and outstanding
under this Plan. The 2005 Plan expires March 15, 2015.





The fair
value of each option is amortized into compensation expense on a straight-line
basis between the grant date for the option and each vesting date. QNB estimated
the fair value of stock options on the date of the grant using the Black-Scholes
option pricing model. The model requires the use of numerous assumptions, many
of which are highly subjective in nature. The following assumptions were used in
the option pricing model in determining the fair value of options granted during
the three-months ended March 31:





Options
      granted
                        
                        2009
                        
                        
                        2008Risk-free
      interest rate
                        
                        
                        1.48
                        %
                        
                        
                        3.00
                        %Dividend
      yield
                        
                        
                        4.80
                        
                        
                        
                        3.64Volatility
                        
                        
                        25.04
                        
                        
                        
                        18.46Expected
      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 2009 and 2008 was $2.17 and $2.63,
respectively.





Stock
option activity during the three months ended March 31, 2009 was as
follows:





Number of
                  Options
                
                
                Weighted
                  Average
                  Exercise Price
                
                
                Weighted
                  Average
                  Remaining
                  Contractual
                  Term (in yrs.)
                
                
                Aggregate
                  Intrinsic
                  ValueOutstanding
      at January 1, 2009
                
                
                221,323
                
                
                $
                20.60Exercised
                
                
                (19,578
                )
                
                
                16.42Expired
                
                
                (2,204
                )
                
                
                16.70Granted
                
                
                20,000
                
                
                
                17.15Outstanding
      at March 31, 2009
                
                
                219,541
                
                
                $
                20.70
                
                
                
                3.2
                
                
                $
                279Exercisable
      at March 31, 2009
                
                
                164,741
                
                
                $
                20.62
                
                
                
                3.0
                
                
                $
                267


- 10
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





4.
SHARE REPURCHASE PLAN





On
January 24, 2008, QNB announced that the Board of Directors authorized the
repurchase of up to 50,000 shares of its common stock in open market or
privately negotiated transactions. The repurchase authorization does not bear a
termination date. On February 9, 2009, the Board of Directors approved
increasing the authorization to 100,000 shares. As of March 31, 2009, 57,883
shares were repurchased under this authorization at an average price of $16.97
and a total cost of $982,000. As of March 31, 2008, QNB had not repurchased any
shares.





5.
EARNINGS PER SHARE





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





For the Three MonthsEnded March 31,2009
                  
                  
                  2008Numerator
      for basic and diluted earnings per share - net income
                  
                  $
                  1,094
                  
                  
                  $
                  1,710Denominator
      for basic earnings per share - weighted average shares
      outstanding
                  
                  
                  3,113,730
                  
                  
                  
                  3,134,704Effect
      of dilutive securities - employee stock options
                  
                  
                  12,953
                  
                  
                  
                  32,272Denominator
      for diluted earnings per share - adjusted weighted average shares
      outstanding
                  
                  
                  3,126,683
                  
                  
                  
                  3,166,976Earnings
      per share-basic
                  
                  $
                  0.35
                  
                  
                  $
                  0.55Earnings
      per share-diluted
                  
                  $
                  0.35
                  
                  
                  $
                  0.54





There
were 141,600 and 87,100 stock options that were anti-dilutive for the
three-month periods ended March 31, 2009 and 2008, 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, 2009 and 2008:


- 11
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





For the Three MonthsEnded March 31,2009
                
                
                2008Unrealized
      holding gains arising during the period on securities available- for-sale
      [net of tax expense of $(98) and $(394), respectively]
                
                $
                189
                
                
                $
                766Reclassification
      adjustment for losses (gains) included in net income [net of (tax benefit)
      tax expense of $(86) and $75, respectively]
                
                
                168
                
                
                
                (147
                )Net
      change in unrealized gains during the period
                
                
                357
                
                
                
                619Accumulated
      other comprehensive (loss) income, beginning of period
                
                
                (233
                )
                
                
                1,504Accumulated
      other comprehensive income, end of period
                
                $
                124
                
                
                $
                2,123Net
      income
                
                $
                1,094
                
                
                $
                1,710Other
      comprehensive income, net of tax:Unrealized
      holding gains arising during the period [net of tax expense of $(184) and
      $(319), respectively]
                
                
                357
                
                
                
                619Comprehensive
      income
                
                $
                1,451
                
                
                $
                2,329





7.
INVESTMENT SECURITIES





The
amortized cost and estimated fair values of investment securities were as
follows:


Available-for-Sale





March 31, 2009
                
                
                December 31, 2008Gross
                
                
                Gross
                
                
                
                
                
                
                
                
                Gross
                
                
                GrossAggregate
                
                
                unrealized
                
                
                unrealized
                
                
                
                
                
                Aggregate
                
                
                unrealized
                
                
                unrealizedfair
                
                
                holding
                
                
                holding
                
                
                Amortized
                
                
                fair
                
                
                holding
                
                
                holding
                
                
                Amortizedvalue
                
                
                gains
                
                
                losses
                
                
                cost
                
                
                value
                
                
                gains
                
                
                losses
                
                
                costU.S.
      Treasury
                
                $
                5,082
                
                
                $
                31
                
                
                $
                1
                
                
                $
                5,052
                
                
                $
                5,124
                
                
                $
                49
                
                
                
                -
                
                
                $
                5,075U.S.
      Government agencies
                
                
                41,088
                
                
                
                520
                
                
                
                -
                
                
                
                40,568
                
                
                
                44,194
                
                
                
                634
                
                
                $
                5
                
                
                
                43,565State
      and municipal securities
                
                
                45,073
                
                
                
                867
                
                
                
                219
                
                
                
                44,425
                
                
                
                42,300
                
                
                
                448
                
                
                
                512
                
                
                
                42,364Mortgage-backed
      securities
                
                
                71,713
                
                
                
                2,708
                
                
                
                6
                
                
                
                69,011
                
                
                
                67,347
                
                
                
                2,126
                
                
                
                -
                
                
                
                65,221Collateralized
      mortgageobligations
      (CMOs)
                
                
                56,605
                
                
                
                1,419
                
                
                
                402
                
                
                
                55,588
                
                
                
                49,067
                
                
                
                963
                
                
                
                591
                
                
                
                48,695Other
      debt securities
                
                
                1,199
                
                
                
                42
                
                
                
                4,408
                
                
                
                5,565
                
                
                
                8,476
                
                
                
                79
                
                
                
                3,171
                
                
                
                11,568Equity
      securities
                
                
                2,766
                
                
                
                20
                
                
                
                382
                
                
                
                3,128
                
                
                
                3,089
                
                
                
                9
                
                
                
                382
                
                
                
                3,462Total
      investment securities available-for-sale
                
                $
                223,526
                
                
                $
                5,607
                
                
                $
                5,418
                
                
                $
                223,337
                
                
                $
                219,597
                
                
                $
                4,308
                
                
                $
                4,661
                
                
                $
                219,950


- 12
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





7.
INVESTMENT SECURITIES (Continued)





Held-To-Maturity




March 31, 2009
                                                                            
                                                                            
                                                                            December 31, 2008Gross
                                                                            
                                                                            
                                                                            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
                                                                            
                                                                            $
                                                                            3,598
                                                                            
                                                                            
                                                                            $
                                                                            142
                                                                            
                                                                            
                                                                            
                                                                            -
                                                                            
                                                                            
                                                                            $
                                                                            3,740
                                                                            
                                                                            
                                                                            $
                                                                            3,598
                                                                            
                                                                            
                                                                            $
                                                                            90
                                                                            
                                                                            
                                                                            $
                                                                            5
                                                                            
                                                                            
                                                                            $
                                                                            3,683





8.
LOANS & ALLOWANCE FOR LOAN LOSSES





The
following table presents loans by category as of March 31, 2009 and December 31,
2008:





March 31,
                    
                    
                    December 31,2009
                    
                    
                    2008Commercial
      and industrial
                    
                    $
                    97,116
                    
                    
                    $
                    97,238Construction
                    
                    
                    23,758
                    
                    
                    
                    21,894Real
      estate-commercial
                    
                    
                    154,763
                    
                    
                    
                    142,499Real
      estate-residential
                    
                    
                    124,933
                    
                    
                    
                    124,538Consumer
                    
                    
                    4,048
                    
                    
                    
                    4,483Indirect
      lease financing
                    
                    
                    12,366
                    
                    
                    
                    12,762Total
      loans
                    
                    
                    416,984
                    
                    
                    
                    403,414Net
      unearned (fees) costs
                    
                    
                    78
                    
                    
                    
                    165Loans
      receivable
                    
                    $
                    417,062
                    
                    
                    $
                    403,579





Activity
in the allowance for loan losses is shown below:





Quarter Ended
                  
                  
                  Year EndedMarch 31,
                  
                  
                  December 31,2009
                  
                  
                  2008
                  
                  
                  2008Balance
      at beginning of period
                  
                  $
                  3,836
                  
                  
                  $
                  3,279
                  
                  
                  $
                  3,279Charge-offs
                  
                  
                  (243
                  )
                  
                  
                  (121
                  )
                  
                  
                  (846
                  )Recoveries
                  
                  
                  27
                  
                  
                  
                  28
                  
                  
                  
                  78Net
      charge-offs
                  
                  
                  (216
                  )
                  
                  
                  (93
                  )
                  
                  
                  (768
                  )Provision
      for loan losses
                  
                  
                  600
                  
                  
                  
                  225
                  
                  
                  
                  1,325Balance
      at end of period
                  
                  $
                  4,220
                  
                  
                  $
                  3,411
                  
                  
                  $
                  3,836


- 13
-





QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





9.
INTANGIBLE ASSETS & SERVICING





Loans
serviced for others are not included in the accompanying consolidated balance
sheets. The unpaid principal balances of mortgage loans serviced for others were
$70,864,000 and $67,412,000 at March 31, 2009 and December 31, 2008,
respectively.





The
following table reflects the activity of mortgage servicing rights for the
periods indicated:





Three Months Ended
                  
                  
                  Year EndedMarch 31,
                  
                  
                  December 31,2009
                  
                  
                  2008Mortgage
      servicing rights beginning balance
                  
                  $
                  402
                  
                  
                  $
                  451Mortgage
      servicing rights capitalized
                  
                  
                  58
                  
                  
                  
                  60Mortgage
      servicing rights amortized
                  
                  
                  (33
                  )
                  
                  
                  (77
                  )Fair
      market value adjustments
                  
                  
                  26
                  
                  
                  
                  (32
                  )Mortgage
      servicing rights ending balance
                  
                  $
                  453
                  
                  
                  $
                  402





The
balance of these mortgage servicing assets are included in other assets at March
31, 2009 and December 31, 2008. The fair value of these rights was $521,000 and
$440,000, respectively. The fair value of servicing rights was determined using
a 9.0% discount rate for both periods presented above.





The
annual estimated amortization expense of mortgage servicing rights for each of
the five succeeding fiscal years ending December 31, is as follows:





2009
                  
                  $
                  1192010
                  
                  
                  962011
                  
                  
                  722012
                  
                  
                  522013
                  
                  
                  37





10.
FAIR VALUE MEASUREMENTS





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 their 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.


- 14
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





10.
FAIR VALUE MEASUREMENTS (Continued)





In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
Statement No. 157, Fair Value Measurements (“SFAS 157”), which defines fair
value, establishes a framework for measuring fair value under GAAP, and expands
disclosures about fair value measurements. SFAS 157 applies to other accounting
pronouncements that require or permit fair value measurements. The Bank adopted
SFAS 157 effective for its fiscal year beginning January 1, 2007.





In
December 2007, the FASB issued FASB Staff Position 157-2, Effective Date of FASB Statement No.
157(“FSP 157-2”). FSP 157-2 delays the effective date of SFAS 157 for
all non-financial assets and liabilities, except those that are recognized or
disclosed at fair value on a recurring basis (at least annually) to fiscal years
beginning after November 15, 2008 and interim periods within those fiscal years.
As such, the Company only partially adopted the provisions of SFAS 157 as of
December 31, 2008, and began to account and report for non-financial assets and
liabilities in 2009. In October 2008, the FASB issued FASB Staff Position 157-3,
Determining the Fair Value of
a Financial Asset When the Market for that Asset is Not Active(“FSP
157-3”), to clarify the application of the provisions of SFAS 157 in an inactive
market and how an entity would determine fair value in an inactive market. FSP
157-3 was effective immediately and QNB has applied the provisions of FSP 157-3
to its financial statements as of and for the three months ended March 31, 2009
and as of and for the year-ended December 31, 2008. At March 31, 2009, the
Company determined that no active market existed for pooled trust preferred
securities with an amortized cost of $5,120,000 and an estimated fair value of
$712,000. At December 31, 2008, the Company determined that no active market
existed for pooled trust preferred securities with an amortized cost of
$5,094,000 and an estimated fair value of $1,963,000.





SFAS 157
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 under SFAS 157 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 principallyto 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.


- 15
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





10.
FAIR VALUE MEASUREMENTS (Continued)





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





Investment securities
available for sale (Carried at Fair Value): The fair value of securities
available for sale are determined by obtaining quoted market prices on
nationally recognized securities exchanges (Level 1), or matrix pricing (Level
2). 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.





Impaired Loans (Generally
Carried at Fair Value): Impaired loans are those that are accounted for
under FASB Statement No. 114, Accounting by Creditors for
Impairment of a Loan(“SFAS 114”), in which the Bank 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, 2009 consists of the loan balances of $281,000, net of a
valuation allowance of $158,000.





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. After stratifying the rights 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.





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 $6,000 at March 31, 2009. Income of $26,000 was included
in earnings for the period which was composed of a $2,000 charge for several
tranches that required a valuation allowance for the quarter, offset by $28,000
of the valuation allowance established at December 31, 2008 that was no longer
required and consequently reversed.





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.


- 16
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





10.
FAIR VALUE MEASUREMENTS (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 Pricesin
                  ActiveMarkets
                  forIdentical
                  Assets
                  (Level 1)
                
                
                Significant
                  Other
                  Observable
                  Input
                  (Level 2)
                
                
                Significant
                  Unobservable
                  Inputs
                  (Level 3)
                
                
                Balance at End
                  of PeriodMarch
      31, 2009Securities
      available-for-sale
                
                $
                7,848
                
                
                $
                214,966
                
                
                $
                712
                
                
                $
                223,526December
      31, 2008Securities
      available-for-sale
                
                $
                8,213
                
                
                $
                209,421
                
                
                $
                1,963
                
                
                $
                219,597




The
following table presents a reconciliation of the securities available for sale
measured at fair value on a recurring basis using significant unobservable
inputs (Level 3) for the three months ended March 31, 2009:





FairValue
                    Measurements
                    UsingSignificant
                    Unobservable
                    Inputs(Level3)Securities
                    available-for-saleBeginning
      balance, January 1, 2009
                  
                  $
                  1,963Purchases,
      issuances and settlements
                  
                  
                  29Total
      gains or losses (realized/unrealized)Included
      in earnings
                  
                  
                  -Included
      in other comprehensive income
                  
                  
                  (1,280
                  )Transfers
      in and/or out of Level 3
                  
                  
                  -Ending
      balance, March 31, 2009
                  
                  $
                  712





There
were no gains or 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.


- 17
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





10.
FAIR VALUE MEASUREMENTS (Continued)





QNB owns
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, 2009 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 as no new
TRUP CDOs have been issued since 2007. There are currently very few market
participants who are willing and or able to transact for these
securities.





The
market values for these securities (and any securities other than those issued
or guaranteed by the U.S. Treasury) are very depressed relative to historical
levels. For example, the yield spreads for the broad market of investment grade
and high yield corporate bonds reached all time wide levels versus Treasuries at
the end of November 2008 and remain near those levels. Thus in the current
market, a low market price for a particular bond may only provide evidence of
stress in the credit markets in general versus being an indicator of credit
problems with a particular issuer.





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,
      2009,


·
            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.





Our TRUP
CDO valuations were prepared by an independent third party. Their approach in
determining fair value involved these steps:


·
            The
      credit quality of the collateral is estimated using average risk-neutral
      probability of default values for each industry (i.e. banks and insurance
      companies are evaluated
separately).


·
            Asset
      defaults are then generated taking into account both the probability of
      default of the asset and an assumed level of correlation among the
      assets.


·
            A
      higher level of correlation is assumed among assets from the same industry
      (e.g. banks with other banks) than among those from different
      industries.


·
            The
      loss given default was assumed to be 95% (i.e. a 5 %
      recovery).


·
            The
      cash flows were forecast for the underlying collateral and applied to each
      CDO tranche to determine the resulting distribution among the
      securities.


·
            The
      calculations were modeled in several thousand scenarios using a Monte
      Carlo engine.


·
            The
      expected cash flows for each scenario were discounted at the risk-free
      rate plus 200 basis points (for illiquidity) to calculate the present
      value of the security.


·
            The
      average price was used for valuation purposes. The overall discount rates
      are highly dependent upon the credit quality of the collateral, the
      relative position of the tranche in the capital structure of the CDO and
      the prepayment assumptions.


- 18
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





10.
FAIR VALUE MEASUREMENTS (Continued)





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 Pricesin
                  ActiveMarkets
                  forIdentical
                  Assets
                  (Level 1)
                
                
                Significant
                  Other
                  Observable
                  Input
                  (Level 2)
                
                
                Significant
                  Unobservable
                  Inputs
                  (Level 3)
                
                
                Balance at End
                  of PeriodMarch
      31, 2009Mortgage
      servicing rights
                
                $
                -
                
                
                $
                -
                
                
                $
                453
                
                
                $
                453Impaired
      loans
                
                $
                -
                
                
                $
                -
                
                
                $
                123
                
                
                $
                123Foreclosed
      assets
                
                $
                -
                
                
                $
                -
                
                
                $
                437
                
                
                $
                437December
      31, 2008Mortgage
      servicing rights
                
                $
                -
                
                
                $
                -
                
                
                $
                402
                
                
                $
                402Impaired
      loans
                
                $
                -
                
                
                $
                -
                
                
                $
                398
                
                
                $
                398





11.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND GUARANTEES





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





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





March 31,
                  
                  
                  December 31,2009
                  
                  
                  2008Commitments
      to extend credit and unused lines of credit
                  
                  $
                  95,081
                  
                  
                  $
                  87,227Standby
      letters of credit
                  
                  
                  11,902
                  
                  
                  
                  12,051$
                  106,983
                  
                  
                  $
                  99,278


- 19
-


QNB
CORP. AND SUBSIDIARY





NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


MARCH
31, 2009 AND 2008, AND DECEMBER 31, 2008


(Unaudited)





11.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS AND GUARANTEES (Continued)





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





Standby
letters of credit are conditional commitments issued by the Bank to guarantee
the financial or performance obligation of a customer to a third party. QNB’s
exposure to credit loss in the event of nonperformance by the other party to the
financial instrument for standby letters of credit is represented by the
contractual amount of those instruments. The Bank uses the same credit policies
in making conditional obligations as it does for on-balance sheet instruments.
These standby letters of credit expire within three years. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending other loan commitments. The Bank requires collateral and personal
guarantees supporting these letters of credit as deemed necessary. Management
believes that the proceeds obtained through a liquidation of such collateral and
the enforcement of personal guarantees would be sufficient to cover the maximum
potential amount of future payments required under the corresponding guarantees.
The amount of the liability as of March 31, 2009 and December 31, 2008 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.


- 20
-


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.
(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. The consolidated entity is
referred to herein as “QNB”.





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 2008 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.


- 21
-


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 other-than-temporary
impairments on investment securities, the determination of impairment of
restricted bank stocks, the determination of the allowance for loan losses, the
determination of the valuation of foreclosed 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.
Once a decline in value is determined to be other-than-temporary, the value of
the security is reduced and a corresponding charge to earnings is recognized. As
a result of declines in the equity markets, QNB recorded an other-than-temporary
impairment charge of $390,000 in the first quarter of 2009 related to several
equity securities held by the Company.





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 evaluates the restricted stock for impairment in accordance
with Statement of Position (SOP) 01-6, Accounting by Certain Entities (Including
Entities With Trade Receivables) That Lend to or Finance the Activities of
Others. 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, 2009.


- 22
-


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 appropriate by management.





The
allowance for loan losses is based on management’s continuous review and
evaluation of the loan portfolio. The level of the allowance is determined by
assigning specific reserves to individually identified problem credits and
general reserves to all other loans. The portion of the allowance that is
allocated to 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, historic and anticipated delinquency and loss experience,
as well as other qualitative factors such as current economic
trends.





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





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





Management
believes that it uses the best information available to make determinations
about the adequacy of the allowance and that it has established its existing
allowance for loan losses in accordance with GAAP. If circumstances differ
substantially from the assumptions used in making determinations, future
adjustments to the 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 from
operations and changes in the valuation allowance are included in net expenses
from foreclosed assets.


- 23
-


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


QNB
sponsors stock-based compensation plans, administered by a board committee,
under which both qualified and non-qualified stock options may be granted
periodically to certain employees. QNB accounts for all awards granted under
stock-based compensation plans in accordance with FASB Statement No. 123
(revised 2004), Share-Based Payment (FASB No. 123R). Compensation cost has been
measured using the fair value of an award on the grant date and is recognized
over the service period, which is usually the vesting period. 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. 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 2009 of $1,094,000, or $0.35 per
share on a diluted basis. These results compare to net income of $1,710,000, or
$0.54 per share on a diluted basis, for the first quarter of 2008.





The core
functions of the Bank, gathering deposits and making loans, continued to show
strength and contributed positively to the results for the first quarter of
2009. However, the challenging economic environment and the continued
uncertainty in the financial markets negatively impacted first quarter 2009
results as QNB had to increase its provision for loan losses, recognize further
declines in the value of the equity securities portfolio and record higher FDIC
insurance premiums.


- 24
-


QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





RESULTS
OF OPERATIONS – OVERVIEW (Continued)





Net
interest income increased $467,000, or 10.1%, to $5,081,000 for the first
quarter of 2009 compared to the first quarter of 2008. This reflects 10.1%
growth in average earning assets and a two basis point increase in the net
interest margin. When comparing the first quarter of 2009 to the same period in
2008, average loans increased 8.7% and average investment securities increased
15.0%. The growth in the loan portfolio was primarily in loans secured by
commercial real estate while the growth in the investment portfolio was
primarily in high quality U.S. Government agency and agency mortgage-backed
securities. On the funding side average time deposits increased 21.8% while
average transaction accounts increased 0.9%.





The net
interest margin was 3.48% for the first quarter of 2009 compared to 3.46% for
the first quarter of 2008 and 3.62% for the fourth quarter of 2008. The decline
in the net interest margin from the fourth quarter of 2008 is mainly the result
of the yield earned on loans and investment securities declining to a greater
degree than the cost of deposits and short-term borrowings as well as the change
in the mix of deposits from lower cost transaction accounts to higher cost time
deposits.





As a
result of loan growth, higher than normal levels of net charge-offs and concern
over current economic conditions, QNB recorded a provision for loan losses of
$600,000 in the first quarter of 2009. This compares to provisions of $225,000
for the quarter ended March 31, 2008 and $750,000 for the quarter ended December
31, 2008. Net loan charge-offs were $216,000 for the first quarter of 2009
compared with $93,000 for the first quarter of 2008 and $407,000 for the fourth
quarter of 2008.





Total
non-performing loans, which represent loans on non-accrual status and loans past
due more than 90 days, improved when compared to both March 31, 2008 and
December 31, 2008. Non-performing loans were $743,000, or 0.18% of total loans,
at March 31, 2009, compared to $1,557,000, or 0.41% of total loans, at March 31,
2008 and $1,308,000, or 0.32%, at December 31, 2008. QNB’s non-performing loans
to total loans experience continues to compare extremely favorably with the
average 1.34% of total loans for Pennsylvania commercial banks with assets
between $500 million and $1 billion, as reported by the FDIC using December 31,
2008 data. QNB’s allowance for loan losses of $4,220,000 represents 1.01% of
total loans at March 31, 2009 compared to an allowance for loan losses of
$3,411,000, or 0.90% of total loans, at March 31, 2008 and $3,836,000, or 0.95%
of total loans, at December 31, 2008. Other real estate owned and other
repossessed assets were $437,000 at March 31, 2009 compared with $37,000 at
March 31, 2008 and $319,000 at December 31, 2008.





Net
investment securities losses were $254,000 for the quarter ended March 31, 2009,
which included a $390,000 charge related to other-than-temporary impairment
(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. This compares to $222,000 of
net securities gains in the first quarter of 2008.





Positively
impacting non-interest income for the first quarter of 2008 was the recognition
of $230,000 of income as a result of the Visa initial public offering.
Non-interest income for the first quarter of 2008, excluding net investment
securities gains and the Visa income, totaled $932,000 compared to $987,000 for
the first quarter of 2009, excluding net investment securities losses. An
increase in residential mortgage activity in the current low interest rate
environment resulted in gains on sales of residential mortgage loans increasing
$136,000, to $168,000, for the 2009 quarter. Partially offsetting this
additional income were lower fees for services to customers which declined
$50,000 when comparing the quarter ended March 31, 2009 to the same period in
2008. This fee decline was caused by a lower level of customer
overdrafts.


- 25
-





QNB
CORP. AND SUBSIDIARY





MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL


CONDITION
AND RESULTS OF OPERATIONS





RESULTS
OF OPERATIONS – OVERVIEW (Continued)





Total
non-interest expense was $3,929,000 for the first quarter of 2009, an increase
of 10.9% compared to $3,543,000 for the first quarter of 2008. The largest
contributing factor to the increase in non-interest expense was FDIC insurance
premium expense which increased $159,000, or 468% to $193,000, when comparing
the first quarter of 2009 to 2008. 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. The lower FDIC expense recorded in the first
quarter of 2008 also reflects the use of the remaining portion of an available
credit. Salary and benefit expense increased $107,000, or 5.4%, to $2,078,000
for the first quarter of 2009. Additional commercial lending personnel and the
staffing of the Wescosville branch, which opened in November 2008, account for
the majority of the increase.





QNB
operates in an attractive market for financial services but also in a market
with intense competition from other local community banks and regional and
national financial institutions. QNB has been able to compete effectively with
other financial institutions by emphasizing technology, including
internet-banking and electronic bill pay, and customer service, including local
decision-making on loans, the establishment of long-term customer relationships
and loyalty, and products and services designed to address the specific needs of
our customers.





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


- 26
-


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 EndedMarch 31, 2009
                                                                                                
                                                                                                
                                                                                                March 31, 2008Average
                                                                                                
                                                                                                
                                                                                                Average
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                Average
                                                                                                
                                                                                                
                                                                                                AverageBalance
                                                                                                
                                                                                                
                                                                                                Rate
                                                                                                
                                                                                                
                                                                                                Interest
                                                                                                
                                                                                                
                                                                                                Balance
                                                                                                
                                                                                                
                                                                                                Rate
                                                                                                
                                                                                                
                                                                                                InterestAssetsFederal
      funds sold
                                                                                                
                                                                                                $
                                                                                                1,497
                                                                                                
                                                                                                
                                                                                                
                                                                                                0.20
                                                                                                %
                                                                                                
                                                                                                $
                                                                                                1
                                                                                                
                                                                                                
                                                                                                $
                                                                                                5,832
                                                                                                
                                                                                                
                                                                                                
                                                                                                2.91
                                                                                                %
                                                                                                
                                                                                                $
                                                                                                42Investment
      securities:U.S.
      Treasury
                                                                                                
                                                                                                
                                                                                                5,064
                                                                                                
                                                                                                
                                                                                                
                                                                                                1.60
                                                                                                %
                                                                                                
                                                                                                
                                                                                                20
                                                                                                
                                                                                                
                                                                                                
                                                                                                5,125
                                                                                                
                                                                                                
                                                                                                
                                                                                                4.12
                                                                                                %
                                                                                                
                                                                                                
                                                                                                52U.S.
      Government agencies
                                                                                                
                                                                                                
                                                                                                37,083
                                                                                                
                                                                                                
                                                                                                
                                                                                                4.77
                                                                                                %
                                                                                                
                                                                                                
                                                                                                442
                                                                                                
                                                                                                
                                                                                                
                                                                                                29,216
                                                                                                
                                                                                                
                                                                                                
                                                                                                5.55
                                                                                                %
                                                                                                
                                                                                                
                                                                                                405State
      and municipal
                                                                                                
                                                                                                
                                                                                                47,732
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.46
                                                                                                %
                                                                                                
                                                                                                
                                                                                                771
                                                                                                
                                                                                                
                                                                                                
                                                                                                42,626
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.56
                                                                                                %
                                                                                                
                                                                                                
                                                                                                700Mortgage-backed
      and CMOs
                                                                                                
                                                                                                
                                                                                                119,098
                                                                                                
                                                                                                
                                                                                                
                                                                                                5.46
                                                                                                %
                                                                                                
                                                                                                
                                                                                                1,625
                                                                                                
                                                                                                
                                                                                                
                                                                                                99,271
                                                                                                
                                                                                                
                                                                                                
                                                                                                5.59
                                                                                                %
                                                                                                
                                                                                                
                                                                                                1,387Corporate
      bonds (fixed and variable)
                                                                                                
                                                                                                
                                                                                                7,486
                                                                                                
                                                                                                
                                                                                                
                                                                                                4.66
                                                                                                %
                                                                                                
                                                                                                
                                                                                                87
                                                                                                
                                                                                                
                                                                                                
                                                                                                13,858
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.62
                                                                                                %
                                                                                                
                                                                                                
                                                                                                230Money
      market mutual funds
                                                                                                
                                                                                                
                                                                                                3,398
                                                                                                
                                                                                                
                                                                                                
                                                                                                1.02
                                                                                                %
                                                                                                
                                                                                                
                                                                                                9
                                                                                                
                                                                                                
                                                                                                
                                                                                                -
                                                                                                
                                                                                                
                                                                                                
                                                                                                0.00
                                                                                                %
                                                                                                
                                                                                                
                                                                                                -Equities
                                                                                                
                                                                                                
                                                                                                3,466
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.04
                                                                                                %
                                                                                                
                                                                                                
                                                                                                26
                                                                                                
                                                                                                
                                                                                                
                                                                                                4,151
                                                                                                
                                                                                                
                                                                                                
                                                                                                2.73
                                                                                                %
                                                                                                
                                                                                                
                                                                                                28Total
      investment securities
                                                                                                
                                                                                                
                                                                                                223,327
                                                                                                
                                                                                                
                                                                                                
                                                                                                5.34
                                                                                                %
                                                                                                
                                                                                                
                                                                                                2,980
                                                                                                
                                                                                                
                                                                                                
                                                                                                194,247
                                                                                                
                                                                                                
                                                                                                
                                                                                                5.77
                                                                                                %
                                                                                                
                                                                                                
                                                                                                2,802Loans:Commercial
      real estate
                                                                                                
                                                                                                
                                                                                                201,399
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.28
                                                                                                %
                                                                                                
                                                                                                
                                                                                                3,117
                                                                                                
                                                                                                
                                                                                                
                                                                                                177,897
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.76
                                                                                                %
                                                                                                
                                                                                                
                                                                                                2,990Residential
      real estate
                                                                                                
                                                                                                
                                                                                                24,187
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.05
                                                                                                %
                                                                                                
                                                                                                
                                                                                                366
                                                                                                
                                                                                                
                                                                                                
                                                                                                21,918
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.19
                                                                                                %
                                                                                                
                                                                                                
                                                                                                339Home
      equity loans
                                                                                                
                                                                                                
                                                                                                67,576
                                                                                                
                                                                                                
                                                                                                
                                                                                                5.25
                                                                                                %
                                                                                                
                                                                                                
                                                                                                875
                                                                                                
                                                                                                
                                                                                                
                                                                                                68,301
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.14
                                                                                                %
                                                                                                
                                                                                                
                                                                                                1,042Commercial
      and industrial
                                                                                                
                                                                                                
                                                                                                72,024
                                                                                                
                                                                                                
                                                                                                
                                                                                                4.94
                                                                                                %
                                                                                                
                                                                                                
                                                                                                876
                                                                                                
                                                                                                
                                                                                                
                                                                                                67,515
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.63
                                                                                                %
                                                                                                
                                                                                                
                                                                                                1,113Indirect
      lease financing
                                                                                                
                                                                                                
                                                                                                15,234
                                                                                                
                                                                                                
                                                                                                
                                                                                                8.43
                                                                                                %
                                                                                                
                                                                                                
                                                                                                321
                                                                                                
                                                                                                
                                                                                                
                                                                                                13,036
                                                                                                
                                                                                                
                                                                                                
                                                                                                10.08
                                                                                                %
                                                                                                
                                                                                                
                                                                                                329Consumer
      loans
                                                                                                
                                                                                                
                                                                                                4,275
                                                                                                
                                                                                                
                                                                                                
                                                                                                10.35
                                                                                                %
                                                                                                
                                                                                                
                                                                                                109
                                                                                                
                                                                                                
                                                                                                
                                                                                                4,362
                                                                                                
                                                                                                
                                                                                                
                                                                                                10.64
                                                                                                %
                                                                                                
                                                                                                
                                                                                                115Tax-exempt
      loans
                                                                                                
                                                                                                
                                                                                                25,424
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.01
                                                                                                %
                                                                                                
                                                                                                
                                                                                                377
                                                                                                
                                                                                                
                                                                                                
                                                                                                24,411
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.13
                                                                                                %
                                                                                                
                                                                                                
                                                                                                372Total
      loans, net of unearned income*
                                                                                                
                                                                                                
                                                                                                410,119
                                                                                                
                                                                                                
                                                                                                
                                                                                                5.97
                                                                                                %
                                                                                                
                                                                                                
                                                                                                6,041
                                                                                                
                                                                                                
                                                                                                
                                                                                                377,440
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.71
                                                                                                %
                                                                                                
                                                                                                
                                                                                                6,300Other
      earning assets
                                                                                                
                                                                                                
                                                                                                3,235
                                                                                                
                                                                                                
                                                                                                
                                                                                                0.18
                                                                                                %
                                                                                                
                                                                                                
                                                                                                1
                                                                                                
                                                                                                
                                                                                                
                                                                                                2,036
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.69
                                                                                                %
                                                                                                
                                                                                                
                                                                                                18Total
      earning assets
                                                                                                
                                                                                                
                                                                                                638,178
                                                                                                
                                                                                                
                                                                                                
                                                                                                5.73
                                                                                                %
                                                                                                
                                                                                                
                                                                                                9,023
                                                                                                
                                                                                                
                                                                                                
                                                                                                579,555
                                                                                                
                                                                                                
                                                                                                
                                                                                                6.36
                                                                                                %
                                                                                                
                                                                                                
                                                                                                9,162Cash
      and due from banks
                                                                                                
                                                                                                
                                                                                                10,092
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                9,994Allowance
      for loan losses
                                                                                                
                                                                                                
                                                                                                (3,925
                                                                                                )
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                (3,292
                                                                                                )Other
      assets
                                                                                                
                                                                                                
                                                                                                21,695
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                21,614Total
      assets
                                                                                                
                                                                                                $
                                                                                                666,040
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                $
                                                                                                607,871Liabilities
      and Shareholders' EquityInterest-bearing
      deposits:Interest-bearing
      demand
                                                                                                
                                                                                                $
                                                                                                64,501
                                                                                                
                                                                                                
                                                                                                
                                                                                                0.49
                                                                                                %
                                                                                                
                                                                                                
                                                                                                78
                                                                                                
                                                                                                
                                                                                                $
                                                                                                54,912
                                                                                                
                                                                                                
                                                                                                
                                                                                                0.16
                                                                                                %
                                                                                                
                                                                                                
                                                                                                22Municipals
                                                                                                
                                                                                                
                                                                                                25,611
                                                                                                
                                                                                                
                                                                                                
                                                                                                1.21
                                                                                                %
                                                                                                
                                                                                                
                                                                                                76
                                                                                                
                                                                                                
                                                                                                
                                                                                                36,421
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.15
                                                                                                %
                                                                                                
                                                                                                
                                                                                                285Money
      market
                                                                                                
                                                                                                
                                                                                                48,064
                                                                                                
                                                                                                
                                                                                                
                                                                                                1.38
                                                                                                %
                                                                                                
                                                                                                
                                                                                                164
                                                                                                
                                                                                                
                                                                                                
                                                                                                49,798
                                                                                                
                                                                                                
                                                                                                
                                                                                                2.35
                                                                                                %
                                                                                                
                                                                                                
                                                                                                291Savings
                                                                                                
                                                                                                
                                                                                                44,790
                                                                                                
                                                                                                
                                                                                                
                                                                                                0.25
                                                                                                %
                                                                                                
                                                                                                
                                                                                                28
                                                                                                
                                                                                                
                                                                                                
                                                                                                42,596
                                                                                                
                                                                                                
                                                                                                
                                                                                                0.39
                                                                                                %
                                                                                                
                                                                                                
                                                                                                42Time
                                                                                                
                                                                                                
                                                                                                215,098
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.49
                                                                                                %
                                                                                                
                                                                                                
                                                                                                1,849
                                                                                                
                                                                                                
                                                                                                
                                                                                                194,909
                                                                                                
                                                                                                
                                                                                                
                                                                                                4.56
                                                                                                %
                                                                                                
                                                                                                
                                                                                                2,210Time
      of $100,000 or more
                                                                                                
                                                                                                
                                                                                                105,216
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.54
                                                                                                %
                                                                                                
                                                                                                
                                                                                                920
                                                                                                
                                                                                                
                                                                                                
                                                                                                68,026
                                                                                                
                                                                                                
                                                                                                
                                                                                                4.68
                                                                                                %
                                                                                                
                                                                                                
                                                                                                792Total
      interest-bearing deposits
                                                                                                
                                                                                                
                                                                                                503,280
                                                                                                
                                                                                                
                                                                                                
                                                                                                2.51
                                                                                                %
                                                                                                
                                                                                                
                                                                                                3,115
                                                                                                
                                                                                                
                                                                                                
                                                                                                446,662
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.28
                                                                                                %
                                                                                                
                                                                                                
                                                                                                3,642Short-term
      borrowings
                                                                                                
                                                                                                
                                                                                                18,488
                                                                                                
                                                                                                
                                                                                                
                                                                                                1.23
                                                                                                %
                                                                                                
                                                                                                
                                                                                                56
                                                                                                
                                                                                                
                                                                                                
                                                                                                23,948
                                                                                                
                                                                                                
                                                                                                
                                                                                                2.87
                                                                                                %
                                                                                                
                                                                                                
                                                                                                171Long-term
      debt
                                                                                                
                                                                                                
                                                                                                35,000
                                                                                                
                                                                                                
                                                                                                
                                                                                                4.27
                                                                                                %
                                                                                                
                                                                                                
                                                                                                374
                                                                                                
                                                                                                
                                                                                                
                                                                                                33,132
                                                                                                
                                                                                                
                                                                                                
                                                                                                4.34
                                                                                                %
                                                                                                
                                                                                                
                                                                                                363Total
      interest-bearing liabilities
                                                                                                
                                                                                                
                                                                                                556,768
                                                                                                
                                                                                                
                                                                                                
                                                                                                2.58
                                                                                                %
                                                                                                
                                                                                                
                                                                                                3,545
                                                                                                
                                                                                                
                                                                                                
                                                                                                503,742
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.33
                                                                                                %
                                                                                                
                                                                                                
                                                                                                4,176Non-interest-bearing
      deposits
                                                                                                
                                                                                                
                                                                                                50,576
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                47,840Other
      liabilities
                                                                                                
                                                                                                
                                                                                                4,293
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                4,273Shareholders'
      equity
                                                                                                
                                                                                                
                                                                                                54,403
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                52,016Total
      liabilities and shareholders' equity
                                                                                                
                                                                                                $
                                                                                                666,040
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                $
                                                                                                607,871Net
      interest rate spread
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.15
                                                                                                %
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.03
                                                                                                %Margin/net
      interest income
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.48
                                                                                                %
                                                                                                
                                                                                                $
                                                                                                5,478
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                
                                                                                                3.46
                                                                                                %
                                                                                                
                                                                                                $
                                                                                                4,986





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


Non-accrual
loans are included in earning assets.


*
Includes loans held-for-sale


- 27
-


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.





March 31, 2009 comparedto March 31, 2008Total
                  
                  
                  Due to change in:Change
                  
                  
                  Volume
                  
                  
                  RateInterest
      income:Federal
      funds sold
                  
                  $
                  (41
                  )
                  
                  $
                  (31
                  )
                  
                  $
                  (10
                  )Investment
      securities:U.S.
      Treasury
                  
                  
                  (32
                  )
                  
                  
                  (1
                  )
                  
                  
                  (31
                  )U.S.
      Government agencies
                  
                  
                  37
                  
                  
                  
                  109
                  
                  
                  
                  (72
                  )State
      and municipal
                  
                  
                  71
                  
                  
                  
                  83
                  
                  
                  
                  (12
                  )Mortgage-backed
      and CMOs
                  
                  
                  238
                  
                  
                  
                  277
                  
                  
                  
                  (39
                  )Corporate
      bonds (fixed and variable)
                  
                  
                  (143
                  )
                  
                  
                  (106
                  )
                  
                  
                  (37
                  )Money
      market mutual funds
                  
                  
                  9
                  
                  
                  
                  -
                  
                  
                  
                  9Equities
                  
                  
                  (2
                  )
                  
                  
                  (5
                  )
                  
                  
                  3Loans:Commercial
      real estate
                  
                  
                  127
                  
                  
                  
                  367
                  
                  
                  
                  (240
                  )Residential
      real estate
                  
                  
                  27
                  
                  
                  
                  36
                  
                  
                  
                  (9
                  )Home
      equity loans
                  
                  
                  (167
                  )
                  
                  
                  (20
                  )
                  
                  
                  (147
                  )Commercial
      and industrial
                  
                  
                  (237
                  )
                  
                  
                  64
                  
                  
                  
                  (301
                  )Indirect
      lease financing
                  
                  
                  (8
                  )
                  
                  
                  55
                  
                  
                  
                  (63
                  )Consumer
      loans
                  
                  
                  (6
                  )
                  
                  
                  (3
                  )
                  
                  
                  (3
                  )Tax-exempt
      loans
                  
                  
                  5
                  
                  
                  
                  13
                  
                  
                  
                  (8
                  )Other
      earning assets
                  
                  
                  (17
                  )
                  
                  
                  11
                  
                  
                  
                  (28
                  )Total
      interest income
                  
                  
                  (139
                  )
                  
                  
                  849
                  
                  
                  
                  (988
                  )Interest
      expense:Interest-bearing
      demand
                  
                  
                  56
                  
                  
                  
                  4
                  
                  
                  
                  52Municipals
                  
                  
                  (209
                  )
                  
                  
                  (87
                  )
                  
                  
                  (122
                  )Money
      market
                  
                  
                  (127
                  )
                  
                  
                  (12
                  )
                  
                  
                  (115
                  )Savings
                  
                  
                  (14
                  )
                  
                  
                  2
                  
                  
                  
                  (16
                  )Time
                  
                  
                  (361
                  )
                  
                  
                  209
                  
                  
                  
                  (570
                  )Time
      of $100,000 or more
                  
                  
                  128
                  
                  
                  
                  423
                  
                  
                  
                  (295
                  )Short-term
      borrowings
                  
                  
                  (115
                  )
                  
                  
                  (40
                  )
                  
                  
                  (75
                  )Long-term
      debt
                  
                  
                  11
                  
                  
                  
                  16
                  
                  
                  
                  (5
                  )Total
      interest expense
                  
                  
                  (631
                  )
                  
                  
                  515
                  
                  
                  
                  (1,146
                  )Net
      interest income
                  
                  $
                  492
                  
                  
                  $
                  334
                  
                  
                  $
                  158


- 28
-


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 periods
ended March 31, 2009 and 2008.





For the Three MonthsEnded March 31,2009
                  
                  
                  2008Total
      interest income
                  
                  $
                  8,626
                  
                  
                  $
                  8,790Total
      interest expense
                  
                  
                  3,545
                  
                  
                  
                  4,176Net
      interest income
                  
                  
                  5,081
                  
                  
                  
                  4,614Tax
      equivalent adjustment
                  
                  
                  397
                  
                  
                  
                  372Net
      interest income (fully taxable equivalent)
                  
                  $
                  5,478
                  
                  
                  $
                  4,986





Net
interest income is the primary source of operating income for QNB. Net interest
income is interest income, dividends, and fees on earning assets, less interest
expense incurred for funding sources. Earning assets primarily include loans,
investment securities and Federal funds sold. Sources used to fund these assets
include deposits 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 27 and 28. 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 $467,000, or 10.1%, to $5,081,000 for the quarter
ended March 31, 2009 as compared to the quarter ended March 31, 2008. On a
tax-equivalent basis, net interest income increased by 9.9% from $4,986,000 for
the three months ended March 31, 2008 to $5,478,000 for the same period ended
March 31, 2009. Strong growth in deposits and the deployment of these deposits
into loans and investment securities was the primary contributor to the growth
in net interest income. Total average deposits increased $59,354,000 or 12.0%
when comparing the three months ended March 31, 2009 and March 31, 2008. Over
this same time period total average loans increased $32,679,000 or 8.7% and
total average investment securities increased $29,080,000 or 15.0%. Also
contributing to the increase in net interest income was a 2 basis point increase
in the net interest margin from 3.46% for the first quarter of 2008 to 3.48% for
the first quarter of 2009.


- 29
-


QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
 
 NET
INTEREST INCOME (Continued)
 
 QNB’s
interest sensitivity position also contributed to the increase in net interest
income and the net interest margin. For the majority of 2008, QNB’s
interest sensitivity position reflected a negative gap position in a one-year
time frame. A negative sensitivity position results when the amount of interest
rate sensitive liabilities (deposits and debt) exceeds interest rate sensitive
assets (loans and investment securities). As a result of this position, QNB’s
cost of interest-bearing liabilities declined to a greater degree than the yield
on its earnings assets, as the Federal Reserve Bank’s Open Market Committee
(Fed) picked up the pace of reducing the Federal funds target rate in response
to liquidity issues in the world’s financial markets, a nationwide housing
slowdown and the impact of the deepening recession on economic growth and
unemployment. The Fed cut its key interest rate, the Federal funds target rate,
seven times in 2008, from 4.25% as the start of the year, in an attempt to boost
the economy, with the last cut in December setting the target rate at 0% to
0.25%, a historic low. The Prime lending rate followed in step and was at 3.25%
as of December 31, 2008. The short end of the treasury yield curve declined
significantly as liquidity and financial market strains caused a flight to
quality and the U.S. T-bill became the safe haven. During the fourth quarter of
2008, short-term T-bill rates hit 0% and the 10-year Treasury yield hit historic
lows. While coming off these historic lows, interest rates remained at low
levels during the first quarter of 2009. At the end of 2008, the three-month
T-bill rate was 0.11%, a decline of 325 basis points from the prior year, the
two-year note yielded 0.76%, down 229 basis points from December 31, 2007 and
the ten-year note yielded 2.25%, a decline of 179 basis points. In comparison,
as of March 31, 2009 and 2008, the three-month T-bill rate was 0.21% and 1.38%,
the two-year note yield was 0.81% and 1.62%, and the ten-year note yield was
2.71% and 3.45%, respectively. During the first quarter of 2009, the yield on
the ten-year note was volatile as the Federal Government, in an effort to
stimulate residential mortgage activity, was purchasing mortgage-backed
securities which had the impact of lowering the ten-year note yield while
concerns over the amount of Government stimulus and its longer-term impact on
the economy had the effect of increasing the yield on the ten-year
note.
 
 The yield
on earning assets on a tax-equivalent basis decreased 63 basis points from 6.36%
for the first quarter of 2008 to 5.73% for the first quarter of 2009. Interest
income on investment securities increased $178,000 when comparing the two
quarters as the increase in average balances offset the 43 basis point decline
in the average yield of the portfolio. The average yield on the investment
portfolio was 5.34% for the first quarter of 2009 compared with 5.77% for the
first quarter of 2008 and 5.44% for the fourth quarter of 2008. The decline in
the yield on the investment portfolio is primarily the result of an increase in
liquidity resulting from deposit growth and a significant 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 securities
and municipal securities. The reinvestment of these funds were in securities
that had lower yields than what they replaced. The growth in the investment
portfolio was primarily in high quality U.S. Government agency and agency
mortgage-backed and CMO securities and tax-exempt State and municipal bonds.
Interest on mortgage-backed securities and CMOs increased $238,000 with growth
in the portfolio contributing $277,000. This was partially offset by a $39,000
decrease in interest income resulting from a 13 basis point decline in yield.
The yield on the mortgage-backed portfolio decreased from 5.59% to 5.46% when
comparing the first quarter of 2008 and 2009. Income on Government agency
securities increased by $37,000 as the 26.9% growth in average balances was
offset by a 78 basis point decline in yield from 5.55% for the first quarter of
2008 to 4.77% for the same period in 2009. Most of the bonds in the agency
portfolio have call features ranging from three months to five years, some of
which were exercised as a result of the significant decline in interest rates.
Interest on tax-exempt municipal securities increased $71,000 with higher
balances accounting for $83,000 of additional income offset by the impact of
lower rates. The yield on the state and municipal portfolio decreased from 6.56%
for the first quarter of 2008 to 6.46% for the first quarter of 2009. Credit
concerns in the municipal market arising from issues
with the insurance companies that insure the bonds resulted in yields on
municipal bonds remaining high despite the significant decline in treasury
market rates. This is known as spread widening. Interest on corporate bonds
declined by $143,000, with lower balances accounting for $106,000 of the decline
and lower rates accounting for $37,000 of the decline. The yield on the
corporate portfolio was 6.62% for the first quarter of 2008 compared to 4.66%
for the first quarter of 2009. To reduce credit risk in the portfolio, in
June 2008, QNB sold approximately $2,000,000 of Lehman Brothers bonds, which had
a yield of 7.25%, at a slight gain. In January 2009, QNB sold another
$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%. In addition, some of the
bonds in the corporate portfolio reprice quarterly based on three-month LIBOR.
The yield on these securities declined as interest rates declined. The yield on
the investment portfolio is anticipated to continue to decline as cash flow from
the portfolio is reinvested at current market rates which are significantly
below the portfolio yield at March 31, 2009 of 5.10%.
  - 30
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
 
 NET
INTEREST INCOME (Continued)
 
 Income on
loans decreased $259,000 to $6,041,000 when comparing the first quarters of
2009 and 2008 as the impact of declining interest rates could not be
overcome by higher balances. Average loans increased $32,679,000, or 8.7%, and
contributed an additional $512,000 in interest income. The yield on loans
decreased 74 basis points to 5.97% when comparing the same periods, resulting in
a reduction in interest income of $771,000. The decline in the yield on the loan
portfolio reflects the impact of lower interest rates, primarily loans indexed
to the Prime lending rate such as commercial and industrial loans and home
equity lines of credit. Reducing the impact of the decline in interest rates on
loan yields 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.
 
 Income on
commercial real estate loans increased $127,000, with average balances
increasing $23,502,000, or 13.2%. The yield on commercial real estate loans was
6.28% for the first quarter of 2009, a decline of 48 basis points from the 6.76%
reported for the first quarter of 2008. Interest on commercial and industrial
loans decreased $237,000 with the impact of the increase in average balances
being offset by the impact of the decline in yield. Average commercial and
industrial loans increased $4,509,000, or 6.7%, when comparing the two periods,
contributing an additional $64,000 in interest income. The average yield on
these loans decreased 169 basis points to 4.94% resulting in a reduction in
interest income of $301,000. The commercial and industrial loan category was
impacted the most by the action by the Fed to lower interest rates since a large
portion of this category of loans is indexed to the Prime rate. In response to
the significant decline in the Prime lending rate QNB has begun to institute
rate floors on these loans.
 
 While QNB
does not originate or hold sub-prime mortgages, or any of the other high-risk
mortgage products, it has been impacted by the overall downturn in the
residential housing market. Residential mortgage loan activity, which was slow
for most of 2008, picked up significantly during the first quarter of 2009 as
mortgage rates declined in response to actions by the Federal Government. Income
on residential real estate loans increased by $27,000 when comparing the two
quarters, as the increase in balances offset the slight decline in yield. The
average balance of residential mortgages increased $2,269,000, or 10.4%, when
comparing the two quarters while the average yield decreased by 14 basis points.
QNB sells most of the fixed rate loans it originates, especially in the current
low rate environment. Included in the increase in average balances was an
increase of $1,191,000 in residential mortgages held-for-sale.
  - 31
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
 
 NET
INTEREST INCOME (Continued)
 
 Income on
home equity loans declined by $167,000 when comparing the two quarters.
Over this same time period average home equity loans decreased 1.1%, to
$67,576,000, while the yield on the home equity portfolio decreased 89 basis
points to 5.25%. The demand for home equity loans has declined as home
values have stabilized or fallen and some homeowners have already borrowed
against the equity in their homes. Included in the home equity portfolio are
floating rate home equity lines tied to the Prime lending rate. The average
balance of these loans increased by $7,745,000, or 65.8%, to $19,507,000 for the
first quarter of 2009. In contrast, average fixed rate loans declined by
$8,470,000, or 15.0% to $48,069,000. The movement from fixed rate to floating
rate loans reflects the significant decline in the prime rate to 3.25% and the
introduction of the Equity Choice product during 2008. This product is a
variable rate line of credit indexed to the prime rate that allows the borrower
to carve out portions of the variable rate balance and to fix the rate on that
portion based on the term and rate at that time. As the fixed rate portion is
paid down, the available amount under the line increases. As with commercial and
industrial loans tied to the prime rate, QNB has begun to institute a rate floor
on these prime based loans.
 
 Interest
income on Federal funds sold decreased $41,000 when comparing the two quarters,
a result of both a 271 basis point decline in rate and a $4,335,000 decrease in
average balances. The average yield on Federal funds sold decreased from 2.91%
for the first quarter of 2008 to 0.20% for the first quarter of 2009, reflecting
the actions by the Fed to reduce the Federal funds target rate. Impacting the
volume of Federal funds sold was the decision by management to invest some of
the short-term excess funds in AAA rated money market mutual funds which were
yielding approximately 80 basis points more than Federal funds.
 
 Income on
other earning assets is comprised of interest on deposits in banks and dividends
on restricted investments in bank stocks, primarily the Federal Home Loan Bank
of Pittsburgh (FHLB). Income on other earning assets declined from $18,000 for
the first quarter of 2008 to $1,000 for the first quarter of 2009. In December
2008, the FHLB notified member banks that it was suspending dividend payments to
preserve capital. FHLB dividend income was $11,000 for the first quarter of
2008.
 
 For the
most part, earning assets are funded by deposits, which increased on average by
$59,354,000, or 12.0%, when comparing the first quarters of 2009 and 2008. It
appears that customers are looking 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. 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. This legislation provides that the basic
deposit insurance limit will return to $100,000 after December 31, 2009.
However, legislation has been proposed that would extend the coverage past this
date. 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 Liquidity Guarantee Program”). All eligible
institutions participated in the program without cost for the first 30 days of
the program. After November 12, 2008, institutions are assessed at the rate of
ten basis points for transaction account balances in excess of $250,000. QNB is
participating in the Transaction Account Guarantee Program.
  - 32
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  NET
INTEREST INCOME (Continued)
 
 Most of
the increase in average deposits was time deposits which increased $57,379,000,
or 21.8%, to $320,314,000 for the first quarter of 2009. Included in this total
was $105,216,000 of time deposits of $100,000 or more, an increase of
$37,190,000 from the $68,026,000 reported for the first quarter of 2008. Higher
yields relative to alternative investments, including other bank deposits, and
the increase in FDIC coverage as discussed above appear to be the impetus behind
this growth.
 
 Average
non-interest bearing and interest-bearing demand accounts increased $2,736,000,
or 5.7% and $9,589,000 or 17.5%, respectively when comparing the first quarters
of 2009 and 2008. Average savings account balances increased $2,194,000, or
5.2%, to $44,790,000 when comparing the same periods.
 
 While
total income on earning assets on a tax-equivalent basis decreased $139,000 when
comparing the first quarter of 2009 to the first quarter of 2008, total interest
expense declined $631,000. Interest expense on total deposits decreased $527,000
while interest expense on borrowed funds decreased $104,000 when comparing the
two quarters. The rate paid on interest-bearing liabilities decreased 75 basis
points from 3.33% for the first quarter of 2008 to 2.58% for the first quarter
of 2009. During this same period, the rate paid on interest-bearing deposits
decreased 77 basis points from 3.28% to 2.51%.
 
 Interest
expense on interest-bearing demand accounts increased $56,000, to $78,000, when
comparing the two quarters. Average interest-bearing demand accounts increased
$9,589,000 or 17.5% when comparing the first quarters of 2009 and 2008. During
the third quarter of 2008 QNB introduced eRewards checking, a high rate checking
account paying 4.01% interest on balances up to $25,000. As of April 1, 2009,
the rate paid was reduced to 3.25%. 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.
At March 31, 2009 this product had a balance of $11,340,000. For the quarter the
average balance in the product was $8,862,000 and the related interest expense
was $70,000 for an average yield of 3.22%. This was the primary contributor to
the increase in rate on total interest-bearing demand accounts from 0.16% for
the first quarter of 2008 to 0.49% for the first quarter of 2009. It is
anticipated that this product will result in the movement of balances from lower
yielding deposit accounts to this product, but will also result in obtaining new
customers and additional deposits of existing customers.
 
 Interest
expense on municipal interest-bearing demand accounts decreased from $285,000
for the first quarter of 2008 to $76,000 for the same period in 2009. The
decrease in interest expense was the result of both volume and rate declines.
The average balance of municipal interest-bearing demand accounts decreased
$10,810,000 or 29.7% while the average interest rate paid on these accounts
decreased from 3.15% for the first quarter of 2008 to 1.21% for the first
quarter of 2009. The decline in average balances accounted for $87,000 of the
decrease in interest expense while the decline in the average rate paid
contributed $122,000. Most of these accounts are tied directly to the Federal
funds rate with some having rate floors of 1.00%.
 
 Interest
expense on money market accounts declined $127,000 to $164,000 for the first
quarter of 2009 compared to the first quarter of 2008. Of this decline $115,000
was a result of lower rates and $12,000 was a result of lower balances. The
average balances of money market accounts declined $1,734,000, or 3.5% when
comparing the two quarters. The average interest rate paid on money market
accounts was 2.35% for the first quarter of 2008 and 1.38% for the first quarter
of 2009, a decline of 97 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 during 2008, the rates paid on the Select money market
account have declined as well.
  - 33
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  NET
INTEREST INCOME (Continued)
 
 When
comparing the first quarter of 2009 to the first quarter of 2008, interest
expense on time deposits decreased $233,000. 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 2008 and
the first quarter of 2009 a significant amount of time deposits have repriced
lower as rates have declined. The average rate paid on time deposits decreased
from 4.59% to 3.51% when comparing the three month periods and as a result
interest expense declined by $865,000. Partially offsetting the impact of lower
rates was $632,000 in additional expense related to the 21.8% increase in
average balances.
 
 Approximately
$230,533,000, or 70.0%, of time deposits at March 31, 2009 will reprice or
mature over the next 12 months. The average rate paid on these time deposits is
approximately 3.31%. 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 as higher costing time deposits are
repriced lower. There are still a few competitors who are offering above market
rates on time deposits which could have an impact on the rate QNB needs to pay
to retain these deposits. To date QNB has been extremely successful in retaining
and growing these balances.
 
 Contributing
to the decrease in total interest expense was a reduction in interest expense on
short-term borrowings of $115,000. The average rate paid on short-term
borrowings declined from 2.87% for the first quarter of 2008 to 1.23% for the
first quarter of 2009. Short-term borrowings are primarily comprised of
repurchase agreements (a sweep product for commercial customers). While not
directly indexed to the Federal funds rate, the rate paid on these accounts
moves closely with the Federal funds rate and as a result declined when
comparing the two periods. Also included in short-term borrowings are overnight
Federal funds purchases from correspondent banks and overnight advances from the
FHLB. The average balance of short-term borrowings decreased from $23,948,000
for the first quarter of 2008 to $18,488,000 for the first quarter of 2009. Most
of this decline was in the commercial sweep accounts.
 
 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 of 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.
  - 34
-
 
 QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  PROVISION
FOR LOAN LOSSES (Continued)
 
 Management
uses various tools to assess the appropriateness of the allowance for loan
losses. One tool is a model that considers a number of relevant factors
including: historical loan loss experience, the assigned risk rating of the
credit, current and projected credit worthiness of the borrower, current value
of the underlying collateral, levels of and trends in delinquencies and
non-accrual loans, trends in volume and terms of loans, concentrations of
credit, and national and local economic trends and conditions. Other tools
utilized to assess the overall reasonableness of the allowance for loan losses
include ratio analysis and peer group analysis.
 
 QNB
utilizes a risk weighting system that assigns a risk code to every commercial
loan. This risk weighting system is supplemented with a program that encourages
account officers to identify potentially deteriorating loan situations. The
officer analysis program is used to complement the on-going analysis of the loan
portfolio performed during the loan review function. In addition, QNB has a
committee that meets quarterly to review the appropriateness of the allowance
for loan losses based on the current and projected status of all relevant
factors pertaining to the loan portfolio.
 
 As a
result of loan growth, higher than normal levels of net charge-offs and concern
over current economic conditions, QNB’s management determined that a $600,000
provision for loan losses was necessary for the three-month period ended March
31, 2009, compared to a provision for loan losses of $225,000 for the same
period in 2008. Net loan charge-offs were $216,000 for the first quarter of 2009
compared with $93,000 for the first quarter of 2008. Indirect lease financing
net charge-offs were $99,000 and $78,000 for the first quarter of 2009 and 2008,
respectively. This portfolio contains loans to business in the trucking and
construction industries which have been hit hard by the significant increase in
fuel costs during most of 2008 and the overall slowdown in the economy. Also
contributing to charge-offs for the first quarter of 2009 were losses related to
one commercial borrower totaling $110,000; part relating to a commercial and
industrial loan and part relating to residential real estate now classified as
other real estate owned.
 
 Non-performing
assets (non-accruing loans, loans past due 90 days or more, other real estate
owned and other repossessed assets) amounted to 0.17% and 0.26% of total assets
at March 31, 2009 and 2008, respectively. These levels compare to 0.24% at
December 31, 2008. Total non-performing loans, which represent loans on
non-accrual status and loans past due more than 90 days, improved when compared
to both March 31, 2008 and December 31, 2008. Non-performing loans were
$743,000, or 0.18% of total loans, at March 31, 2009, compared to $1,557,000, or
0.41% of total loans, at March 31, 2008 and $1,308,000, or 0.32%, at December
31, 2008. QNB’s non-performing loans to total loans experience continues to
compare extremely favorably with the average 1.34% of total loans for
Pennsylvania commercial banks with assets between $500 million and $1 billion,
as reported by the FDIC using December 31, 2008 data. Non-accrual loanswere $523,000, $830,000
and $1,418,000 at March 31, 2009, December 31, 2008 and March 31, 2008,
respectively. Loans past due 90 days or more and still accruing were $220,000,
$478,000 and $139,000, respectively, at these same period-ends.
 
 Other
real estate owned and other repossessed assets were $437,000 at March 31, 2009
compared with $37,000 at March 31, 2008 and $319,000 at December 31,
2008.
 
 Delinquent
loans include loans past due more than 30 days. Total delinquent loans at March
31, 2009, December 31, 2008 and March 31, 2008 represent 0.83%, 0.98% and 1.08%
of total loans, respectively. As of March 31, 2009, 8.34% of the indirect lease
portfolio was past due more than 30 days. This compares to 11.29% at December
31, 2008 and 13.04% at March 31, 2008. The asset quality of the commercial loan
portfolio, the largest component of total loans, representing approximately 74%
of total loans, remains strong. Total delinquent commercial loans were 0.48% of
total commercial loans at March 31, 2009. This compares to 0.37% and 0.48% at
December 31, 2008 and March 31, 2008, respectively. Included in the calculation
of delinquent commercial loans as of March 31, 2009 was a loan for $775,000
which paid off on April 1, 2009. Excluding this loan total delinquency and
commercial delinquency would have been 0.65% and 0.23%, respectively, at March
31, 2009.
  - 35
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  PROVISION
FOR LOAN LOSSES (Continued)
 
 There
were no restructured loans as of March 31, 2009, December 31, 2008 or March 31,
2008, respectively, as defined in FASB Statement No. 15, Accounting by Debtors and Creditors
for Troubled Debt Restructurings, that have not already been included in
loans past due 90 days or more or non-accrual loans.
 
 The
allowance for loan losses was $4,220,000, $3,836,000 and $3,411,000 at March 31,
2009, December 31, 2008, and March 31, 2008, respectively. The ratio of the
allowance to total loans was 1.01%, 0.95% and 0.90% at the respective period end
dates. The increase in the ratio reflects the increase in the provision for loan
losses recorded during 2008 and the first quarter of 2009. The ratio, at 1.01%,
is at a level that QNB management believes is adequate based on its
analysis.
 
 A loan is
considered impaired, based on current information and events, if it is probable
that QNB will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan agreement. The
measurement of impaired loans is generally based on the present value of
expected future cash flows discounted at the effective interest rate, except
that all collateral-dependent loans are measured for impairment based on the
fair value of the collateral. At March 31, 2009, December 31, 2008 and March 31,
2008, the recorded investment in loans for which impairment had been recognized
in accordance with FASB Statement No. 114, Accounting by Creditors for
Impairment of a Loan—an amendment of FASB Statements No. 5 and 15,
totaled $466,000, $824,000 and $949,000, respectively, of which $185,000,
$238,000 and $841,000, respectively required no specific allowance for loan
losses. The recorded investment in impaired loans requiring a specific allowance
for loan losses was $281,000, $586,000 and $108,000 at March 31, 2009, December
31, 2008 and March 31, 2008, respectively. At March 31, 2009, December 31, 2008
and March 31, 2008 the related allowance for loan losses associated with these
loans was $158,000, $188,000 and $54,000, respectively. Most of the loans that
have been identified as impaired are collateral-dependent.
 
 QNB has
loans to automobile dealers and residential home builders, two industries hit
hard by the recession. All loans in these categories were performing as of March
31, 2009. In April 2009, loans totaling $1,340,000 to a residential home builder
were placed on non-accrual because of concerns over their ability to continue to
perform. Several entities related to this home builder recently filed for
Chapter 11 bankruptcy. QNB will continue to monitor these industries and these
loans. Changes in conditions could result in the need for additional provision
for loan losses.
 
 NON-INTEREST
INCOME
 
 QNB,
through its core banking business, generates various fees and service charges.
Total non-interest income includes service charges on deposit accounts, ATM and
check card income, income on bank-owned life insurance, mortgage servicing fees,
gains and losses on the sale of investment securities and residential mortgage
loans.
 
 Total
non-interest income for the first quarter of 2009 was $733,000 compared to
$1,384,000 for the first quarter of 2008. Positively impacting net income for
the first quarter of 2008 was the recognition of $230,000 of income as a result
of the Visa initial public offering comprised of a $175,000 gain related to the
mandatory redemption of shares of restricted common stock in Visa and $55,000 of
income related to the reversal of liabilities recorded in the fourth quarter of
2007 to fund settlements of indemnified litigation involving
Visa.
  - 36
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  NON-INTEREST
INCOME (Continued)
 
 Non-interest
income for the first quarter of 2008, excluding net investment securities gains
of $222,000 and the Visa income, totaled $932,000 compared to $987,000 for the
first quarter of 2009, excluding net investment securities losses of $254,000.
Net investment securities gains and losses are discussed below.
 
 Fees for
services to customers are primarily comprised of service charges on deposit
accounts. These fees decreased $50,000, or 11.2%, to $395,000 when comparing the
three-month periods. Overdraft income decreased $61,000 for the three-month
period as a result of a significant decline in the volume of overdrafts. This
appears to be a reflection of the slower economy as customers reduce their
number of transactions. In February 2009, QNB increased the per item charge for
overdrafts by $2.00. Fees on business checking accounts increased $9,000 for the
three-month period. This increase reflects the impact of a lower earnings credit
rate in the first quarter of 2009 as compared to the first quarter of 2008,
resulting from the significant decline in short-term interest rates. These
credits are applied against service charges incurred.
 
 ATM and
debit card income is primarily comprised of transaction income on debit cards
and ATM cards and ATM surcharge income for the use of QNB’s ATM machines by
non-QNB customers. ATM and debit card income was $228,000 for the first quarter
of 2009, an increase of $9,000, or 4.1%, from the amount recorded during the
first quarter of 2008. This primarily reflects growth in ATM and debit card
transactions; however, the rate of growth has slowed as spending by both
consumers and businesses declined as the economy contracted. During the third
quarter of 2008, QNB introduced eRewards checking, a high yield checking account
which requires a minimum of twelve debit card transactions per statement cycle
to receive the high interest rate. This may result in an increase in debit card
transactions, helping offset the impact of a slowdown in spending.
 
 Income on
bank-owned life insurance represents the earnings and death benefits on life
insurance policies on which the Bank is the owner and beneficiary. The earnings
on these policies were $71,000 and $106,000 for the three months ended March 31,
2009 and 2008, respectively. Life insurance death benefit income was $48,000 for
the three-month period ended March 31, 2008 compared with $0 for same period in
2009. The insurance carriers reset the rates on these policies annually taking
into consideration the interest rate environment as well as mortality costs. The
existing policies have rate floors which minimize how low the earnings rate can
go. Some of these policies are currently at their floor.
 
 When QNB
sells its residential mortgages in the secondary market, it retains servicing
rights. A normal servicing fee is retained on all mortgage loans sold and
serviced. QNB recognizes its 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, 2009 and 2008 were $36,000 and $20,000,
respectively. 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, 2009 and 2008 was $33,000 and $23,000,
respectively. Mortgage refinance activity increased significantly during the
first quarter of 2009 as residential mortgage rates declined. The increase in
amortization expense reflects the increase in refinancing activity. The average
balance of mortgages serviced for others was $70,864,000 for the first quarter
of 2009 compared to $69,313,000 for the first quarter of 2008, an increase of
2.2%. The timing of mortgage payments and delinquencies also impacts the amount
of servicing fees recorded.
  - 37
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  NON-INTEREST
INCOME (Continued)
 
 The
fixed-income securities portfolio represents a significant portion of QNB’s
earning assets and is also a primary tool in liquidity and asset/liability
management. QNB actively manages its fixed income portfolio in an effort to take
advantage of changes in the shape of the yield curve and changes in spread
relationships in different sectors and for liquidity purposes. Management
continually reviews strategies that will result in an increase in the yield or
improvement in the structure of the investment portfolio.
 
 Net
investment securities losses were $254,000 for the quarter ended March 31, 2009,
which included a $390,000 charge related to other-than-temporary impairment
(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. This compares to $222,000 of
net securities gains for the three-months ended March 31, 2008. Included in
these gains were $66,000 from the sale of debt securities by the Bank and
$156,000 of gains from the sale of marketable equity securities by the
Company.
 
 The net
gain on the sale of residential mortgage loans was $168,000 and $32,000 for the
quarters ended March 31, 2009 and 2008, respectively. This $136,000 increase in
the net gain on sale of loans was a result of the increased activity in the
current low interest rate environment. 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 $58,000 and $25,000, respectively,
related to the recognition of mortgage servicing assets. Proceeds from the sale
of residential mortgages were $7,685,000 and $3,278,000 for the first quarters
of 2009 and 2008, respectively.
 
 Other
income was $89,000 for the first quarter of 2009 and $340,000 for the same
period during 2008. Excluding the impact of the Visa transactions, other income
was $110,000 for the first quarter of 2008. The majority of the difference was
caused by the following:
 ·
              Merchant
      income increased $12,000, or 35.5%, for the three-month period which is
      attributable to a change in vendor and new merchant accounts being
      obtained.
 ·
              Letter
      of credit fees increased $11,000 mainly as a result of a quarterly fee
      related to a letter of credit participation which was entered into during
      the fourth quarter of 2008.
 ·
              Income
      from the sale of checks to customers increased $10,000 primarily as a
      result of an annual incentive payment from our
  vendor.
 ·
              Income
      related to official check program decreased $17,000 due to ending our
      relationship with our third-party provider and running the entire process
      internally.
 ·
              Loss
      on sale of repossessed assets was $44,000 higher than first quarter of
      2008.
 
 NON-INTEREST
EXPENSE
 
 Non-interest
expense is comprised of costs related to salaries and employee benefits, net
occupancy, furniture and equipment, marketing, third party services and various
other operating expenses. Total non-interest expense was $3,929,000 for the
first quarter of 2009, an increase of 10.9% compared to $3,543,000 for the first
quarter of 2008.
  - 38
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  NON-INTEREST
EXPENSE (Continued)
  during
the first quarter of 2009. Also, included in salary expense for the first
quarter of 2009 and 2008, was $13,000 and $14,000, respectively, in stock option
compensation expense. Excluding the incentive compensation accrual, salary
expense increased 8.6% when comparing the first quarter of 2009 and 2008. Merit
increases, as well as an increase in the average number of full-time equivalent
employees accounts for the higher salary expense. The average number of full
time-equivalent employees increased by ten when comparing the first quarter of
2009 and 2008. Additional commercial lending personnel and the staffing of the
Wescosville branch, which opened in November 2008, account for the majority of
the increase. Comparing the two quarters, benefits expense increased $28,000, or
7.0%, to $431,000. Increases in social security taxes, payroll tax expense,
including Pennsylvania unemployment taxes, increased $18,000 and retirement plan
contribution expense increased by $6,000 when comparing the two quarters. In
addition, costs related to employee tuition reimbursement programs accounted for
$6,000 of the increase.
 
 Net
occupancy expense increased $13,000 to $353,000, when comparing the first
quarter of 2009 to the first quarter of 2008. The largest contributor to the
increase was higher costs related to utilities of $9,000. Several municipalities
have increased utility rates significantly either late in 2008 or early in
2009.
 
 Marketing
expense increased $22,000, to $175,000, for the quarter ended March 31, 2009.
Advertising expense and public relations expense was $15,000 and $9,000 higher
in 2009 when compared to 2008. The increase was related to the addition of the
Wescosville location in the fourth quarter of 2008 and a continued focus on
marketing in that region. These increases were partially offset by a reduction
in expenses related to sales promotion, which decreased $9,000 when comparing
the three-month period in 2009 to the same period in 2008. Prior year expense
was higher due to expenses related to the rebranding of the Quakertown National
Bank as QNB Bank.
 
 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 $42,000 for the three months ended March 31, 2009
when comparing the same period in 2008. Total expense was $230,000 for the first
quarter of 2009 compared to $188,000 for the first quarter of 2008. The largest
portion of the increase related to the following third party
services:
 ·
              $9,100
      increase related to new vendor for internet based bill pay service to
      provide enhanced functionality for
customers
 ·
              $8,000
      increase in fees for correspondent banking services, primarily caused by
      much lower crediting rates to help offset the fees incurred on these
      accounts.
 ·
              $8,000
      increase relates to vendor costs in connection with the eRewards checking
      account that was introduced during 2008. There were no such expenses for
      the first quarter of 2008.
 ·
              $6,000
      increase relates to a new service provider for outsourced Asset Liability
      reporting. In 2008, there were maintenance charges related to software
      that was utilized internally that were recorded in equipment
      maintenance.
 ·
              $3,400
      increase in statement printing and mailing
  expenses
 
 Telephone,
postage and supplies expense decreased $12,000 to $149,000, when comparing the
three-month periods. Supplies expense decreased $28,000 when comparing the
periods. The first quarter of 2008 included supply costs related to the
rebranding of QNB Bank. This included the purchase of new supplies including
plastics for ATM and debit cards and obsolescence costs related to Quakertown
National Bank supplies. Telephone expense increased $11,000, to $45,000, when
comparing the three months ended March 31, 2009 to the same period in 2008. The
addition of a new branch in the fourth quarter of 2008 as well as ongoing
charges related to an upgraded Multiprotocol Label Switching (MPLS) network were
the reasons for the increase in expense compared to the first quarter of
2008.
  - 39
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  NON-INTEREST
EXPENSE (Continued)
 
 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 $135,000 for the first quarter of 2009,
an increase of $5,000 compared to the same period in 2008. This increase was a
result of a higher shares tax of $7,000 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 $159,000, or 468% to $193,000, when
comparing the first quarter of 2009 to 2008. 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. The amount of expense recorded in the first
quarter of 2008 was reduced by $130,000 by the use of the remaining portion of a
credit approved by the FDIC in 2006. In addition to the increase in the regular
FDIC assessment rates, the FDIC has proposed an emergency special assessment of
20 basis points on deposits as of June 30, 2009. However legislation has not yet
been enacted to increase the FDIC’s borrowing authority that the FDIC has
indicated could lower the special assessment to 10 basis points. The special
assessment will be payable on September 30, 2009 if enacted in the second
quarter.
 
 Other
expense increased $43,000 to $320,000 for the first quarter of 2009. The main
contributors to the increase in this category were an $18,000 increase in
service and sales training for branch and call center personnel and $26,000
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, 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. As of March 31, 2008, QNB’s net deferred tax asset was $262,000. The
primary components of deferred taxes in this period were a deferred tax asset of
$1,160,000 relating to the allowance for loan losses and a deferred tax
liability of $1,094,000 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.
  - 40
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  INCOME
TAXES (Continued)
 
 Applicable
income taxes and the effective tax rate were $191,000, or 14.9%, for the
three-month period ended March 31, 2009. Applicable income taxes and the
effective rate were $520,000, or 23.3%, for the three-month period ended March
31, 2008. The low effective rate for the first quarter of 2009 in comparison to
prior year is predominantly a result of tax-exempt income from loans and
securities comprising a higher proportion of pre-tax income.
 
 FINANCIAL
CONDITION ANALYSIS
 
 The
following balance sheet analysis compares average balance sheet data for the
three months ended March 31, 2009 and 2008, as well as the period ended balances
as of March 31, 2009 and December 31, 2008.
 
 Average
earning assets for the three-month period ended March 31, 2009 increased
$58,623,000, or 10.1%, to $638,178,000 from $579,555,000 for the three months
ended March 31, 2008. The mix of earning assets changed slightly when comparing
the two periods. Average loans increased $32,679,000, or 8.7%, while average
investment securities increased $29,080,000, or 15.0%. Average loans represented
64.3% of earning assets for the first quarter of 2009 while average investment
securities represented 35.0% for the same period. This compares to 65.1% and
33.5% for the first quarter of 2008. Average Federal funds sold decreased
$4,335,000 when comparing these same periods. Given the low yield on Federal
funds sold QNB has attempted to keep these balances low by being fully invested
in debt securities or AAA rated money market mutual funds which on average
yielded 82 basis points more for the quarter than the average yield on Federal
funds.
 
 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 9.8% between March 31, 2008 and March 31, 2009 and increased
3.3% since December 31, 2008. The growth in loans despite the economic
environment reflects QNB’s commitment to make credit available to its customers.
The hiring of three experienced commercial loan officers in 2008 provides
support to our continued goal of increasing loans outstanding and building
customer relationships.
 
 Average
total commercial loans increased $29,024,000 when comparing the first three
months of 2009 to the first three months of 2008. Most of the 10.8% growth in
average commercial loans was in loans secured by real estate, either commercial
or residential properties, which increased $23,502,000, or 13.2%. 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
$4,509,000, or 6.7%, when comparing the average balances for the two quarters.
Also contributing to the growth in total commercial loans was an increase in
tax-exempt loans. QNB continues to be successful in competing for loans to
schools and municipalities. Average tax-exempt loans increased $1,013,000, or
4.1%, when comparing the three-month periods.
  - 41
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  FINANCIAL
CONDITION ANALYSIS (Continued)
 
 Indirect
lease financing receivables represent loans to small businesses that are
collateralized by equipment. These loans tend to have higher risk
characteristics but generally provide higher rates of return. These loans are
originated by third parties and purchased by QNB based on criteria specified by
QNB. The criteria include minimum credit scores of the borrower, term of the
lease, type and age of equipment financed and geographic area. The geographic
area primarily represents Pennsylvania and states contiguous to Pennsylvania.
QNB is not the lessor and does not service these loans. Average indirect lease
financing loans increased $2,198,000, or 16.9% when comparing the three-month
periods. This increase is primarily related to a lease to the United States
Department of Agriculture.
 
 Average
residential mortgage loans increased $2,269,000, or 10.4%, when comparing the
first three months of 2009 to the first three months of 2008. With the decline
in mortgage rates during the fourth quarter of 2008 and the first quarter of
2009, mortgage activity, especially refinancing activity, has increased
significantly. QNB does not originate or hold subprime mortgages or any other
high-risk mortgage products. In addition, QNB sells, but continues to service,
most of the fixed rate 1-4 family residential mortgages it originates,
especially in the current low interest rate environment.
 
 Total
investment securities were $227,124,000 at March 31, 2009 and $223,195,000 at
December 31, 2008. The growth in the investment portfolio was primarily in high
quality U.S. Government agency and agency mortgage-backed and CMO securities and
tax-exempt State and municipal bonds. During the first quarter of 2009 QNB sold
$6,000,000 in corporate bonds issued by financial institutions at a gain of
$136,000. These bonds were sold to reduce credit risk in the
portfolio.
 
 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 it
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 financial institutions, 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. The senior tranches have
the greatest level of protection, then the mezzanine tranches, and finally the
income note holders who have the least protection. QNB holds eight of these
securities with a book value of $5,120,000 and a fair value of $712,000. All of
the trust preferred securities are available-for-sale securities and are carried
at fair value with changes in fair value being reflected on the balance sheet
(and equity). The changes are also reflected in other comprehensive income, but
are not included in the income statement. The market for these securities at
March 31, 2009 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 as no new
pooled trust preferred securities have been issued since 2007. There are
currently very few market participants who are willing and or able to transact
for these securities. The market values for these securities are very depressed
relative to historical levels. Thus in today’s market, a low market price for a
particular bond may only provide evidence of stress in the credit markets in
general versus being an indicator of credit problems with a particular issuer.
Although these securities are classified as available-for-sale, the Company does
have the ability and intent to hold these investments until maturity or for a
reasonable time period sufficient to allow for a recovery of fair value. All of
the trust preferred securities are rated lower than AA and are subject to the
guidance of EITF 99-20-1. Cash flow analyses for these trust preferred
securities were prepared by a third party using various default and deferral
scenarios of the issuers to determine if there was possible impairment. No
other-than-temporary impairment charges on any of these trust preferred
securities has been incurred as of March 31, 2009. It is possible that future
calculations could require recording an other-than-temporary impairment
charge through earnings. These securities were downgraded below investment grade
by Moody’s during the first quarter of 2009.
  - 42
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  FINANCIAL
CONDITION ANALYSIS (Continued)
 
 For the
most part, earning assets are funded by deposits. Total average deposits
increased $59,354,000, or 12.0% to $553,856,000 for the first quarter of 2009
compared to the first quarter of 2008. It appears that customers are looking 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 time deposits which increased $57,379,000,
or 21.8%, to $320,314,000 for the first quarter of 2009. Included in this total
was $105,216,000 of time deposits of $100,000 or more, an increase of
$37,190,000 from the $68,026,000 reported for the first quarter of 2008. Higher
yields relative to alternative investments, including other bank deposits, and
the increase in FDIC coverage from $100,000 to $250,000 appear to be the impetus
behind this growth.
 
 Average
non-interest bearing and interest-bearing demand accounts increased $2,736,000,
or 5.7% and $9,589,000 or 17.5%, respectively when comparing the first quarters
of 2009 and 2008. Average savings account balances increased $2,194,000, or
5.2%, to $44,790,000 when comparing the same periods while the average balance
of municipal interest-bearing demand accounts decreased $10,810,000 or
29.7%.
 
 Total
assets at March 31, 2009 were $683,944,000 compared with $664,394,000 at
December 31, 2008, an increase of 2.9%. Most of the growth in total assets since
December 31, 2008 was in loans receivable and loans held-for-sale, which
increased a combined $16,565,000.
 
 On the
liability side, total deposits increased by $23,959,000, or 4.4%, since
year-end. Time deposits continued to be the product of choice, increasing
$17,834,000 since December 31, 2008. The addition of the Wescosville branch
during the fourth quarter of 2008 contributed to the growth in time deposits
since the first quarter of 2008 and also since December 31, 2008. Total deposits
at this branch were $37,500,000 at March 31, 2009 compared with $22,500,000 at
December 31, 2008. Included in these amounts were time deposits of $35,600,000
and $22,400,000, respectively at March 31, 2009 and December 31, 2008.
Non-interest bearing demand accounts increased $2,148,000 while interest bearing
demand accounts declined $3,833,000. These deposits can be volatile depending on
the timing of deposits and withdrawals. The decrease in interest-bearing demand
accounts was centered in municipal deposits which declined by $6,369,000. These
accounts, especially the school district accounts, have some seasonality to
them, increasing when taxes are collected in late summer and declining during
the course of the school year as expenses are paid. Partially offsetting the
decline in municipal balances was an increase in eRewards checking balances of
$4,443,000 since December 31, 2008. Money market accounts increased $4,674,000
from December 31, 2008 to $50,246,000 at March 31, 2009 and savings accounts
increased $3,136,000 to $47,142,000 over the same time period.
 
 When
comparing December 31, 2008 to March 31, 2009, short-term borrowing declined
from $21,663,000 to $16,822,000. Lower balances in commercial sweep accounts
recorded as repurchase agreements accounted for the entire
decline.
  - 43
-
  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 commitments to borrowers and demands of
depositors. QNB manages its mix of cash, Federal funds sold and investment
securities in order to match the volatility, seasonality, interest sensitivity
and growth trends of its loans and deposits. Liquidity is provided from asset
sources through maturities and repayments of loans and investment securities.
The portfolio of investment securities classified as available-for-sale and
QNB's policy of selling certain residential mortgage originations in the
secondary market also provide sources of liquidity. Additional sources of
liquidity are provided by the Bank’s membership in the FHLB and two unsecured
Federal funds lines granted by correspondent banks totaling $18,000,000. At
March 31, 2009, the Bank had a maximum borrowing capacity with the FHLB of
approximately $215,696,000. At March 31, 2009, QNB had $10,000,000 in
outstanding borrowings from the FHLB at a rate of 2.97%. These borrowings mature
in January 2010.
 
 Cash and
due from banks, interest-bearing deposits in banks, Federal funds sold,
investment securities available-for-sale and loans held-for-sale totaled
$243,283,000 and $236,168,000 at March 31, 2009 and December 31, 2008,
respectively. The increase in liquidity sources is primarily the result of an
increase of the available-for-sale securities portfolio and loans held-for-sale.
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 provide significant liquidity as
agency and municipal bonds are called and as cash flow increases on
mortgage-backed and CMO securities as prepayment speeds increase.
 
 Average
Federal funds purchased and overnight FHLB advances were $2,734,000 for the
first quarter of 2009 and $2,213,000 for the first quarter of 2008. At March 31,
2009, QNB had no Federal funds purchased or overnight FHLB advances. During the
first quarter of 2009, QNB used its Federal funds lines and overnight FHLB
advances to help temporarily fund loan growth. During the first quarter of 2008,
QNB used its Federal funds line to prefund the purchase of investment securities
in anticipation of declining interest rates and to fund seasonal deposit
withdrawals. The maximum balance of Federal funds purchased and overnight FHLB
advances were $13,337,000 and $14,617,000 during the first quarter of 2009 and
2008, respectively.
 
 Approximately
$86,191,000 and $101,302,000 of available-for-sale securities at March 31, 2009
and December 31, 2008, respectively, were pledged as collateral for repurchase
agreements and deposits of public funds. The decrease in the amount of pledged
securities when comparing March 31, 2009 to December 31, 2008 is a result of a
decrease in repurchase agreement balances (commercial sweep accounts) and
municipal deposit balances. In addition, under terms of its agreement with the
FHLB, QNB maintains otherwise unencumbered qualifying assets (principally 1-4
family residential mortgage loans and U.S. Government and agency notes, bonds,
and mortgage-backed securities) in the amount of at least as much as its
advances from the FHLB.
 
 In 2008,
QNB opted into the FDIC’s Transaction Account Guarantee Program. This program
provides unlimited deposit insurance for non-interest bearing transaction
accounts. This program expires December 31, 2009.
 
 As an
additional source of liquidity, QNB has made the decision to become 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 its balance sheet. It enables financial institutions to provide customers
with full FDIC insurance on time deposits over $250,000.
  - 44
-
  
 QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  CAPITAL
ADEQUACY
 
 A strong
capital position is fundamental to support continued growth and profitability
and to serve the needs of depositors. QNB's shareholders' equity at March 31,
2009 was $53,766,000, or 7.86% of total assets, compared to shareholders' equity
of $53,909,000, or 8.11% of total assets, at December 31, 2008. Shareholders’
equity at March 31, 2009 included a positive adjustment of $124,000 related to
unrealized holding gains, net of taxes, on investment securities
available-for-sale while shareholders’ equity at December 31, 2008 included a
negative adjustment of $233,000 related to unrealized holding losses, net of
taxes, on investment securities available-for-sale. Without these adjustments,
shareholders' equity to total assets would have been 7.84% and 8.15% at March
31, 2009 and December 31, 2008, respectively.
 
 Average
shareholders' equity and average total assets were $54,403,000 and $666,040,000
for the first three months of 2009, an increase of 1.7% and 4.5%, respectively,
from the averages for the year ended December 31, 2008. The ratio of average
total equity to average total assets was 8.17% for the first three months of
2009 compared to 8.47% for all of 2008.
 
 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 asletters 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,
                                        2009
                                      
                                      
                                      December 31,
                                        2008Tier
      IShareholder's
      Equity
                                      
                                      $
                                      53,766
                                      
                                      
                                      $
                                      53,909Net
      unrealized securities (gains) losses
                                      
                                      
                                      (124
                                      )
                                      
                                      
                                      233Net
      unrealized losses on available-for-sale equity securities
                                      
                                      
                                      (239
                                      )
                                      
                                      
                                      (246
                                      )Total
      Tier I risk-based capital
                                      
                                      $
                                      53,403
                                      
                                      
                                      $
                                      53,896Tier
      IIAllowable
      portion: Allowance for loan losses
                                      
                                      
                                      4,220
                                      
                                      
                                      
                                      3,836Total
      risk-based capital
                                      
                                      $
                                      57,623
                                      
                                      
                                      $
                                      57,732Risk-weighted
      assets
                                      
                                      $
                                      504,552
                                      
                                      
                                      $
                                      466,721Average
      assets
                                      
                                      $
                                      666,040
                                      
                                      
                                      $
                                      648,110
  - 45
-
  QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  CAPITAL
ADEQUACY (Continued)
 
 Capital RatiosMarch 31,
                              2009
                            
                            
                            December 31,
                              2008Tier
      I capital/risk-weighted assets
                            
                            
                            10.58
                            %
                            
                            
                            11.55
                            %Total
      risk-based capital/risk-weighted assets
                            
                            
                            11.42
                            %
                            
                            
                            12.37
                            %Tier
      I capital/average assets (leverage ratio)
                            
                            
                            8.02
                            %
                            
                            
                            8.32
                            %
 
 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
10.58% and 11.55%, a total risk-based ratio of 11.42% and 12.37% and a leverage
ratio of 8.02% and 8.32% at March 31, 2009 and December 31, 2008,
respectively.
 
 The
decline in capital ratios from December 31, 2008 was a result of asset growth
exceeding the growth rate of capital. Capital levels were impacted by the
decision to repurchase common stock as well as the decision to increase the cash
dividend during the first quarter of 2009. On January 24, 2008, QNB announced
that the Board of Directors authorized the repurchase of up to 50,000 shares of
its common stock in open market or privately negotiated transactions. The
repurchase authorization does not bear a termination date. On February 9, 2009,
the Board of Directors approved increasing the authorization to 100,000 shares.
As of March 31, 2009, 57,883 shares were repurchased under this authorization at
an average price of $16.97 and a total cost of $982,000. As of March 31, 2008,
QNB had not repurchased any shares.
 
 Also
impacting the regulatory capital ratios was an increase in risk-weighted assets
during the first quarter of 2009. Commercial loan growth accounted for
approximately $20.0 million of the growth in risk-weighted assets while $29.5
million of the increase in risk-weighted assets was due to mezzanine tranches of
pooled trust preferred securities that were downgraded below investment grade
during the quarter. Although the amortized cost of these securities was only
$5,120,000 at March 31, 2009, regulatory guidance required an additional
$29,946,000 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 5 out of 8 pooled trust
preferred securities (PreTSLs) held by the Bank as of March 31, 2009. 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, 2009 and December 31, 2008, QNB met the "well
capitalized" criteria which requires minimum Tier I and total risk-based capital
ratios of 6.00% and 10.00%, respectively, and a leverage ratio of
5.00%.
 
 INTEREST
RATE SENSITIVITY
 
 Since the
assets and liabilities of QNB have diverse repricing characteristics that
influence net interest income, management analyzes interest sensitivity through
the use of gap analysis and simulation models. Interest rate sensitivity
management seeks to minimize the effect of interest rate changes on net interest
margins and interest rate spreads and to provide growth in net interest income
through periods of changing interest rates. QNB’s Asset/Liability Management
Committee (ALCO) is responsible for managing interest rate risk and for
evaluating the impact of changing interest rate conditions on net interest
income.
  - 46
-
 
 QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  INTEREST
RATE SENSITIVITY (Continued)
 
 Gap
analysis measures the difference between volumes of rate-sensitive assets and
liabilities and quantifies these repricing differences for various time
intervals. Static gap analysis describes interest rate sensitivity at a point in
time. However, it alone does not accurately measure the magnitude of changes in
net interest income because changes in interest rates do not impact all
categories of assets and liabilities equally or simultaneously. Interest rate
sensitivity analysis also involves assumptions on certain categories of assets
and deposits. For purposes of interest rate sensitivity analysis, assets and
liabilities are stated at their contractual maturity, estimated likely call
date, or earliest repricing opportunity. Mortgage-backed securities, CMOs and
amortizing loans are scheduled based on their anticipated cash flow.
Interest-bearing demand accounts, money market accounts and savings accounts do
not have stated maturities or repricing terms and can be withdrawn or repriced
at any time. This may impact QNB’s margin if more expensive alternative sources
of deposits or borrowed funds are required to fund loans or deposit runoff.
Management projects the repricing characteristics of these accounts based on
historical performance and assumptions that it believes reflect their rate
sensitivity.
 
 A
positive gap results when the amount of interest rate sensitive assets exceeds
interest rate sensitive liabilities. A negative gap results when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive
assets.
 
 QNB
primarily focuses on the management of the one-year interest rate sensitivity
gap. At March 31, 2009, interest-earning assets scheduled to mature or likely to
be called, repriced or repaid in one year were $334,949,000. Interest-sensitive
liabilities scheduled to mature or reprice within one year were $355,323,000.
The one-year cumulative gap, which reflects QNB’s interest sensitivity over a
period of time, was a negative $20,374,000 at March 31, 2009. The cumulative
one-year gap equals -3.1% of total rate sensitive assets. This gap position
compares to a positive gap position of $2,132,000, or 0.3%, of total rate
sensitive assets, at December 31, 2008.
 
 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, 2009, it is unlikely that interest rates would
decline by 200 or 300 basis points. The simulation results can be found in the
chart on page 48.
 
 Net
interest income declines in a falling rate environment. This result reflects
that income on earning assets would decline to a greater degree than the expense
associated with interest-bearing liabilities. In a lower rate environment, the
cash flow or repricing characteristics from both the loan and investment
portfolios would increase and be reinvested at lower rates resulting in less
income. Loan customers would likely either refinance their fixed rate loans at
lower rates or request rate reductions on their existing loans. While interest
expense on time deposits would decrease, the interest rate floors on some
municipal interest-bearing demand accounts, hypothetical interest rate floors on
interest-bearing transaction accounts, regular money market accounts and savings
accounts would prevent a reduction in interest expense on these accounts. In a
rising rate environment net interest income increases as loans and investments
reprice more than rates on interest-bearing liabilities. The rate of increase in
net interest income declines the more rates increase because prepayments and
calls on investments and loans slow resulting in fewer amounts repricing at
higher rates. Actual results may differ from simulated results due to various
factors including time, magnitude and frequency of interest rate changes, the
relationship or spread between various rates, loan pricing and deposit
sensitivity, and asset/liability strategies.
  - 47
-
 
 QNB
CORP. AND SUBSIDIARY
 
 MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL
 CONDITION
AND RESULTS OF OPERATIONS
  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, 2009, 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
                        
                        $
                        23,034
                        
                        
                        $
                        1,751
                        
                        
                        
                        8.23
                        %+200
      Basis Points
                        
                        
                        22,609
                        
                        
                        
                        1,326
                        
                        
                        
                        6.23
                        %+100
      Basis Points
                        
                        
                        22,054
                        
                        
                        
                        771
                        
                        
                        
                        3.62
                        %Flat
      Rate
                        
                        
                        21,283
                        
                        
                        
                        -
                        
                        
                        
                        0.00
                        %-100
      Basis Points
                        
                        
                        20,535
                        
                        
                        
                        (748
                        )
                        
                        
                        -3.51
                        %
  - 48
-
  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.
  - 49
-
  QNB
CORP. AND SUBSIDIARY
 
 PART
II.  OTHER INFORMATION
 
 MARCH
31, 2009
 
 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, 2008.
 
 Item
      2.
              Unregistered Sales of
      Equity Securities and Use of
Proceeds
  The
following table sets forth certain information relating to shares of QNB’s
common stock repurchased by the Company during the quarter ended March 31,
2009.
 
 Period
                      
                      Total Number
                        of Shares
                        Purchased
                      
                      
                      Average Price
                        Paid per Share
                      
                      
                      Total Number
                        of Shares
                        Purchased as
                        Part of
                        Publicly
                        Announced
                        Plan
                      
                      
                      Maximum
                        Number of
                        Shares that
                        may yet be
                        Purchased
                        Under the PlanJanuary
      1, 2009 through January 31, 2009
                      
                      
                      -
                      
                      
                      
                      N/A
                      
                      
                      
                      -
                      
                      
                      
                      43,342February
      1, 2009 through February 28, 2009
                      
                      
                      22,695
                      
                      
                      $
                      16.90
                      
                      
                      
                      22,695
                      
                      
                      
                      70,647March
      1, 2009 through March 31, 2009
                      
                      
                      28,530
                      
                      
                      
                      16.90
                      
                      
                      
                      28,530
                      
                      
                      
                      42,117Total
                      
                      
                      51,225
                      
                      
                      
                      16.90
                      
                      
                      
                      51,225
                      
                      
                      
                      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 onJanuary
      24, 2008 and subsequently increased on February 9,
  2009.
 (3)
              The
      number of shares approved for repurchase under QNB’s current stock
      repurchase plan is 100,000as
      of the filing of this Form 10-Q.
 (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 notintend
      to make further purchases.
 
 Item
      3.
              Default Upon Senior
      Securities
  None.
 
 Item
      4.
              Submission of Matters
      to Vote of Security Holders
  None.
  - 50
-
 
 Item
      5.
              Other
      Information
  None.
 
 Item
      6.
              Exhibits
  Exhibit  3(i)
                    
                    Articles
      of Incorporation of Registrant, as amended. (Incorporated by reference to
      Exhibit 3(i) of Registrants Form DEF 14-A filed with the Commission on
      April 15, 2005).Exhibit  3(ii)
                    
                    Bylaws
      of Registrant, as amended. (Incorporated by reference to Exhibit 3(ii) of
      Registrants Form 8-K filed with the Commission on January 23,
      2006).Exhibit  11
                    
                    Statement
      Re: Computation of Earnings Per Share. (Included in Part I, Item I,
      hereof.)Exhibit
      31.1
                    
                    Section
      302 Certification of President and CEOExhibit
      31.2
                    
                    Section
      302 Certification of Chief Financial OfficerExhibit
      32.1
                    
                    Section
      906 Certification of President and CEOExhibit
      32.2
                    
                    Section
      906 Certification of Chief Financial
Officer
  - 51
-
  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 15,
      2009
                      By:/s/
      Thomas J. BiskoThomas
      J. BiskoPresident/CEODate: May 15,
      2009
                      By:/s/
      Bret H. KrevolinBret
      H. KrevolinChief
      Financial
Officer