Qnb Corp. QNBC US Equity☆

ITEM 1A. RISK FACTORS

The following discusses risks that management believes are specific to our business and could have a negative impact on QNB’s financial performance. When analyzing an investment in QNB, the risks and uncertainties described below, together with all of the other information included or incorporated by reference in this report, should be carefully considered. This list should not be viewed as comprehensive and may not include all risks that may affect the financial performance of QNB.

Our net interest income, net income and results of operations are sensitive to fluctuations in interest rates.

QNB’s profitability is largely a function of the spread between the interest rates earned on earning assets and the interest rates paid on deposits and other interest-bearing liabilities. Like most financial institutions, QNB’s net interest income and margin will be affected by general economic conditions and other factors, including fiscal and monetary policies of the Federal government, that influence market interest rates and QNB’s ability to respond to changes in such rates. At any given time, QNB’s assets and liabilities may be such that they are affected differently by a change in interest rates. As a result, an increase or decrease in rates, the length of loan terms or the mix of adjustable- and fixed-rate loans or investment securities in QNB’s portfolio could have a positive or negative effect on its net income, capital and liquidity. Although management believes it has implemented strategies and guidelines to reduce the potential effects of adverse changes in interest rates on results of operations, any substantial and prolonged change in market interest rates could affect operating results negatively.

We are subject to credit risk in connection with our lending activities, and our financial condition and results of operations may be negatively affected by economic conditions and other factors that could adversely affect our customers.

As a lender, QNB is exposed to the risk that its borrowers may be unable to repay their loans and that the current market value of any collateral securing the payment of their loans may not be sufficient to assure repayment in full. Credit losses are inherent in the lending business and could have a material adverse effect on the operating results of QNB. Adverse changes in the economy or business conditions, either nationally or in QNB’s market areas, could increase credit-related losses and expenses and/or limit growth. Substantially all of QNB’s loans are to businesses and individuals in its limited geographic area and any economic decline in this market could impact QNB adversely. QNB makes various assumptions and judgments about the collectability of its loan portfolio and provides an allowance for loan losses based on a number of factors. If these assumptions are incorrect, the allowance for loan losses may not be sufficient to cover losses and may cause QNB to increase the allowance in the future by increasing the provision for loan losses, thereby having an adverse effect on operating results. QNB has adopted underwriting and credit monitoring procedures and credit policies that management believes are appropriate to control these risks; however, such policies and procedures may not prevent unexpected losses that could have a material adverse effect on QNB’s financial condition or results of operations.

A deterioration in regional or national economic conditions may adversely affect our financial condition and results of operations.

QNB primarily provides banking services to customers located in the Bucks, Lehigh and Montgomery Counties in Pennsylvania. Adverse effects of a regional economic downturn could affect QNB’s ability to attract deposits and qualified loans. Economic factors impacting the local economy with this region, such as a decline in real estate values, unemployment, natural disasters, or the effects of armed conflict in other parts of the world, including present armed conflicts in Ukraine, may have a negative impact on credit-worthiness of customers, the value of collateral, and customers’ ability to repay loans, which would result in write-downs, increases in non-performing loans, and a decline in QNB’s financial performance measurements. Unlike larger banks that are more geographically diversified, we provide banking and financial services locally and therefore are more affected by adverse local economic conditions.

Similarly, potential adverse effects of any national economic downturn or concerns with the stability of the financial markets could lead to lack of consumer confidence, increased market volatility, and a general reduction in business activity. Such events may result in increased regulation of the financial services industry and increased compliance costs; greater difficulty in assessing the creditworthiness of customers and increased credit risk; greater difficulty in originating loans that meet our underwriting criteria; liquidity issues to the extent that it becomes more difficult to borrow from third parties, including other financial institutions; and limitations on growth.

We face significant competition from other banks and financial institutions in our market area, many of which are larger in terms of asset size and market capitalization.

The financial services industry is highly competitive, with competition for attracting and retaining deposits and making loans coming from other banks and savings institutions, credit unions, mutual fund companies, insurance companies and other non-bank businesses. Many of QNB’s competitors are much larger in terms of total assets and market capitalization, have a higher lending limit, have greater access to capital and funding, and offer a broader array of financial products and services. In light of this, QNB’s ability to continue to compete effectively is dependent upon its ability to maintain and build relationships by delivering top quality service. Competition within the financial services industry also impacts QNB’s ability to attract and retain low-cost deposits which could impact QNB’s liquidity. Lowering loan rates and increasing deposit rates compresses the interest rate margin and profitability.

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At December 31, 2021, our lending limit per borrower was approximately $20,763,000. Accordingly, the size of loans that we may offer to potential borrowers (without participation by other lenders) is less than the size of loans that many of our competitors with larger capitalization are able to offer. Our legal lending limit also impacts the efficiency of our lending operation because it tends to lower our average loan size, which means we have to generate a higher number of transactions to achieve the same portfolio volume. We may engage in loan participations with other banks for loans in excess of our legal lending limit. However, there can be no assurance that such participations will be available or on terms which are favorable to us and our customers.

Our results of operations may be adversely affected by other-than-temporary impairment charges relating to our debt securities.

QNB purchases U.S. Government and U.S. Government agency debt securities, U.S. Government agency issued mortgage-backed securities or collateralized mortgage obligation securities, obligations of states and municipalities and corporate debt securities. QNB is exposed to the risk that the issuers of these debt securities may experience significant deterioration in credit quality which could impact the market value of such issuer’s securities. QNB periodically evaluates its debt securities to determine if market value declines are other-than-temporary. Once a decline is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized for the credit related portion of the impairment.

Our results of operations may be adversely affected by fair value declines in our investments in equity securities.

The Company’s investment in marketable equity securities primarily consists of investments in large cap stock companies. Changes in fair value are recorded in unrealized gain/(losses) in non-interest income These equity securities are carried at fair value. QNB had nine equity securities with unrealized losses of approximately $474,000 at December 31, 2021. The severity and duration of the fair value declines are consistent with current stock market developments.

At December 31, 2021, the Bank had $1,317,000 in capital stock of the FHLB and $12,000 in capital stock of ACBB. These equity securities are restricted in that they can only be sold back to the respective institutions or another member institution at par. Therefore, they are less liquid than other tradable equity securities, their fair value is equal to amortized cost, and no impairment write-downs have been recorded on these securities.

Our assets at December 31, 2021 included a deferred tax asset and we may not be able to realize the full benefit of that asset.

As of December 31, 2021, QNB had a net deferred tax asset of $2,449,000. Our ability to realize these tax benefits ultimately depends on the existence of sufficient taxable income of the appropriate character (ordinary income or capital gains) within the applicable carryback and carryforward periods provided under the tax law. Estimating whether the deferred tax asset will be realized requires us to exercise significant judgment and is inherently uncertain because it requires the prediction of future occurrences. The deferred tax asset may be reduced in the future if estimates of future income, our tax planning strategies, or tax rate changes resulting from Federal tax reform do not support the amount of the deferred tax asset. If it is determined in the future that a valuation allowance of the deferred tax asset is necessary, we may incur a charge to earnings resulting and a reduction to regulatory capital for the amount included in any such allowance.

A disruption in components of our business infrastructure resulting from financial or technological difficulties of our third- party vendors on which we rely could adversely affect our business.

Third parties provide key components of our business infrastructure, such as Internet connections, software platforms and network access. Any disruption in Internet, network access or other voice or data communication services provided by these third parties or any failure of these third parties to handle current or higher volumes of use could adversely affect the ability to deliver products and services to clients and otherwise to conduct business. Disruptions or failures in the business infrastructure or operating systems that support our business and customers, or cyber-attacks or security breaches of the networks, systems, or devices that our customers use to access our products and services, could damage our reputation, cause us to incur additional expenses, result in losses, or subject us to regulatory sanctions or additional regulatory scrutiny, any of which could adversely affect our results of operations or financial condition.

Our failure to properly or timely utilize effective technologies to deliver our products and services, or a systems failure or breach of network security with respect to our information systems could adversely affect our business.

The market for financial services is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and mobile banking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able to properly or timely anticipate or implement such technologies or properly train our staff to use such technologies. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results.

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In addition, we rely heavily on our information systems to conduct business. Maintaining and protecting those systems is difficult and expensive, as is dealing with any failure, interruption or breach in security of these systems, whether due to acts or omissions by us or by a third party and whether intentional or not. Any such failure, interruption or breach could result in failures or disruptions in our customer relationship management or our information systems. The policies, procedures and technical safeguards we have in place to prevent or limit the effect of any failure, interruption or security breach of our information systems may be insufficient to prevent or remedy the effects of any such event. Moreover, as cyber threats continue to evolve, we may be required to expend significant additional resources to modify or enhance our protective measures relating to information security. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, cause us to incur additional expenses, result in losses, or subject us to regulatory sanctions or additional regulatory scrutiny, any of which could adversely affect our business, financial condition or operating results.

Changes in accounting standards applicable to us could materially impact how we report our financial condition and results of operations.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time the FASB changes the financial accounting and reporting standards that govern the preparation of our financial statements.

These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in our restating prior period financial statements. Management believes the current financial statements are prepared in accordance with U.S. generally accepted accounting principles.

A new accounting standard, which requires us to measure certain financial assets (including loans) using current expected credit losses (“CECL”) beginning in calendar year 2023, will likely result in material changes to our allowance for loan losses.

Current US GAAP requires an incurred loss methodology for recognizing credit losses that delays recognition until it is probable that a loss has been incurred as of the balance sheet date. The Financial Accounting Standards Board has adopted a new accounting standard, effective for QNB beginning January 1, 2023, referred to as CECL. The new accounting standard replaces the current loss methodology with a methodology that reflects current expected credit losses and requires consideration of a broader range of reasonableness and reportable information to determine credit loss estimates. QNB is in the process of evaluating the impact of the adoption of the new accounting standard on QNB’s financial statements; however, it is expected that the allowance for loan losses will materially change upon the adoption of CECL. Any increase in our allowance for loan losses may have a material adverse effect on our financial condition and results of operations.

We operate in a highly regulated environment and are subject to examination and supervision by bank regulatory agencies, which could have an adverse impact on our operations or increase the cost of our operations.

We operate in a highly regulated environment and are subject to extensive examination by the Board of Governors of the Federal Reserve System, the FDIC, and the Pennsylvania Department of Banking and Securities. The bank regulatory agencies exercise broad discretion in connection with their supervisory and enforcement activities. Federal and state banking laws and regulations are designed primarily to protect depositors, the deposit funds, and consumers, and not necessarily shareholders of a financial institution. Banking regulations or the activities of bank regulatory agencies may, for example, limit a financial institution’s growth and potential shareholder returns by restricting certain activities such as the payment of dividends, expansion of branch offices, and acquisition activities.

The significant laws and regulations that govern our activities are described under “Item 1 - Description of Business” in this Form 10-K. These laws and regulations, along with existing tax, accounting, securities, and monetary laws, regulations, standards, policies, and interpretations control the manner in which financial institutions conduct business. Such laws, regulations, standards, policies, and interpretations are constantly evolving and may change significantly over time. The potential exists for additional federal or state laws or regulations, or new policies or interpretations by regulatory agencies having jurisdiction over our activities, to affect many aspects of our operations, including capital requirements, lending and funding practices, and liquidity standards. Additional laws, regulations or other regulatory requirements, or any substantial change in regulation and oversight, may have a material impact on our operations by increasing our cost of regulatory compliance and of doing business and otherwise affecting our operations, and may significantly affect the markets in which we do business, the markets for and value of our investments, the fees we charge and our ongoing operations, costs and profitability.

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If we lose the availability of wholesale funding we may be unable to support interest-earning asset growth, which could adversely impact our operating results and liquidity.

Management periodically uses wholesale funding sources to support loan demand and deposit withdrawals and to provide sufficient liquidity. Wholesale funding primarily is made up of borrowings from the FHLB but may also include unsecured Federal funds from correspondent banks, Federal advances and wholesale certificates of deposit.

If wholesale funding becomes unavailable, QNB may need to reduce interest-earning asset growth through production reduction, sale of assets, or participating out future and current loans; this could adversely impact future net income. A termination or change in borrowings from the FHLB, the Federal Reserve or correspondent banks may have an adverse effect on our liquidity and operating results.

Our disclosure controls and procedures and our internal control over financial reporting may not achieve their intended objectives.

Management diligently reviews and updates its internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Our disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by QNB in reports filed or submitted under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Management believes that any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Any undetected circumvention of these controls could have a material adverse impact on QNB’s financial condition and results of operations.

These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected.

We may not be able to attract and retain highly qualified personnel to execute our business strategy.

Our success depends upon the ability to attract and retain highly motivated, well-qualified personnel. We face significant competition in the recruitment of qualified employees. Our ability to execute our business strategy and provide high-quality service may suffer if we are unable to recruit or retain a sufficient number of qualified employees or if the costs of employee compensation or benefits increase substantially. QNB currently has employment agreements and change of control agreements with five of its senior officers.

Acts of terrorism and other external events, including natural disasters, national or global health emergencies, and events of armed conflict in other countries, could impact our ability to do business or otherwise adversely affect our business, operations or financial condition.

Financial institutions have been, and continue to be, targets of terrorist threats aimed at compromising operating and communications systems. Such events could cause significant damage, impact the stability of our facilities, result in additional expenses, and impair the ability of our borrowers to repay their loans. Although we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations, and financial condition. In addition, other external events, including natural disasters, health emergencies and epidemics or pandemics, such as the COVID-19 pandemic, and events of armed conflict in other parts of the world, such as the present armed conflict involving Ukraine and Russia, could adversely affect the global or regional economies resulting in unfavorable economic conditions in the United States. Any of such developments could have an adverse effect on our business, operations or financial condition.

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The continuing COVID-19 pandemic may adversely impact our business and financial results, and the ultimate impact will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.

Since the beginning of January 2020, the coronavirus outbreak has disrupted global supply chains, lowered equity market valuations, created significant volatility and disruption in financial markets, increased unemployment levels, and decreased consumer confidence. Additionally, the COVID-19 pandemic has resulted in temporary closures of many businesses and the institution of social distancing and sheltering in place requirements in many states and communities, including in our primary market areas. As a result, the demand for our products and services may be significantly impacted, which could adversely affect our revenue. This may result in a significant decrease in business and/or cause QNB’s customers to be unable to meet existing payment or other obligations to QNB, particularly in in QNB’s market area. The continuing COVID-19 pandemic could result in the recognition of credit losses in our loan portfolios and increases in our allowance for credit losses, particularly if businesses remain closed, the impact on the global economy worsens, or more customers draw on their lines of credit or seek additional loans to help finance their businesses. Similarly, because of changing economic and market conditions affecting bond issuers, we may be required to recognize impairments on the securities we hold as well as reductions in other comprehensive income. Although the Company maintains contingency plans for pandemic outbreaks, a spread of COVID-19, or an outbreak of another contagious disease, could also negatively impact the availability of key personnel of QNB necessary to conduct the business of QNB. Our business operations may be further disrupted if significant portions of our workforce are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. Such a spread or outbreak could also negatively impact the business and operations of third-party service providers who perform critical services for QNB’s business. Moreover, the pandemic has created additional operational and compliance risks, including the need to quickly implement and execute new programs and procedures for the products and services we offer our customers, provide enhanced safety measures for our employees and customers, comply with rapidly changing regulatory requirements, address any increased risk of fraudulent activity, and protect the integrity and functionality of our systems and networks as a larger number of our employees work remotely. The extent to which the COVID-19 pandemic impacts our business, results of operations, and financial condition, as well as our regulatory capital and liquidity ratios and our cost of capital, will depend on future developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities and other third parties in response to the pandemic.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

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ITEM 2. PROPERTIES

The principal office of both QNB Bank and QNB Corp. is located at 15 North Third Street, Quakertown, Pennsylvania. QNB Bank conducts business from its principal office and eleven other branch offices located in Bucks, Lehigh, and Montgomery Counties in Pennsylvania. QNB Bank owns its principal office, three branch locations, its administrative and operations facility and a computer facility. QNB Bank leases its remaining eight branch properties. The leases on the properties generally contain renewal options. In management’s opinion, these properties are in good condition and are currently adequate for QNB’s purposes.

The following table details QNB Bank’s properties:

Location

• Quakertown, PA – Towne Bank Center - 320-322 West Broad Street Owned

• Quakertown, PA – Computer Center - 121 West Broad Street Owned

• Quakertown, PA – Country Square Branch - 240 South West End Boulevard Owned

• Dublin, PA – Dublin Branch - 161 North Main Street Leased

• Pennsburg, PA – Upper Perkiomen Valley Branch - 410 Pottstown Avenue Leased

• Coopersburg, PA – Coopersburg Branch - 51 South Third Street Owned

• Perkasie, PA – Perkasie Branch - 607 Chestnut Street Owned

• Souderton, PA – Souderton Branch - 750 Route 113 Leased

• Wescosville, PA – Wescosville Branch - 950 Mill Creek Road Leased

• Colmar, PA – Colmar Branch - 127 Bethlehem Pike Owned

• Warminster, PA – Warminster Branch - 1402 West Street Road Leased

• Allentown, PA – Allentown Branch - 535 N. 19th Street Leased

ITEM 3. LEGAL PROCEEDINGS

Although there are currently no material proceedings to which QNB is the subject, future litigation that arises during the normal course of QNB’s business could be material and have a negative impact on QNB’s earnings. Future litigation also could adversely impact the reputation of QNB in the communities that it serves.

ITEM 4. MINE SAFETY DISCLOSURES

None.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Stock Information

QNB common stock is quoted on the over-the-counter bulletin board (“OTCBB”). QNB had approximately 640 shareholders of record as of February 25, 2022.

The following table sets forth the high and low bid and ask stock prices for QNB common stock on a quarterly basis during 2021 and 2020. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

Cash

High Low dividend

Bid Ask Bid Ask per share

QNB has traditionally paid quarterly cash dividends on the last Friday of each quarter. The Company expects to continue the practice of paying quarterly cash dividends to its shareholders; however, future dividends are dependent upon future earnings, financial condition, appropriate legal restrictions, and other factors relevant at the time the board of directors considers declaring a dividend. Certain laws restrict the amount of dividends that may be paid to shareholders in any given year. See “Shareholders’ Equity - Capital Adequacy” included in Item 7 of this Form 10-K filing and Note 20 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K filing, for additional information that discusses and quantifies this regulatory restriction.

The following table provides information on repurchases by QNB of its common stock in each month of the quarter ended December 31, 2021.

(1) Transactions are reported as of settlement dates.

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

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Stock Performance Graph

Set forth below is a performance graph comparing the yearly cumulative total shareholder return on QNB’s common stock with:

All of these cumulative total returns are computed assuming the reinvestment of dividends at the frequency with which dividends were paid during the applicable years.

Period Ending

Source: S&P Global Market Intelligence ©2021

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1ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Results of Operations – Overview

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

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

The following table displays five years of selected financial amounts and ratios for the QNB:

Income and expense

Share and Per Share Data

Balance Sheet at Year-end

Selected Financial Ratios

Net income as a percentage of:

Average shareholders' equity to average total assets 8.53 9.21 9.63 9.20 9.09

QNB experienced significant growth in net income for 2021. Net income for the year ended December 31, 2021 was $16,492,000, or $4.64 per share on a diluted basis. This compares to 2020 net income of $12,083,000, or $3.42 per share on a diluted basis and 2019 net income of $12,357,000, or $3.53 per share on a diluted basis. Two important measures of profitability in the banking industry are an institution’s return on average assets and return on average shareholders’ equity. Return on average assets was 1.04%, 0.90% and 1.02% in 2021, 2020, and 2019, respectively, and return on average shareholders’ equity was 12.19%, 9.76% and 10.58%, respectively, during those same periods.

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The Bank contributed $14,607,000 to net income for the year ended December 31, 2021 compared to $11,753,000 for the same period in 2020; whereas the holding company contributed $1,885,000 to net income for the year ended December 31, 2021 compared to $330,000 for the same period in 2020. The increase at the holding company resulted primarily from an increase in gains on sales of equity securities and anincrease in the fair value of the equity portfolio during 2021.

2021 versus 2020

The results for 2021 include the following significant components:

2020 versus 2019

The results for 2020 include the following significant components:

• Provision for income taxes decreased $288,000.

These items, as well as others, will be explained more thoroughly in the next sections.

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 years ended December 31, 2021, 2020, and 2019.

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 interest-bearing balances at the Federal Reserve Bank (Fed). 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.

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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 table that appears above. This adjustment to interest income is made for analysis purposes only. Interest income is increased by the amount of savings of Federal income taxes, which QNB realizes by investing in certain tax-exempt state and municipal securities and by making loans to certain tax-exempt organizations. In this way, the ultimate economic impact of earnings from various assets can be more easily compared.

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

2021 versus 2020

On a tax-equivalent basis, net interest income for 2021 increased $4,894,000, or 12.9%, to $42,833,000. The net interest margin, which decreased 13 basis points to 2.79% was unfavorably impacted by decreased rates on loans and investments. The average rate earned on earning assets decreased 33 basis points from 3.42% for 2020 to 3.09% for 2021 with the yield on investments decreasing 35 basis points and the yield on loans decreasing nine basis points. The yield on investment securities was unfavorably impacted by decreased yields on all categories except corporate debt securities, causing a reduction in interest income of $2,145,000; this was favorable offset by an increase in average volume of $175,018,000 contributing to a $3,528,000 increase in interest income. The yield on loans was unfavorably impacted by decreased rates in all loan categories except commercial and industrial loans, contributing to a $994,000 decline in interest income; this was favorably offset by a $59,997,000 net increase in average volume, of which $70,591,000 was related to an increase in average commercial real estate loans, contributing $2,727,000 in interest income. The yield on total average interest-bearing liabilities decreased 24 basis points from 0.63% for 2020 to 0.39% for 2021. The growth in loans and investment securities was funded by a $208,689,000, or 18.1%, increase in average total deposits. The average rate paid on interest-bearing deposits decreased from 0.63% to 0.38% for the same time periods, respectively, contributing to a decrease in interest expense of $2,051,000, partially offset by a $159,075,000 increase in average interest-bearing deposits resulting in additional interest expense of $215,000.

Relief efforts in place to mitigate the economic impact of COVID-19 pandemic contributed to loan and deposit growth which was partially offset by the competitive local interest rate market for quality loans and deposits. Net interest spread decreased nine basis points to 2.70% for 2021 compared to 2.79% for 2020.

2020 versus 2019

On a tax-equivalent basis, net interest income for 2020 increased $865,000, or 2.3%, to $37,939,000. The net interest margin, which decreased 24 basis points to 2.92% was unfavorably impacted by decreased rates on loans. The average rate earned on earning assets decreased 60 basis points from 4.02% for 2019 to 3.42% for 2020 with the yield on loans decreasing 53 basis points, favorably impacted by a $48,161,000 increase in average commercial and industrial loans partially offset by an 123 basis point decrease in the related yield and a $9,475,000 increase in average residential real estate loans partially offset by a 19 basis point decrease in yield, and unfavorably impacted by a 36 basis point decrease in the yield partially offset by a $21,719,000 increase in average commercial real estate loans. The yield on investment securities declined 45 basis points to 1.92%. In comparison, the interest rate paid on total average interest-bearing liabilities decreased 44 basis points from 1.07% for 2019 to 0.63% for 2020 with the average rate paid on interest-bearing deposits increasing from 1.06% to 0.63% for the same time periods, respectively, partially offset by a $75,213,000 increase in average interest-bearing deposits.

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

Average Average Average Average Average Average

balance rate Interest balance rate Interest balance rate Interest

Assets

Investment securities (AFS & Equities):

Loans:

Liabilities and Shareholders' Equity

Interest-bearing deposits:

Tax-exempt securities and loans were adjusted to a tax-equivalent basis and are based on the marginal Federal corporate tax rate of 21 percent. Non-accrual loans and investment securities are included in earning assets.

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* Includes loans held-for-sale

Rate-Volume Analysis of Changes in Net Interest Income (1) (2) (3)

Due to change in: Total Due to change in: Total

Volume Rate Change Volume Rate Change

Interest income:

Investment securities (AFS & Equities):

U.S. Treasury $ — $ — $ — $ (46 ) $ — $ (46 )

Pooled trust preferred — (1 ) (1 ) — (1 ) (1 )

Loans:

Interest expense:

The Rate-Volume Analysis tables, as presented on a tax-equivalent basis, highlight the impact of changing rates and volumes on interest income and interest expense. Total interest income on a tax-equivalent basis increased $3,092,000 to $47,476,000 for 2021, while total interest expense decreased $1,802,000 to $4,643,000. Volume growth in earning assets contributed an additional $6,262,000 of interest income and interest rate decreases contributed to a reduction in interest income of $3,170,000. Rate-related interest expense decreased $2,135,000, while volume-related interest expense increased $333,000.

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Investments

2021 versus 2020

Interest income on available-for-sale and equity investment securities increased $1,383,000 when comparing the two years. The increase in average balances contributed an additional $3,528,000 to interest income but was partially offset by $2,145,000 due to the 35-basis point decrease in rates. The average yield on the available-for-sale and equity investment portfolio decreased to 1.57% for 2021 compared to 1.92% for 2020.

Income on U.S. Government agency securities decreased $49,000, due to a 33-basis point decrease in the yield from 1.38% for 2020 to 1.05% for 2021, partially offset by an increase in average balances totaling $15,823,000. Most of the bonds in the agency portfolio have call features ranging from three months to three years, many of which were exercised during 2021 as a result of the declining rates during the year; these bonds were replaced by lower-yielding securities.

Interest income on tax-exempt municipal securities increased $738,000. Average balances, which increased $46,187,000, contributed $1,423,000 to interest income. The decrease in yield of 61 basis points from 3.08% in 2020 to 2.47% in 2021 partially offset the increase in interest income by $685,000. Many of these bonds have either reached maturity or their call dates and are being replaced with municipal bonds with less favorable tax-equivalent yields. Typically, QNB purchased municipal bonds with 10- to 15-year maturities with call dates between 2 and 5 years. Future demand for tax-exempt municipal securities is uncertain, as the tax-equivalent yield could be less favorable compared to other securities with similar risk-based capital asset-weighting characteristics.

All the mortgage-backed and collateralized mortgage obligations (“CMO”) securities owned by QNB are issued by U.S. Government agencies and sponsored enterprises (“GSE”) and carry the implicit backing of the U.S. Government, but they are not direct obligations of the U.S. Government. Interest income on mortgage-backed securities and CMOs increased $632,000 due to a $109,762,000 increase in average balances, partially offset by a 32-basis point decrease in rate from 1.61% for 2020 to 1.29% for 2021. This portfolio generally provides higher yields relative to agency bonds and provides monthly cash flow which can be used for liquidity purposes or can be reinvested as interest rates increase.

Income on corporate debt securities increased $18,000 due to an increase in yield from 3.69% for 2020 to 4.03% for 2021 partially offset by a decrease in average balances of $158,000.

Dividend income on equities increased $45,000 due to an increase in average balances of $3,405,000, partially offset by a decrease in yield of 52 basis points.

2020 versus 2019

Interest income on available-for-sale and equity investment securities decreased $1,043,000 when comparing the two years. The increase in average balances contributed an additional $878,000 to interest income but was offset by $1,921,000 due to the 45-basis point decrease in rates. The average yield on the available-for-sale and equity investment portfolio decreased to 1.92% for 2020 compared to 2.37% for 2019.

Income on U.S. Government agency securities decreased $370,000, due to a decrease in average balances totaling $5,225,000 and a 43-basis point decrease in the yield from 1.81% for 2019 to 1.38% for 2020. Most of the bonds in the agency portfolio have call features ranging from three months to three years, many of which were exercised during 2020 as a result of the declining rates during the year.

Interest income on tax-exempt municipal securities increased $91,000. Average balances, which increased $11,192,000, contributed $396,000 to interest income. The decrease in yield of 46 basis points from 3.54% in 2019 to 3.08% in 2020 partially offset the increase in interest income by $305,000.

Interest income on mortgage-backed securities and CMOs decreased $807,000 due to 57-basis point decrease in rate from 2.18% for 2019 to 1.61% for 2020 partially offset by an increase of $25,401,000, or 11.7%, in average balances.

Income on corporate debt securities decreased $28,000 due to a decrease in average balances of $653,000 and a decrease in yield from 3.74% for 2019 to 3.69% for 2020.

Dividend income on equities increased $118,000 due to an increase in average balances of $2,790,000 and an increase in yield of 23 basis points.

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Loans

2021 versus 2020

The largest category of the loan portfolio is commercial real estate loans. This category of loans includes commercial purpose loans secured by either commercial properties such as office buildings, hotels, factories, warehouses, medical facilities and retail establishments, or residential real estate, usually the residence of the business owner or investment properties. The category also includes construction and land development loans. Income on commercial real estate loans increased $1,436,000. The increase in average balances of $70,591,000, or 14.5%, contributed an increase in interest income of $3,145,000; this was partially offset by the 31-basis point decrease in yield, from 4.46% in 2020 to 4.15% in 2021 which resulted in a decrease of interest income of $1,709,000.

Income on commercial and industrial loans, the second largest category, increased $916,000 with the positive impact from an increase in average yield of 73 basis points to 4.75% in 2021 from 4.02% in 2020, contributing to a $1,403,000 increase in interest income. Many of the loans in this category are indexed to the prime interest rate. This was partially offset by a decrease in average commercial and industrial loans of $12,075,000, or 5.9%, to $193,491,000 for 2021, resulting in a $487,000 decrease in interest income. Included in this category are the PPP loans which contributed $7,422,000 of the net volume decrease. The PPP loans yield one percent to the customer; however, QNB received origination fees from the SBA ranging from a flat fee of $2,500 to one to five basis points, resulting in a yield of approximately 7.48% for 2021 compared to 3.36% for 2020. The PPP loans contributed 109 basis points to the increase in the average yield.

Tax-exempt loan income decreased $439,000 from $1,274,000 in 2020. When comparing the same periods, average balances decreased $11,639,000 to $24,026,000, which contributed a $416,000 decrease in interest income. The average yield on the tax-exempt loan portfolio decreased from 3.57% for 2020 to 3.47% for 2021, resulting in a decrease in interest income of $23,000.

QNB strives to be the “local consumer lender of choice.” QNB continues to focus on its retail lending efforts by adding new product offerings and by marketing and promotion. Overall, retail lending balances increased $13,120,000 while interest income for retail lending decreased $180,000 in 2021 compared with 2020, driven by the 49-basis point decrease in yield.

Given the low yields on alternative investment securities, QNB retained certain fixed rate and hybrid adjustable-rate mortgages to borrowers with high credit scores and low loan-to-value ratios. As a result, average residential mortgage loans secured by first lien 1-4 family residential mortgages increased by $18,164,000, or 23.6%, to $95,241,000 for 2021. The average yield on the residential real estate portfolio decreased 38 basis points to 3.41% for 2021 compared to 3.79% for 2020. Overall, interest income for this segment grew $322,000 in 2021.

Income on home equity loans decreased by $442,000 when comparing 2021 and 2020. During 2021 and 2020, QNB offered attractive rates on both variable rate and fixed rate home equity loans. Mortgage rates dropped during 2021 resulting in the refinancing home-equity loans and lines into longer-term mortgages, this contributed to the decrease in average balances of $4,182,000, or 6.8%, to $57,311,000 when comparing 2021 and 2020. The yield on the home equity portfolio decreased 50 basis points to 3.29% when comparing the two years. The home values have continued to grow; therefore, we expect that the demand for home equity loans will continue.

Interest income on consumer loans decreased $60,000. Consumer loans at QNB experienced a decline in average balances in 2021 of $862,000, or 14.5%, led by a decline in student loans. Student loan balances are no longer insured, and QNB ceased funding originations through its third-party provider during the second half of 2018; average balances decreased $470,000 and interest income decreased $42,000 when comparing 2021 and 2020.

2020 versus 2019

Income on commercial real estate loans decreased $731,000. The increase in average balances of $21,719,000, or 4.7%, contributed an increase in interest income of $1,047,000; this was offset by the 36-basis point decrease in yield, from 4.82% in 2019 to 4.46% in 2020 resulted in a decrease of interest income of $1,778,000.

Income on commercial and industrial loans increased $4,000 with the positive impact from an increase in average balances. Average commercial and industrial loans increased $48,161,000, or 30.6%, to $205,566,000 for 2020, resulting in a $2,531,000 increase in interest income. PPP loans which contributed $53,374,000 of the net volume increase. Average yield on these loans decreased 123 basis points to 4.02% causing a decrease of $2,527,000 in interest income.

Tax-exempt loan income decreased $335,000 from $1,609,000 in 2019. When comparing the same periods, average balances decreased $11,904,000 to $35,665,000, which contributed a $402,000 decrease in interest income. The average yield on the tax-exempt loan portfolio increased from 3.38% for 2019 to 3.57% for 2020, resulting in an increase in interest income of $67,000.

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Interest income for retail lending decreased $691,000 in 2020 compared with 2019, driven by the 62-basis point decrease in yield. Average residential mortgage loans secured by first lien 1-4 family residential mortgages increased by $9,475,000, or 14.0%, to $77,077,000 for 2020. The average yield on the residential real estate portfolio decreased 19 basis points to 3.79% for 2020 compared to 3.98% for 2019. Overall, interest income for this segment grew $234,000 in 2020.

Average home equity loans balances decreased $6,145,000, or 9.1%, to $61,493,000 when comparing 2020 and 2019. The yield on the home equity portfolio decreased 88 basis points to 3.79% when comparing the two years.

Interest income on consumer loans decreased $95,000 primarily due to a $544,000 decrease in Student loans average balances.

Deposits and Borrowings

2021 versus 2020

Earning assets are funded primarily by deposits, which increased on average by $208,689,000, or 18.1%, to $1,359,100,000, when comparing 2021 and 2020. Total interest expense for 2021 was $4,643,000 compared with $6,445,000 for 2020, a decrease of $1,802,000. Interest expense on total deposits decreased $1,836,000 and interest expense on borrowed funds increased $34,000 when comparing the two years. The rate paid on interest-bearing deposits decreased 25 basis points; the rate paid on borrowings decreased 13 basis points, when comparing the two periods. Deposit and borrowing costs are expected to increase as the competition for deposits increases when rates rise

Consistent with the past several years, the growth in deposits during 2021 was centered in accounts with greater liquidity. Average non-interest-bearing demand accounts increased $49,614,000, or 26.5%, to $236,511,000 for 2021; QNB has been successful in increasing both personal and business checking accounts. Average interest-bearing demand accounts increased $55,208,000, or 21.9%, to $307,258,000 for 2021 compared with 2020, with interest expense on interest-bearing demand accounts decreasing $44,000 to $624,000 for 2021. The average rate paid decreased six basis points to 0.20% for 2021 compared to 026% for 2020. Interest-bearing business checking account average balances increased by $7,025,000, or 12.8%, and related interest expense decreased $79,000, or 19 basis points in yield, when comparing the two years. Also included in this category is QNB-Rewards checking, a tiered-rate checking account product. In order to receive the high rate a customer must receive an electronic statement, have one direct deposit or other ACH transaction and have at least 12 debit card purchase transactions post and clear per statement cycle. If these qualifications are not met, the rate paid during 2021 was reduced from 0.20% to 0.10%. For 2021, the average balance in this product was $96,522,000 and the related interest expense was $350,000 for an average cost of funds of 0.36%. In comparison, the average balance in this product for 2020 was $74,447,000 and the related interest expense was $325,000 for an average cost of funds of 0.44%. The rates paid on the QNB-Rewards product, assuming qualifications are met, is attractive relative to competitors’ offerings as well as other QNB products. This product also generates fee income through the use of the debit card. The average balance of other interest-bearing demand accounts included in this category increased from $122,861,000 for 2020 to $148,969,000 for 2021. The average rate paid on these balances was 0.05% for both years.

Average money market accounts increased $31,372,000, or 34.5%, to $122,361,000 for 2021 compared with 2020. Interest expense on money market accounts decreased $24,000 to $381,000 for 2021 compared with 2020. The average interest rate paid on money market accounts was 0.31% for 2021, a decrease of 14 basis points compared with 2020. The balances in this category primarily comprise Select money market accounts, a product that pays a tiered rate based on account balances. The balances remaining in these accounts for 2021 were primarily at higher-yielding tiers.

Interest expense on municipal interest-bearing demand accounts decreased $268,000 to $411,000 for 2021. The average balance of municipal interest-bearing demand accounts increased $8,155,000, or 6.8%, to $127,828,000 and the average interest rate paid on these accounts decreased 25 basis points to 0.32% for 2021 from 0.57% for 2020. Most of these accounts are indexed to the Federal funds rate with negotiated rate floors between 0.15% and 0.35%. Many of these deposits are seasonal in nature and are received during the third quarter as tax receipts are collected and are withdrawn over the course of the next year.

QNB’s online e-Savings product is the largest category of savings deposits and was created to compete with other online savings accounts. Average balances increased $82,736,000, or 39.9%, to $289,913,000 in 2021 compared with $207,177,000 in 2020. The average cost of funds on these accounts was 0.36% for 2021 and 0.50% for 2020. The yield on this account may rise along with market rates and as competition for savings balances increases. Traditional statement savings accounts and club accounts are also included in the savings category and increased on average by $15,609,000, or 19.2%, to $96,717,000. The average rate paid on total savings accounts was 0.30% for 2021, a ten-basis point decrease from 0.40% for 2020 and interest expense increased $23,000, to $1,178,000 from $1,155,000 over the same period.

Interest expense on time deposits decreased $1,523,000, to $1,632,000 in 2021, due to a 57-basis point decrease in yield, from 1.48% in 2020 to 0.91% in 2021. The decrease in average balances was $34,005,000 in 2021, to $178,512,000. 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. However, the maturity and repricing characteristics of time deposits tend to be shorter.

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Approximately $95,703,000, or 56.8%, in time deposits will reprice or mature over the next 12 months compared with 66.6% of the portfolio at December 31, 2020. The average rate paid on these time deposits is approximately 0.57%.

Short-term borrowings are comprised of sweep accounts structured as repurchase agreements with our commercial customers and overnight borrowings from correspondent banks with average balances in 2021 of $71,467,000 and $191,000, respectively. Interest expense on short-term borrowings increased by $11,000 to $258,000 when comparing the two years. During this period average balances of repurchase agreements increased $21,460,000 with a seven-basis point decrease in average rate paid, resulting in an increase of cost of funds of $43,000. The average balances of borrowings from correspondent banks declined $1,547,000 and the average rate paid decreased 138 basis points, resulting in a decrease in cost of funds of $32,000.

Average long-term debt was $10,000,000 with an average yield of 1.57%. The yield on interest-bearing liabilities decreased 24 basis points to 0.39% for 2021.

2020 versus 2019

Total interest expense for 2020 was $6,455,000 compared with $10,124,000 for 2019, a decrease of $3,679,000. Interest expense on total deposits decreased $3,362,000 and interest expense on borrowed funds decreased $317,000 when comparing the two years. The rate paid on interest-bearing deposits decreased 43 basis points and the rate paid on borrowings decreased 59 basis points, when comparing the two periods.

Average non-interest-bearing demand accounts increased $44,825,000, or 31.6%, to $186,897,000 for 2020; QNB has been successful in increasing both personal and business checking accounts. Average interest-bearing demand accounts increased $39,635,000, or 18.7%, to $252,050,000 for 2020 compared with 2019, with interest expense on interest-bearing demand accounts decreasing $322,000 to $668,000 for 2020. The average rate paid decreased 21 basis points to 0.26% for 2020 compared to 0.47% for 2019. Interest-bearing business checking account average balances increased by $10,689,000, or 24.3%, and related interest expense decreased $265,000, or 72 basis points in yield, when comparing the two years. This was primarily due to initial proceeds from PPP loans being held by customers at the Bank. For 2020, the average balance QNB-Rewards checking was $74,447,000 and the related interest expense was $325,000 for an average cost of funds of 0.44%. In comparison, the average balance in this product was $59,490,000 and the related interest expense was $392,000 for an average cost of funds of 0.66%. The average balance of other interest-bearing demand accounts included in this category increased from $108,872,000 for 2019 to $122,861,000 for 2020. The average rate paid on these balances was 0.05% for both years.

Average money market accounts increased $839,000, or 0.9%, to $90,989,000 for 2020 compared with 2019. Interest expense on money market accounts decreased $410,000 to $405,000 for 2020 compared with 2019. The average interest rate paid on money market accounts was 0.45% for 2020, a decrease of 45 basis points compared with 2019

Average money market accounts increased $839,000, or 0.9%, to $90,989,000 for 2020 compared with 2019. Interest expense on money market accounts decreased $410,000 to $405,000 for 2020 compared with 2019. The average interest rate paid on money market accounts was 0.45% for 2020, a decrease of 45 basis points compared with 2019.

Online eSavings average balances increased $7,134,000, or 6.3%, to $119,673,000 and the average interest rate paid on these accounts decreased 123 basis points to 0.57% for 2020 from 1.80% for 2019. Traditional statement savings accounts and club accounts are also included in the savings category and increased on average by $10,376,000, or 14.7%, to $81,108,000. The average rate paid on total savings accounts was 0.40% for 2020, a 26-basis point decrease from 0.66% for 2019 and interest expense decreased $450,000, to $1,155,000 from $1,605,000 over the same period.

Interest expense on time deposits decreased $836,000, to $3,155,000 in 2020, due to a 25-basis point decrease in yield, from 1.73% in 2019 to 1.48% in 2020. The decrease in average balances was $17,821,000 in 2020, to $212,517,000.

Short-term borrowings are comprised of sweep accounts structured as repurchase agreements with our commercial customers and overnight borrowings from correspondent banks with average balances in 2020 of $50,007,000 and $1,738,000, respectively. Interest expense on short-term borrowings decreased by $453,000 to $247,000 when comparing the two years. During this period average balances of repurchase agreements increased $9,788,000 with a 28-basis point decrease in average rate paid, resulting in a decrease of cost of funds of $69,000. The average balances of borrowings from correspondent banks declined $15,023,000 and the average rate paid decreased 59 basis points, resulting in a decrease in cost of funds of $384,000.

Average long-term debt was $8,566,000 with an average yield of 1.57%, 33 basis points lower than the yield on short-term FHLB borrowings. The yield on interest-bearing liabilities decreased 44 basis points to 0.63% for 2020.

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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. QNB recorded a provision for loan losses of $458,000, $1,250,000 and $1,300,000 for the twelve-month periods ended December 31, 2021, 2020 and 2019, respectively. Net loan charge-offs were $100,000, or 0.01% of total average loans for 2021 compared with $311,000, or 0.04% of total average loans in 2020 and $247,000, or 0.03% of total average loans in 2019. The majority of the commercial loans charged off during 2021 and 2020 had specific reserves established during the allowance for loan loss calculation process prior to the decision to charge-off the loans. Deterioration in credit quality or significant growth in the loan portfolio may result in a higher provision for loan losses in 2022.

Non-Interest Income

Non-interest income comparison

Change from prior year

$ Change % Change

N/M - Not Meaningful

2021 versus 2020

QNB, through its core banking business, generates various fees and service charges. Total non-interest income includes service charges on deposit accounts, ATM and debit card income, retail brokerage and advisory income, income on bank-owned life insurance, merchant income and gains and losses on investment securities and residential mortgage loans. Total non-interest income was $7,602,000 in 2020 compared with $9,781,000 in 2021, an increase of $2,179,000.

Fees for services to customers are primarily comprised of service charges on deposit accounts. These fees were $1,326,000 for 2021, an increase of $11,000 from 2020. Overdraft income, which represented approximately 72% and 71% of total fees for services to customers in 2021 and 2020, respectively, increased by $20,000, or 2.2%, when comparing 2021 to 2020. The increasein overdraft income primarily reflects an increase in the number of overdraft occurrences.

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 $2,682,000 in 2021, an increase of $487,000, or 22.2%, from the amount recorded in 2020. Debit card interchange income increased $489,000, or 22.9%, to $2,620,000 in 2021, while ATM surcharge income and monthly card fees income decreased $2,000 to $62,000. The growth in checking accounts and card usage contributed to the increase in debit card income, including the QNB Rewards checking product, a tiered-rate checking account which requires, among other terms, the posting of a minimum of twelve debit card purchase transactions per statement cycle to receive the high interest rate.

QNB provides securities and advisory services under the name QNB Financial Services through an independent third-party registered Broker/Dealer and Registered Investment Advisor. QNB terminated its contract with its third-party broker-dealer effective August 1, 2018 and entered into a similar arrangement with another third-party provider. QNB Financial Services finalized the transferring of accounts to the new provider’s platform during 2019. QNB receives a percentage of the revenue generated but is responsible for salaries and expenses of advisors who are QNB employees. Retail brokerage and advisory revenue was $786,000 for 2021 compared with $581,000 in 2020, an increase of $205,000, or 35.3%. Advisory fees increased $175,000 comparing 2021 to 2020. Sales in front-loaded products, such as annuities and alternative investments (which include private equity, hedge funds, managed futures, real estate “REITs”, commodities and derivatives contracts) and trailing income related to these increased $30,000 in 2021 over 2020. In 2021, the net income provided by QNB Financial Services was $206,000, compared with $197,000 in net income for 2020.

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Income on bank-owned life insurance (“BOLI”) represents the earnings and death benefits on life insurance policies in which the Bank is the beneficiary. The insurance carriers reset the rates on these policies annually taking into consideration the interest rate environment as well as mortality costs. The existing policies have rate floors which limit how low the earnings rate can go. Some of these policies are currently at their floor. Income on these policies during 2021 was $497,000 compared to $294,000 for 2020; there was a life insurance benefit of $193,000 realized during 2021.

Merchant income represents fees charged to merchants for the Bank’s handling of credit card or charge sales. Merchant income was $451,000 for 2021, an increase of $34,000, or 8.28%, from the amount reported in 2020. The increase in merchant income is primarily a result of increased usage.

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 to take advantage of changes in the shape of the yield curve, changes in spread relationships in different sectors, and for liquidity purposes. Management continually reviews strategies that will result in an increase in the yield or improvement in the structure of the investment portfolio, including monitoring credit and concentration risk in the portfolio. In addition, the Corporation owns a small portfolio of equity securities for the purpose of generating both dividend income and capital appreciation.

Net gains on sales of investment securities increased $1,197,000 to a net gain of $1,806,000 for the year ended December 31, 2021, compared with a net gain of $609,000 for the year ended December 31, 2020, primarily due to market conditions which resulted in greater opportunities for profitable sales in 2021 compared with 2020. Gains from equity securities were $1,788,000 in 2021 compared to gains of $585,000 in 2020. Net gains on the sale of fixed income securities were $18,000 for 2021 compared to $24,000 for 2020. Unrealized losses on equity securities of $47,000 were recorded during 2020 compared to unrealized gains $926,000 during 2021.

The net gain on residential mortgage sales is directly related to the volume of mortgages sold and the timing of the sales relative to the interest rate environment. Residential mortgage loans to be sold are identified at origination. The net gain on the sale of residential mortgage loans was $595,000 and $1,724,000 for 2021 and 2020, respectively. Mortgage financing activity increased in 2020, as an improvement in rates prompted borrowers to purchase and continued to represent opportunities in 2021. Proceeds from the sale of residential mortgages were $16,773,000 and $35,605,000 for the years ended December 31, 2021 and 2020, respectively. Included in the gains on the sale of residential mortgages in 2021 and 2020 are $122,000 and $249,000, respectively, related to the recognition of mortgage servicing assets.

QNB retains servicing rights for residential mortgages sold in the secondary market. A 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 income of $102,000 for 2021 and $41,000 for 2020 is included in other non-interest income.

Other non-interest income, excluding mortgage servicing income, was $610,000 for 2021, an increase of $137,000 from the amount recorded in 2020. Other non-interest income included broker-dealer conversion costs reimbursements of $55,000 and $66,000 for 2021 and 2020, respectively. Other non-interest income included $37,000 in an anti-trust settlement. Title company income increased $79,000 and letter of credit fees increased $45,000 when comparing 2021 to 2020.

2020 versus 2019

Total non-interest income was $8,317,000 in 2019 compared with $7,602,000 in 2020, a decline of $715,000.

Fees for services to customers were $1,315,000 for 2020, a decrease of $376,000, or 22.2%, from 2019, primarily due to a reduction in overdraft fees. ATM and debit card income was $2,195,000 in 2020, an increase of $125,000, or 6.0%, from the amount recorded in 2019. Debit card interchange income increased $117,000, or 5.8%, to $2,131,000 in 2020, while ATM surcharge income and monthly card fees income increased $8,000 to $64,000.

Retail brokerage and advisory revenue was $581,000 for 2020 compared with $560,000 in 2019, an increase of $21,000, or 3.8%. In 2018 and throughout 2019, there was a transition to move toward advanced advisory fees based on assets under management in lieu of fees per transaction; advisory fees increased $24,000 comparing 2020 to 2019. There was a decreased in sales of front-loaded products in 2020 than in 2019, resulting in decreased revenues of $3,000.

Income on bank-owned life insurance policies during 2020 was $294,000 compared to $292,000 for 2019.

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Merchant income was $417,000 for 2020, an increase of $69,000, or 19.8%, from the amount reported in 2019. The increase in merchant income is primarily a result of increased usage.

Net gains on investment securities decreased $1,146,000 to a net gain of $609,000 for the year ended December 31, 2020, compared with a net gain of $1,755,000 for the year ended December 31, 2019, primarily due to market conditions which resulted in greater opportunities for profitable sales in 2019 compared with 2020. Gains from equity securities were $1,781,000 in 2019 compared to gains of $585,000 in 2020. Net gains on the sale of fixed income securities were $24,000 for 2020 compared to net losses of $26,000 for 2019. Unrealized losses on equity securities of $47,000 were recorded during 2020 compared to unrealized gains $770,000 during 2019.

The net gain on the sale of residential mortgage loans was $1,724,000 and $195,000 for 2020 and 2019, respectively. Mortgage financing activity increased in 2020, as an improvement in rates prompted borrowers to purchase. Proceeds from the sale of residential mortgages were $35,605,000 and $7,324,000 for the years ended December 31, 2020 and 2019, respectively. Included in the gains on the sale of residential mortgages in 2020 and 2019 are $249,000 and $54,000, respectively, related to the recognition of mortgage servicing assets. Mortgage servicing income of $41,000 for 2020 and $117,000 for 2019 is included in other non-interest income.

Other non-interest income, excluding mortgage servicing income, was $473,000 for 2020, a decline of $46,000 from the amount recorded in 2019. Other non-interest income included broker-dealer conversion costs reimbursements of $66,000 and $83,000 for 2020 and 2019, respectively. Other non-interest income included a $58,000 deferred gain on the sale of a bank-financed other real estate owned property in 2019. Title company income increased $31,000 when comparing 2020 to 2019.

Non-Interest Expense

Non-interest expense comparison

Change from prior year

$ Change % Change

2021 versus 2020

Non-interest expense is comprised of costs related to salaries and employee benefits, net occupancy, furniture and equipment, marketing, third party services, FDIC insurance premiums, regulatory assessments and taxes and various other operating expenses. Total non-interest expense was $30,997,000 in 2021, an increase of $2,042,000, or 7.1%, from the $28,955,000 in 2020. QNB’s overhead efficiency ratio, which represents the percentage of each dollar of revenue that is used for non-interest expense, is calculated by taking non-interest expense divided by net operating revenue (tax-equivalent net interest income plus non-interest income). QNB’s efficiency ratios for 2021, 2020 and 2019 were 58.9%, 63.6%, and 61.9%, respectively. The favorable decrease in the 2021 efficiency ratio is primarily due to tax-equivalent income increasing $4,895,000 in 2021 over 2020 and partially offset by non-interest expense in 2021 increasing $2,179,000, over the same period.

Salaries and benefits expense is the largest component of non-interest expense. QNB monitors, using various surveys, the competitive salary and benefit information in its markets and makes adjustments when appropriate. Salaries and benefits expense for 2021 was $17,453,000, an increase of $912,000 compared with $16,541,000 reported in 2020. Salary expense and related payroll taxes for 2021 was $14,704,000, an increase of $942,000 compared with $13,762,000 reported in 2020. Included in salary expense in 2021 was incentive compensation plus related payroll taxes of $1,182,000, a $451,000 increase over incentive compensation in 2020. Benefit expense for 2021 was $1,544,000, a decline of $94,000, or 5.7%, from the amount recorded in 2020. Medical premiums decreased $151,000 primarily due to stop-loss adjustments. Retirement plan matching and safe harbor declined $18,000 compared to 2020. QNB utilized unvested forfeited 401(k) contributions to offset retirement plan matching in 2021 and 2020.

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Net occupancy and furniture and equipment expense increased $101,000, to $5,015,000 when comparing 2021 to 2020, due primarily to increased software maintenance, additional building maintenance resulting from the COVID-19 Pandemic was recognized in 2021 and 2020.

Marketing expense was $922,000 for 2021, a $46,000 increase from the expense recorded in 2020. QNB’s contributions and sponsorships for not-for-profit organizations, events and clubs in the communities it serves are included in public relations expense which increased $45,000 in 2021; many of these events were cancelled or postponed in 2020 due to the COVID-19 Pandemic.

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 increased $237,000; QNB incurred additional legal, consulting and other third party services to implement a new retail loan software.

Telephone, postage and supplies expense decreased $21,000 to $715,000 in 2021 compared with 2020, primarily due to an increase in supplies during 2020 related to the COVID-19 Pandemic.

The premium assessment formula for small institutions is based on asset growth and related risk assumptions determined by the FDIC as well as capital. Small institutions, for FDIC premium assessments purposes, are defined as those with total consolidated assets less than $10 billion. FDIC insurance premium expense increased $224,000 in 2021 primarily due to asset growth.

State tax expense represents the payment of the Pennsylvania Shares Tax and Pennsylvania sales and use tax. State tax expense was $1,013,000 and $887,000 for the years 2021 and 2020, respectively. The Pennsylvania Shares Tax is based primarily on the equity of the Bank. The increase in Pennsylvania Shares Tax is a result of growth of the Bank’s capital.

Other operating expenses for the twelve months ended December 31, 2021 increased $417,000, or 16.6%. During 2020 there was reduced business development, travel, seminar and meeting expenses related to cancellations of events due to the COVID-19 Pandemic; many of these activities returned in 2021.

2020 versus 2019

Total non-interest expense was $28,955,000 in 2020, an increase of $851,000, or 3.0%, from the $28,104,000 in 2019. Salaries and benefits expense for 2020 was $16,541,000, an increase of $455,000 compared with $16,086,000 reported in 2019. Salary expense and related payroll taxes for 2020 was $13,762,000, an increase of $88,000 compared with $13,674,000 reported in 2019. Included in salary expense in 2020 was incentive compensation plus related payroll taxes of $731,000, a $309,000 decrease over incentive compensation in 2019. Benefit expense for 2020 was $2,779,000, an increase of $367,000, or 15.2%, from the amount recorded in 2019. Medical premiums increased $330,000. Retirement plan matching and safe harbor increased $92,000 compared to 2019. QNB utilized unvested forfeited 401(k) contributions to offset retirement plan matching in 2020 and 2019.

Net occupancy and furniture and equipment expense increased $378,000, to $4,914,000 when comparing 2020 to 2019, due primarily to increased software, additional 2020 building and equipment maintenance resulting from the COVID-19 Pandemic, branch rent related to a 2020 renewed lease and higher depreciation in 2020 resulting from renovations, one new branch and a branch relocation in 2019.

Marketing expense was $876,000 for 2020, a $166,000 decrease from the expense recorded in 2019. Advertising and sales promotions expense declined $87,000 and marketing expenses related to public relations declined $82,000, respectively, for the year ended December 31, 2020 compared with 2019. QNB’s contributions and sponsorships for not-for-profit organizations, events and clubs in the communities it serves are included in public relations expense; many of these events were cancelled or postponed due to the COVID-19 Pandemic.

Third party services increased $70,000 when comparing the two periods.

Telephone, postage and supplies expense increased $16,000 to $736,000 in 2020, compared with 2019, primarily due to an increase in supplies of $16,000 related to the COVID-19 Pandemic.

FDIC insurance premium expense decreased $355,000 in 2020. QNB received $273,000 in assessment credits during 2019.

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State tax expense was $887,000 and $760,000 for the years 2020 and 2019, respectively. The Pennsylvania Shares Tax is based primarily on the equity of the Bank. The increase in Pennsylvania Shares Tax is a result of growth of the Bank’s capital.

Other operating expenses for the twelve months ended December 31, 2020 decreased $329,000, or 11.6%. In 2019 there was a write-off of a receivable of $103,000 and foreclosure expenses of $42,000. The remaining decreases were primarily due to reduced business development, travel, seminar and meeting expenses related to cancellations of events due to the COVID-19 Pandemic.

Income Taxes

Applicable income tax expense and effective tax rates were $3,961,000, or 19.4% for 2021, $2,562,000, or 17.5% for 2020 compared with $2,850,000, or 18.7%, for 2019. The primary reason for the increased effective tax rate for 2021 over 2020 was due to the state taxes on the realized gains on equity sales securities in 2021. The primary reason for the decreased effective tax rate for 2020 over 2019 was due to the state taxes on the realized gains on securities in 2019.

QNB expects the effective tax rate in 2022 to be less than the 21% corporate rate, due to its holdings of tax-free assets, including municipal bonds, municipal loans, and life insurance contracts. For a more comprehensive analysis of income tax expense and deferred taxes, refer to Note 11 in the Notes to Consolidated Financial Statements.

Financial Condition

ASSETS

The following table presents total assets at the dates indicated:

Change from prior year

Cash and interest-earning deposits

Total cash and cash equivalents decreased $25,941,000 from $39,331,000 at December 31, 2020 to $13,390,000 at December 31, 2021. QNB had interest-bearing balances at the Federal Reserve Bank of $2,931,000 compared with $25,581,000 and interest-bearing balances in a brokerage account of $1,234,000 compared with $242,000 at December 31, 2021 and December 31, 2020, respectively. Net cash was provided by both operating and financing activities. The maturity, prepayment and sales of investment securities and proceeds received from deposit growth more than offset loan growth and the purchases of investment securities.

Investment Securities and Other Short-Term Investments

At December 31, 2021 and 2020, QNB had no Federal funds sold. With the Federal funds rate between 0% and 0.25%, excess funds for liquidity purposes are kept at the Federal Reserve. These funds carry a 0% risk weighting for risk-based capital calculation purposes.

QNB accounts for its investments by classifying securities into four categories. Debt securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. Debt securities that QNB has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. Debt securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses, net of tax, excluded from earnings and reported as a separate component of shareholders’ equity. Equity investments with readily determinable fair values

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are measured at fair value with changes in fair value recognized in net income. Management determines the appropriate classification of securities at the time of purchase.

Investment Portfolio History

Investment Securities Available-for-Sale

U.S. Government agencies and sponsored enterprises (GSEs):

Pooled trust preferred 75 70 79

Equity Investments

Investments Available-For-Sale Debt Securities

Available-for-sale investment securities include securities that management intends to use as part of its liquidity and asset/liability management strategy. These securities may be sold in response to changes in market interest rates, changes in the securities prepayment or credit risk, the need for liquidity, or growth in loan demand. At December 31, 2021, the fair value of investment debt securities available-for-sale was $692,360,000, or $4,734,000 less the amortized cost of $697,094,000. This compares to a fair value of $435,646,000, or $7,151,000 above the amortized cost of $428,495,000, at December 31, 2020. The available-for-sale portfolio, excluding the pooled trust preferred securities, had a weighted average maturity of approximately 5.7 years at December 31, 2021 and 5.2 years at December 31, 2020. The weighted average tax-equivalent yield, excluding the pooled trust preferred securities, was 1.56% and 1.57% at December 31, 2021 and 2020, respectively.

At December 31, 2021, approximately 80% of QNB’s investment securities available-for-sale were either U.S. Government agency debt securities, U.S. Government agency issued mortgage-backed securities or CMOs. As of December 31, 2021, QNB held no securities of any one issue or any one issuer (excluding the U.S. Government and its agencies) that were in excess of 10% of shareholders’ equity.

The QNB investment portfolio represents a significant portion of earning assets and interest income. QNB actively manages the investment portfolio in an attempt to maximize earnings, while considering liquidity needs, interest rate risk and credit risk. The increase of the investment portfolio as a percent of total assets in 2021 is due to deposit growth and the investment of excess funds. During 2021, $385,926,000 of investment securities available-for-sale were purchased compared with $295,734,000 during 2020. Proceeds from the sale of investment securities available-for-sale were $282,000 during 2021 compared with $6,930,000 during 2020. In addition to the proceeds from the sale of investment securities available-for-sale, proceeds from maturities, calls and prepayments were $113,911,000 in 2021 compared with $207,245,000 in 2020.

The balance of U.S. Government agency securities increased $27,723,000 to $97,499,000 at December 31, 2021 and represents 14.1% of the available-for-sale investment portfolio, compared with 16.0% at December 31, 2020. U.S. Government agency issued CMO and MBS balances increased $186,155,000 to $456,950,000 and represents 66.0% of the available-for-sale portfolio compared with 62.2% at December 31, 2020. These bonds provide monthly cash flow to be reinvested in either loans or other securities, potentially at higher yields as rates increase.

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The balance of municipal securities increased $43,223,000 to $131,035,000 at December 31, 2021, representing 18.9% of the available-for-sale portfolio compared with 20.2% at December 31, 2020. QNB focuses on the financial performance of the underlying issuer for municipal bond purchases in addition to the bond rating of the issuer or the rating of bond insurer, if present. Eighty bonds were purchased with a book value of $48,750,000 and tenbonds with a book value of $2,990,000 were called or matured in 2021.

QNB owns one collateralized debt obligations (“CDO”) in the form of a pooled trust preferred security. The security is comprised of securities issued by banks or bank holding companies. QNB owns the mezzanine tranche of this security. The security is 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 trust preferred security the Bank continues to hold has a carrying balance of $75,000 at December 31, 2021 and represents the senior-most obligation of the trust. There was no credit-related other-than-temporary impairment charge during 2021, 2020 or 2019. Future estimates of fair value of the remaining security could require recording additional OTTI charges through earnings. For additional detail on these securities see Notes 4 and 17 of the Notes to Consolidated Financial Statements.

The weighted average maturity is based on the stated contractual maturity or likely call date of all securities except for MBS and CMOs, which are based on estimated average life. The maturity of the portfolio could become shorter if interest rates declined and prepayments on MBS and CMOs increased or securities are called. However, the estimated average life could lengthen if interest rates were to increase and principal payments on MBS and CMOs slowed or securities anticipated to be called extend past their call date.

Investment Portfolio Maturities and Weighted Average Yields

Investment Securities Available-for-Sale

U.S. Government agency:

Weighted average yield — 0.76 % 1.19 % — 1.08 %

State and municipal:

Mortgage-backed:

Collateralized mortgage obligations (CMOs):

Pooled trust preferred:

Fair value — — — 75 75

Weighted average yield — — — 2.63 % 2.63 %

Corporate debt:

Weighted average yield — 2.30 % 4.16 % — 3.57 %

Securities are assigned to categories based on stated contractual maturity except for mortgage-backed securities and CMOs which are based on anticipated payment periods and state and municipal securities which are based on pre-refunded date, if applicable. Tax-exempt securities were adjusted to a tax-equivalent basis and are based on the marginal Federal corporate tax rate of 21% and a Tax Equity and Financial Responsibility Act (“TEFRA”) adjustment for the cost of funds. Weighted average yields on investment securities available-for-sale are based on amortized cost.

Investments in Equity Securities

Equity securities decreased $439,000 to $12,410,000 at December 31, 2021 from $12,849,000 at December 31, 2020. QNB sold $7,768,000 in equity securities for a net gain of $1,788,000 and purchased $4,615,000 in equities during 2021.

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Increases and decreases in the fair value of equity securities were recognized in net income during 2021, 2020 and 2019. At December 31, 2021, the fair value of the equity securities was $12,410,000, or $991,000 above the cost of $11,419,000 compared to $12,849,000, or $65,000 above the cost of $12,784,000 at December 31, 2020.

The equities portfolio comprises blue-chip large-capitalized stocks, providing a taxable equivalent dividend yield of 3.02%. The estimated cumulative contribution (realized and unrealized net gains (losses), plus dividends) of the equity portfolio to earnings per share from January 1, 2008 through December 31, 2021 is $2.43 per diluted share. Details of the equity portfolio’s contribution to net income is detailed in the following table.

Net Income (Expense) on Equity Securities For the Year Ended December 31,

Equity Securities:

OTTI (55 ) (192 ) (80 ) N/A N/A N/A N/A

Loans

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

QNB has comprehensive policies and procedures that define and govern commercial and retail loan originations and the management of risk. All loans are underwritten in a manner that emphasizes the borrowers’ capacity to pay. The measurement of capacity to pay delineates the potential risk of non-payment or default. The higher potential for default determines the need for and amount of collateral required. QNB makes unsecured commercial loans when the capacity to pay is considered substantial. As capacity lessens, collateral is required to provide a secondary source of repayment and to mitigate the risk of loss. Various policies and procedures provide guidance to the lenders on such factors as amount, terms, price, maturity and appropriate collateral levels. Each risk factor is considered critical to ensuring that QNB receives an adequate return for the risk undertaken, and that the risk of loss is minimized.

QNB manages the risk associated with commercial loans by having lenders work in tandem with credit analysts while maintaining independence between personnel. In addition, a Bank loan committee and a committee of the Board of Directors review and approve certain loan requests on a weekly basis. Other than disclosed in the forthcoming Loan Portfolio Table, at December 31, 2021, there was a concentration of loans to lessors of residential buildings and dwellings of 18.0% of total loans and to lessors of nonresidential buildings of 24.2% of total loans, compared with 14.9% and 19.6% of total loans, respectively, at December 31, 2020. These concentrations were primarily within the commercial real estate categories.

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QNB’s commercial lending activity is focused on small businesses within the local community. Commercial purpose loans are generally perceived as having more risk of default than residential real estate loans with a personal purpose and consumer loans. These types of loans involve larger loan balances to a single borrower or group of related borrowers and are more susceptible to a risk of loss during a downturn in the business cycle. These loans may involve greater risk because the availability of funds to repay these loans depends on the successful operation of the borrower’s business. The assets financed are used within the business for its ongoing operation. Repayment of these types of loans generally comes from the cash flow of the business or the ongoing conversions of assets, such as accounts receivable and inventory, to cash. Commercial and industrial loans represent commercial purpose loans that are either secured by collateral other than real estate or unsecured.

Commercial loans secured by commercial real estate include commercial purpose loans collateralized at least in part by commercial real estate. Some of these loans may not be for the express purpose of conducting commercial real estate transactions. Commercial loans secured by residential real estate are commercial purpose loans generally secured by the business owner’s residence or residential investment properties owned by the borrower and rented to tenants. Commercial loans secured by either commercial real estate or residential real estate are originated primarily within the Eastern Pennsylvania market area, are within the Bank’s underwriting criteria, and generally include the guarantee of the borrowers. Repayment of this kind of loan is dependent upon either the ongoing cash flow of the borrowing entity or the resale of or lease of the subject property. Commercial real estate and commercial construction loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because commercial real estate borrowers’ ability to repay their loans depends on successful development of their properties.

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

The Company originates fixed rate and adjustable-rate residential real estate loans that are secured by the underlying 1-4 family residential properties. Credit risk exposure in this area of lending is minimized by the evaluation of the credit worthiness of the borrower, including debt-to-income ratios, credit scores and adherence to underwriting policies that emphasize conservative loan-to-value ratios of generally no more than 80%. To reduce interest rate risk, qualifying originations of fixed-rate loans to individuals for 1-4 family residential mortgages with maturities of 15 years or greater are generally sold in the secondary market. Mortgage loan origination activity decreased in 2021 with $16,773,000 in residential mortgages originated for sale during 2021, compared with $39,474,000 for 2020. There were no in residential mortgage loans held-for-sale at December 31, 2021 and $6,570,000 at December 31, 2020. These loans are carried at the lower of aggregate cost or market.

The home equity portfolio consists of fixed-rate home equity loans and variable rate home equity lines of credit. These loans are often in a junior lien position and therefore carry a higher risk than first lien 1-4 family residential loans. Risks associated with loans secured by residential properties, either first lien residential mortgages or home equity loans and lines, are generally lower than commercial loans and include general economic risks, such as the strength of the job market, employment stability and the strength of the housing market. Since most loans are secured by a primary or secondary residence, the borrower’s continued employment is the greatest risk to repayment.

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

Under the CARES Act, enacted on March 27, 2020, QNB continues to provide customers experiencing financial hardship caused by the COVID-19 Pandemic, solutions to help them through this difficult period. QNB had modified a total 305 commercial loans or $160,676,000 and 61 retail loans or $8,808,000 during 2020 due to COVID-19. As of December 31, 2021, QNB had modifications on one commercial loan with an outstanding balance of $290,000 which was extended for one deferment period, and one retail loan with an outstanding balance of $42,000 which had extended the initial deferment period, related to the COVID-19 Pandemic. QNB will continue work with our borrowers during this difficult time. During 2020, the Bank originated $82,475,000 in PPP loans, enabling 660 businesses to maintain their payrolls and stay in operation. At December 31, 2020, QNB had 556 PPP loans totaling $72,821,000 reported in commercial and industrial loans. PPP loan origination fees net of costs amounted to $1,909,000 at December 31, 2020 and are recognized in interest income as a yield adjustment over the term of the loans. At December 31, 2021 there were 16 loans remaining outstanding under the 2020 originated PPP loans totaling $806,000 and related net originations costs were $11,000.

Under the Economic Aid Act, enacted on December 27, 2020, QNB originated additional first draw PPP loans and second draw PPP loans during 2021. QNB closed 315 loans totaling $35,021,000, including first draw loans of $2,781,000 and second draw loans of

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$32.241.000. There were 82 loans totaling $13,521,000 outstanding at December 31, 2021. QNB received origination fees from the SBA ranging from a flat fee of $2,500 to five basis points which are recognized in interest income as a yield adjustment over the term of the loan. Net unearned fees and costs on PPP loans was $471,000 at December 31, 2021. The PPP loans are 100% guaranteed by the SBA.

Excluding PPP loans net of deferred fees at December 31, 2021 and December 31, 2020, loans receivable would have increased $63,678,000, or 7.5% since year-end 2020 and $28,514,000, or 3.5% in 2020 over 2019.

Total loan receivables at December 31, 2021 were $926,470,000, an increase of $6,428,000, or 0.7%, from December 31, 2020. This follows a 12.1% increase in outstanding loans in 2020. A key financial ratio, loans to deposits was 63.9% at December 31, 2021, compared with 74.9% at December 31, 2020. QNB continues to be committed to make loans available to credit worthy consumers and businesses.

Loan Portfolio

Commercial:

Retail:

Loan Maturities and Interest Sensitivity

Loans due after one year

Commercial:

Retail:

Demand loans and loans with no stated maturity are included in one year or less. Table details final maturity.

The Allowance for Loan Losses Allocation table on Page 40 shows the percentage composition of the loan portfolio over the past five years. There was little change in the composition of the portfolio between the periods ended December 31, 2020 and 2021. Loans secured by commercial real estate remained the largest sector of the portfolio amounting to 48.7% and 41.0% of the portfolio at

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December 31, 2021 and December 31, 2020, respectively, as the balances in this sector grew by $73,818,000, or 19.5%, from $377,586,000 at December 31, 2020 to $431,404,000 at December 31, 2021. While loans secured by commercial real estate represent a significant portion of the total portfolio, the collateral is diversified, including investment properties, manufacturing facilities, office buildings, hospitality properties, hospitals, retirement and nursing home facilities, warehousesand owner-occupied facilities. Commercial real estate loans have drawn the attention of the regulators in recent years as a potential source of risk. QNB monitors these types of loans closely, obtaining updated appraisals on loans classified substandard or worse. As detailed in the Allowance for Loan Losses table, QNB had no charge-offs in this category in 2021, 2020 or 2019.

Commercial loans secured by residential real estate increased by $2,844,000, or 3.5%, to $84,741,000 at December 31, 2021 and at 9.2% represent a slightly higher share of the overall portfolio than the 8.9% at December 31, 2020. Some of the properties that serve as collateral for these loans are located outside the Bank’s market area and have experienced vacancies and significant declines in market value in prior years. Non-accrual commercial loans secured by residential real estate were $391,000, $875,000, and $851,000 at December 31, 2021, 2020, and 2019, respectively. Charge-offs in this category have significantly decreased over the past three years. Net charge-off were $9,000 in 2021, compared to net recoveries of $68,000 in 2020 and net recoveries of $72,000 in 2019. In 2021, $23,000 in net charge-offs were on out-of-market properties compared with $64,000 of the net recoveries in 2020 and $73,000 of the net recoveries in 2019.

Commercial and industrial loans, the second largest sector of the portfolio, experienced a decline in balances of $78,821,000, or 34.7%, to $148,610,000 at December 31, 2021. This followed a growth in this category of $59,400,000, or 35.4%, in 2020. Excluding PPP loans, commercial and industrial loans increased $49,069,000, or 7.0%, in 2021 and decreased $13,421,000, or 8.0% in 2020. Commercial and industrial loans represented 16.0% of the portfolio at year-end 2020 compared with 24.7% at December 31, 2020. Excluding PPP loans, commercial and industrial loans represented 14.7% of the portfolio at year-end 2021 compared to 18.2% of the portfolio at year-end 2020. This category of loans generally presents a greater risk than loans secured by real estate since these loans are either secured by accounts receivable, inventory or equipment, or are unsecured. During 2021, nonaccrual commercial and industrial loan balances decreased $998,000 to $3,369,000, the majority of which is due to paydowns of $998,000. During 2020, nonaccrual commercial and industrial loan balances decreased $1,534,000 to $4,367,000, the majority of which is due to paydowns of $1,270,000 and the partial charge-off of three credits totaling of $263,000. In 2021, 2020 and 2019, there were charge-off of $0, $268,000 and $207,000, respectively.

Construction loans decreased 3.0% to $55,855,000, or 6.0% of the portfolio at December 31, 2021, from $57,594,000, or 6.2% of the portfolio at December 31, 2020. These loans are primarily to developers and builders for the construction of residential units or commercial buildings or to businesses for the construction of owner-occupied facilities. This portfolio is diversified among different types of collateral including: 1-4 family residential construction, medical and retirement home facilities, office buildings, hotels and land for development loans. Construction loans are generally made only on projects that have municipal approval. These loans are usually originated to include a short construction period followed by permanent financing provided through a commercial mortgage after construction is complete. Once construction is complete, the balance is moved to the secured by commercial real estate category if the permanent financing is provided by the Bank. There were no charge-offs in the construction loan portfolio since 2011, and no construction loans on non-accrual since 2014.

Loans to state and political subdivisions decreased $5,527,000, or 21.8%, to $19,775,000 at December 31, 2020 from $25,302,000 at December 31, 2020. This sector decreased to 2.1% of the total loan portfolio at December 31, 2021 from 2.7% at December 31, 2020. Many municipalities, counties and school districts refinanced their existing bonds or bank debt due to decreased. The decrease in 2021 was primarily due to one relationship lost during the end of 2021.

Residential mortgage loans secured by first lien balances increased by $17,542,000, or 21.2%, to $100,281,000 at December 31, 2021. This followed an increase of $13,270,000, or 19.1%, between December 31, 2019 and December 31, 2020. In 2021 and 2020, QNB retained some adjustable and fixed rate mortgages to borrowers with high credit scores and low loan-to-value ratios.

Balances in home equity loans and lines decreased $2,161,000, or 3.4%, to $61,782,000 at December 31, 2021. During 2021, QNB continued to offer very attractive rates on both variable and fixed rate home equity loans and lines. These attractive rates, along with excellent customer service, including quick turnaround time, resulted in new originations in home equity loans, however, paydowns and refinancing into mortgage loans contributed to the decline. QNB expects demand for home equity loans will increase as rates normalize and debt consolidation into mortgage loans decline.

Consumer loan balances decreased $665,000 to $4,699,000 at December 31, 2021. In 2013, QNB reentered the private student loan market through a relationship with a third party. These student loans are either fixed or variable rate with the rate dependent on the credit scores of the student and/or the cosigner. As of December 31, 2021 the balance of student loans was $2,436,000, a decrease of $288,000 compared with December 31, 2020. Student loan balances will decline, as their balances are no longer insured, and QNB ceased funding originations through the third party during 2019 and forward.

Non-Performing Assets

Non-performing assets include non-performing loans, OREO and repossessed assets and non-performing trust preferred securities. Non-performing assets totaled $11,672,000, or 0.70% of total assets at December 31, 2021, a $2,355,000 decrease over the $14,109,000, or 0.98% of total assets at December 31, 2020.

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Total non-performing loans, which represent loans on non-accrual status, loans past due 90 days or more and still accruing interest and troubled debt restructured loans were $11,672,000, or 1.26%of total loans receivable at December 31, 2021 compared with $14,109,000, or 1.53% of total loans receivable at December 31, 2020. Loans on non-accrual status were $7,530,000 at December 31, 2021 compared $9,640,000 at December 31, 2020. The decrease was primarily due to paydowns of $2,516,000 and net charge-offs of $65,000, partially offset by $471,000 being placed on nonaccrual of which $391,000 were due to three retail relationships; specific impairment reserves have been established based on updated collateral values even if the borrower continues to pay in accordance with the terms of the agreement. Of the total amount of non-accrual loans at December 31, 2021, $4,499,000, or approximately60% of the loans classified as non-accrual, are current or past due less than 30 days.

QNB had no loans 90 days or more past due and still accruing at December 31, 2021 or at December 31, 2020. Total loans that are 30 days or more past due decreased $1,457,000 to $4,243,000, representing 0.46% of total loans at December 31, 2021 compared with $5,700,000 and 0.62% of total loans at December 31, 2020. Restructured loans, as defined in accounting guidance for troubled debt restructuring in ASC 310-40, that have not already been included in loans past due 90 days or more and still accruing or in non-accrual loans, totaled $4,142,000 and $4,469,000 at December 31, 2021 and 2020, respectively.

QNB held no OREO at December 31, 2021 or 2020. There were no repossessed assets as of December 31, 2021 or 2020.

Non-Performing Assets

Loans past due 90 days or more and accruing

Commercial:

Commercial and industrial $ — $ — $ — $ — $ —

Construction — — — — —

Secured by commercial real estate — — — — —

Secured by residential real estate — — — — —

State and political subdivisions — — — — —

Indirect lease financing — — — — —

Retail: — — — — —

1-4 family residential mortgages — — — — —

Home equity loans and lines — — — — —

Consumer — — — — —

Total loans past due 90 days or more and accruing — — — — —

Non-accrual loans

Commercial:

Construction — — — — —

State and political subdivisions — — — — —

Indirect lease financing — — — — —

Retail:

Additional loan quality information can be found in Note 5 of the Notes to the Consolidated Financial Statements included in Item 8 of this Form 10-K. Management’s view is that loans classified as substandard or doubtful that are not included in the past due, non-accrual or restructured categories are potential problem loans. For some of these loans, management may have knowledge of possible credit problems that will cause management to question the ability of the borrowers to comply with the present loan repayment terms. Commercial loans classified as substandard or doubtful, which includes non-performing loans, continue to show improvement. At

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December 31, 2021, substandard or doubtful loans totaled $18,531,000, a decrease of $3,662,000, or 16.5%, from the $22,193,000, reported as of December 31, 2020

Allowance for Loan Losses

The allowance for loan losses represents management’s best estimate of the known and inherent losses in the existing loan portfolio. Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance with U.S. generally accepted accounting principles (“US 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 on conditions that may be beyond QNB’s control, it is at least reasonably possible that management’s estimates of the allowance for loan losses and actual results could differ. In addition, various regulatory agencies, as an integral part of their examination process, periodically review QNB’s allowance for losses on loans. Such agencies may require QNB to recognize changes to the allowance based on their judgments about information available to them at the time of their examination. Actual loan losses, net of recoveries, serve to reduce the allowance.

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

Economic conditions, nationally and in QNB’s market, improved in 2021 and asset quality remained strong. The allowance level stated as a percent of loans receivable increased from 1.18% at December 31, 2020 to 1.21% at December 31, 2021. Excluding PPP loans, the allowance level stated as a percent of loans receivable was 1.27% at December 31, 2020 and 1.23% at December 31, 2021. PPP loans are 100% guaranteed by the SBA. The allowance for loan losses increased to $11,184,000 at year-end 2021 from $10,826,000 at year-end 2020, due to the increase in loans receivable over the same period partially offset by the improvement in economic conditions.

Allowance for Loan Losses Allocation

Balance at end of period applicable to:

Commercial:

Retail:

Gross loans represent loans before unamortized net loan fees and costs. Percent gross loans lists the percentage of each loan type to total loans.

A loan is considered impaired, based on current information and events, if it is probable that QNB will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls may not be classified as

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impaired. Management determines the significance of payment delays and shortfalls on a case-by-case basis, taking into consideration all the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral, if the loan is collateral dependent. At December 31, 2021 and 2020, the recorded investment in loans for which impairment has been identified totaled $12,192,000 and $14,516,000, respectively, of which $4,633,000 and $6,432,000, respectively, required no specific allowance for loan loss. The recorded investment in impaired loans requiring an allowance for loan losses was $7,559,000 and $$8,084,000 at December 31, 2021 and 2020, respectively. At December 31, 2021 and 2020, the related allowance for loan losses associated with these loans was $2,873,000 and $3,050,000, respectively. See Note 5 to the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K for additional detail of impaired loans.

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Allowance for Loan Losses

Allowance for loan losses:

Charge-offs

Commercial:

Construction — — — — —

Secured by commercial real estate — — — — —

Secured by residential real estate 38 — 51 77 23

State and political subdivisions — — — — —

Retail:

1-4 family residential mortgages — — — 1 —

Home equity loans and lines 49 — 17 84 —

Recoveries

Commercial:

Construction — — — — —

Secured by commercial real estate — 12 10 23 8

State and political subdivisions — — — — —

Retail:

1-4 family residential mortgages — — — — —

Total loans (excluding loans held-for-sale)

Ratios:

Net charge-offs to:

Allowance for loan losses to:

QNB had net loan charge-offs of $100,000, or 0.01% of average loans for 2021 compared with $311,000, or 0.04% of average loans for 2020 and $247,000, or 0.03% of average loans for 2019. The majority of charge-offs recorded during these periods had specific reserves established during the allowance for loan loss calculation process prior to the decision to charge-off the loan. The increase in commercial and industrial charge-offs in 2020 and 2019 was primarily related to a single relationship as well as in 2017.

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Management believes the allowance for loan losses of $11,184,000 is adequate as of December 31, 2021, in relation to the estimate of known and inherent losses in the portfolio.

Premises and equipment

Premises and equipment includes a right-of-use asset of $3,423,000 and $4,258,000 at December 31, 2021 and December 31, 2020 respectively. The discount rates used in determining the initial value of the right of use assets are based on the FHLB Amortizing Fixed Loan Rate for the term of each lease. QNB typically enters into lease agreements with an initial term of 5 to 10 years and subsequent additional optional terms in increments of 5 years. The lease agreements also contain termination options. None of the leases contain purchase options and none transfer the ownership of the leased asset. QNB has renewed one operating lease during 2021 and acquired the underlying assets of one of its leased properties. QNB has renewed one operating lease during 2020. Operating lease liabilities are included with “Other liabilities” on the Consolidated Balance Sheets. All operating lease costs are included in non-interest expense within “Net occupancy” on the Consolidated Statements of Income. Other premises and equipment, net of depreciation increased $1,971,000 to $13,117,000 at December 31, 2021; this was primarily due to the acquisition of assets formerly under a lease.

Other assets

Other assets increased $2,868,000 from $3,556,000 at December 31, 2020 to $6,424,000 at December 31, 2021. Most of the increase in other assets relates to a $2,383,000 increase to the deferred tax asset resulting from the fair value adjustment on investment securities available-for-sale of $11,885,000. The detail of the net deferred tax asset can be found in Note 11 in the Notes to Consolidated Financial Statements.

LIABILITIES

The following table presents total liabilities at the dates indicated:

Change from prior year

Deposits

QNB primarily attracts deposits from within its market area by offering various deposit products. These deposits are in the form of time deposits, which include certificates of deposit and individual retirement accounts (“IRAs”) which have a stated maturity, and non-maturity deposit accounts, which include: non-interest-bearing demand accounts, interest-bearing demand accounts, money market accounts and savings accounts.

Total deposits increased $221,678,000, or 18.1%, to $1,449,745,000 at December 31, 2021. This follows an increase of $190,207,000, or 18.3%, to $1,228,067,000 at December 31, 2020. Relief efforts in place to mitigate the economic impact of COVID-19 pandemic, as well as, branch consolidations of QNB’s competitors contributed to deposit growth in 2020 and 2021, which was partially offset by the competitive local interest rate market for deposits. The growth in deposits as well as the mix of deposits continues to be impacted by customers’ reactions to the competition, regulations and the interest rate environment. Many customers are looking for transaction accounts that provide liquidity and pay a reasonable amount of interest, while others look for high rate. Time deposit balances decreased $28,712,000, or 14.6% between 2020 and 2021. Customers appear to be looking for the safety of FDIC insured deposits and the stability of a strong local community bank.

Non-interest-bearing demand accounts increased $38,422,000 to $243,006,000 at December 31, 2021. This followed growth of $58,314,000 between December 31, 2019 and December 31, 2020. These deposits are both retail and commercial checking accounts and are volatile depending on the timing of deposits and withdrawals. QNB has been successful in attracting new customers and expanding relationships with existing customers, which provides an opportunity for fee income.

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Interest-bearing demand accounts, retail and business interest checking and municipal accounts increased $72,835,000, or 18.4%, to $468,199,000 at December 31, 2021. All three segments experienced growth in 2021. QNB has been successful in developing relationships with several school districts and municipalities as well as expanding existing relationships, the balances in these accounts are seasonal in nature and can be volatile on a daily basis. Most of the school district taxes are collected during the third quarter of the year and are disbursed over a nine-month period.Business checking increased from $55,051,000 at December 31, 2020 to $67,069,000 at December 31, 2021. Retail checking accounts increased $48,226,000, or 21.5%, to $272,338,000 at December 31, 2021. QNB continues to open a significant number of new checking accounts; additionally, customers may choose to switch products. Rewards checking balances increased $21,971,000 from $85,499,000 at December 31, 2020 to $107,470,000 at December 31,2021, and personal interest-bearing balances increased $6,909,000. The balances in the Select 50 product increased $19,263,000 from $115,652,000 at December 31, 2020 to $134,915,000 at December 31, 2021.

Money Market accounts increased from $96,811,000 at December 31, 2020 to $143,942,000 at December 31, 2021 due to increases in both personal and business accounts.

Total savings account balances increased $92,002,000, or 27.5%, to $426,225,000 at December 31, 2021. This increase is due primarily to an increase in the online eSavings account of $79,280,000, or 32.5%, to $323,523,000 at December 31, 2021. The rate on eSavings accounts was changed from 0.40% at the end of 2020 to 0.35% in 2021.

Total time deposit account balances were $168,373,000 at December 31, 2021, a decrease of $28,712,000, or 14.6%, from the amount reported at December 31, 2020. QNB was able to retain many maturing deposits during 2021 by offering competitive rates and many current customers move balances from more liquid accounts to take advantage of these rates.

Maturity of Time Deposits of $250,000 or More

To continue to attract and retain deposits, QNB plans to remain competitive with respect to rates and to continue to deliver products with terms and features that appeal to customers. The QNB Rewards checking accounts and time deposits are examples of such products.

The following table presents trends in balances and yield on the major deposit groups.

Average Deposits by Major Classification

Balance Rate Balance Rate Balance Rate

Short-term borrowings

Short-term borrowings comprising commercial sweep accounts and overnight FHLB borrowings increased $9,638,000, or 16.4%, to $68,476,000 at December 31, 2021. Commercial sweeps accounted for the entire increase. There were no overnight FHLB borrowings outstanding at December 31, 2021 or at December 31, 2020..

Long-term debt

Long-term debt comprises of $10,000,0000 in FHLB borrowings. During 2020, QNB borrowed long-term debt of $10,000,000 at fixed rates to lock in at a lower yield than the overnight borrowing costs at that time.

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Other liabilities

Other liabilities comprise accrued expenses including salaries, post-retirement life insurance benefits and income taxes, operating lease liability, deferred revenue, and ATM/debit card processing clearing. These balances decreased $115,000, to $8,414,000 at December 31, 2021 QNB purchased the underlying assets of a formerly leased branch in 2021 reducing its lease liability.

SHAREHOLDERS’ EQUITY

The following table presents total shareholders’ equity at the dates indicated:

Change from prior year

Total shareholders’ equity increased $2,049,000, or 1.5%, to $136,494,000 at December 31, 2021 with retained earnings (net income less dividends paid) contributing $11,519,000 and the dividend reinvestment and stock purchase plan, employee stock purchase plan and stock option plan contributing $1,275,000. During 2021, QNB purchased $1,356,000 in treasury stock.

Accumulated other comprehensive income (loss) decreased from a gain of $5,649,000 to a loss of $3,740,000, resulting from the decrease in fair value of the available-for-sale investment portfolio due to maturities of securities and calls on securities being replaced and the purchase of additional mortgage-backed and municipal securities during 2021.

QNB offers a Dividend Reinvestment and Stock Purchase Plan (the “Plan”) to provide participants a convenient and economical method for investing cash dividends paid on the Company’s common stock in additional shares. The Plan also allows participants to make additional cash purchases of stock. Stock purchases under the Plan contributed $841,000 and $898,000 to capital during 2021 and 2020, respectively.

The Board of Directors has authorized the repurchase of up to 200,000 shares of QNB’s common stock in open market or privately

negotiated transactions. The repurchase authorization does not bear a termination date. During 2021, 38,017 shares were repurchased at an average price of $35.68. As of December 31, 2021, a total of 100,000 shares were repurchased under this authorization at an average price of $24.69 and a total cost of $2,469,000.

Liquidity and Capital Resources

Liquidity Management

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

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An additional source of liquidity is provided by the Bank’s membership in the FHLB. At December 31, 2021, the Bank’s total maximum borrowing capacity at the FHLB was $341,398,000 of which $331,015,000 remained available. The Bank had $10,000,000 in long-term debt outstanding at year-end 2021, related interest payable of $33,000, and $350,000 in FHLB-issued letters of credit. The maximum borrowing capacity changes depending upon the Bank’s level of qualifying collateral assets. In addition, the Bank maintains five unsecured Federal funds lines with five correspondent banks totaling $101,000,000. At December 31, 2021 and 2020, there were no outstanding borrowings under these lines. Future availability under these lines is subject to the policies of the granting banks and may be withdrawn. As part of its contingency funding plan, QNB successfully tested its ability to borrow from these sources during 2021.

Total cash and cash equivalents, equity and available-for-sale securities and loans held-for-sale totaled $718,160,000 at December 31, 2021 and $494,396,000 at December 31, 2020, of which $264,154,000 and $220,934,000, respectively, were pledged as collateral for repurchase agreements and public deposits. This increase in liquid sources is primarily the result of a $256,714,000 increase in available-for-sale securities. Management anticipates that these liquid sources are adequate to meet normal fluctuations in loan demand or deposit withdrawals. It is anticipated that the investment portfolio will continue to provide sufficient liquidity as municipal bonds are called and as principal and interest payments on mortgage-backed and CMO securities provide steady cash flow. Increases in interest rates, however, result in decreased cash flow available from the investment portfolio.

QNB is a member of the Certificate of Deposit Account Registry Services (“CDARS”) program offered by the Promontory Interfinancial Network, LLC. CDARS is a funding and liquidity management tool used by banks to access funds and manage their balance sheet. It enables financial institutions to provide customers with full FDIC insurance on time deposits over $250,000 that are placed in the program. QNB also has available Insured Cash Sweep (“ICS”), another program through Promontory Interfinancial Network, LLC, which is a product similar to CDARS, but one that provides liquidity like a money market or savings account. QNB had $2,446,000 in CDARS time deposits at December 31, 2021.

Capital Resources

A strong capital position is fundamental to support continued growth and profitability and to serve the needs of depositors. QNB’s shareholders’ equity at December 31, 2021 was $136,494,000, or 8.16% of total assets, compared with shareholders’ equity of $134,445,000, or 9.33% of total assets, at December 31, 2020. Shareholders’ equity at December 31, 2021 included a negative of $3,740,000 related to unrealized holding losses, net of taxes, on investment securities available for sale. At December 31, 2020 included a positive adjustment of $5,649,000 related to unrealized holding gains, net of taxes, on investment securities available for sale. Excluding these adjustments, shareholders’ equity to total assets would have been 8.368% and 8.98% at December 31, 2021 and 2020, respectively.

Average shareholders’ equity and average total assets were $135,324,000 and $1,585,627,000 for 2021, an increase of 9.3% and 18.0%, respectively, from 2020 average equity and average total assets of 123,790,000 and $1,343,984,000 , respectively. The ratio of average total equity to total average assets was 8.53% for 2021, compared with 9.21% for 2020.

QNB is subject to restrictions on the payment of dividends to its shareholders pursuant to the Pennsylvania Business Corporation Law of 1988 as amended (the BCL). The BCL operates generally to preclude dividend payments, if the effect thereof would render QNB insolvent, as defined. As a practical matter, QNB’s payment of dividends is contingent upon its ability to obtain funding in the form of dividends from the Bank. Under Pennsylvania banking law, the Bank is subject to certain restrictions on the amount of dividends that it may declare without prior regulatory approval. At December 31, 2021, the retained earnings of the Bank totaling $122,052,000 was available for dividends without prior Pennsylvania Department of Banking approval, subject to the regulatory capital requirements discussed below. Under the Federal Deposit Insurance Act, an insured depository institution may not pay a dividend if, after the payment of the dividend, the institution would be undercapitalized under the FDIC’s prompt corrective action rules. In addition, federal banking agencies have the authority to restrict dividend payments under certain circumstances if such payments are not consistent with the capital needs and financial condition of the institution. It is the policy of the Federal Reserve that a bank holding company generally should not maintain its existing rate of cash dividends on common stock unless the net income available to common shareholders over the prior four quarters, net of dividends previously paid during that period, has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears consistent with the company’s capital needs, asset quality, and overall financial condition. QNB paid dividends to its shareholders of $1.40 per share, $1.36 per share, and $1.32 per share, in 2021, 2020, and 2019, respectively.

QNB is subject to various regulatory capital requirements as issued by Federal regulatory authorities. Regulatory capital is defined in terms of Tier 1 capital and Tier 2. Risk-based capital ratios are expressed as a percentage of risk-weighted assets. Risk-weighted assets are determined by assigning various weights to all assets and off-balance sheet arrangements, such as letters of credit and loan commitments, based on associated risk. QNB is subject to various regulatory capital requirements as issued by Federal regulatory authorities.

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Minimum requirements for both the quantity and quality of capital held by banks are as follows: Common equity Tier 1 capital to risk-weighted assets of 4.5%; Tier 1 capital to risk-weighted assets of 6.0%; Total Capital to risk-weighted assets of 8.0%; and, Tier 1 leverage ratio of 4.0%. The capital conservation buffer, comprised of common equity Tier 1 capital, wasestablished above the regulatory minimum capital requirements at 2.5%.

The Federal Deposit Insurance Corporation Improvement Act of 1991 established five capital level designations for insured institutions ranging from “well capitalized” to “critically undercapitalized.” At December 31, 2021 and 2020, management believes that the Company and the Bank met all capital adequacy requirements to which they are subject and have met the “well capitalized” criteria.

Capital Analysis

Regulatory Capital

Net unrealized securities losses, net of tax 3,740 (5,649 )

Deferred tax assets on net operating loss — —

Disallowed goodwill and other disallowed intangible assets (8 ) (8 )

Quarterly average assets for leverage capital purposes $ 1,672,259 $ 1,419,404

Capital Ratios

Common equity tier I capital / risk-weighted assets 12.59 % 12.86 %

Tier 1 capital / risk-weighted assets 12.59 % 12.86 %

Total regulatory capital / risk-weighted assets 13.60 % 13.95 %

Tier 1 capital / average assets (leverage ratio) 8.39 % 9.07 %

Material Cash Requirements from Known Contractual and Other Obligations

QNB has various financial obligations, including contractual obligations and commitments, which may require future cash payments.

The following table presents, as of December 31, 2021, significant contractual obligations to third parties by payment date and the amounts and expected maturities of significant commitments. Further discussion of the nature of each obligation can be found in the Notes to Consolidated Financial Statements. The Company’s reserve for unfunded commitments totaled $91,000 at both December 31, 2021 and December 31, 2020.

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Commitments to extend credit, including loan commitments, standby letters of credit, and commercial letters of credit do not necessarily represent future cash requirements, as these commitments often expire without being drawn upon. The Company does not currently have any commitments for significant capital expenditures or other purchase obligations.

RECENTLY ISSUED ACCOUNTING STANDARDS

Refer to Note 1 of the Notes to Consolidated Financial Statements for discussion of recently issued accounting standards.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Disclosure of the Company’s significant accounting policies is included in Note 1 to Consolidated Financial Statements. Additional information is contained in Management’s Discussion and Analysis and the Notes to Consolidated Financial Statements for the most sensitive of these issues. 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 US GAAP and predominant practices within the banking industry. The preparation of these Consolidated Financial Statements requires QNB to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. QNB evaluates estimates on an on-going basis, including those related to the determination of the allowance for loan losses, the determination of the valuation of other real estate owned, other-than-temporary impairments on investment securities, the determination of impairment of restricted bank stock, the valuation of deferred tax assets, stock-based compensation and income taxes. QNB bases its estimates on historical experience and various other factors and assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Other-than-Temporary Investment Security Impairment

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

The Company follows the accounting guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 320-10 as it relates to the recognition and presentation of other-than-temporary impairment (“OTTI”). This accounting guidance specifies that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When an entity does not intend to sell the security, and it is more likely than not, the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. For held to maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the non-credit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security. For equity securities without a readily determinable market value, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced to fair value and a corresponding charge to earnings is recognized.

Allowance for Loan Losses

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

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

Management emphasizes loan quality and close monitoring of potential problem credits. Credit risk identification and review processes are utilized in order to assess and monitor the degree of risk in the loan portfolio. QNB’s lending and credit administration staff are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower’s circumstances which

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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 collection. 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 US GAAP. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. Because future events affecting borrowers and collateral cannot be predicted with certainty, increases to the allowance may be necessary should the quality of any loans deteriorate as a result of the factors discussed above.

Foreclosed Assets

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

Stock-Based Compensation

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

Income Taxes

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk reflects the risk of economic loss resulting from changes in interest rates and market prices. QNB’s primary market risk exposure is interest rate risk and liquidity risk. QNB’s liquidity position was discussed in a prior section.

QNB’s largest source of revenue is net interest income, which is subject to changes in market interest rates. Interest rate risk 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 and Investment Management Committee (“ALCO”) is responsible for managing interest rate risk and for evaluating the impact of changing interest rate conditions on net interest income.

QNB uses computer simulation analysis to measure the sensitivity of projected earnings to changes in interest rates. Simulation considers current balance sheet volumes and the scheduled repricing dates, instrument level optionality, and maturities of assets and liabilities. It incorporates assumptions for growth, changes in the mix of assets and liabilities, prepayments, and average rates earned and paid. Based on this information, management uses the model to project net interest income under multiple interest rate scenarios.

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A balance sheet is considered liability sensitive when its liabilities (deposits and borrowings) reprice faster or to a greater extent than its earning assets (loans and securities). A liability sensitive balance sheet will produce relatively less net interest income when interest rates rise and more net interest income when they decline. Based on our simulation analysis, management believes QNB’s interest sensitivity position at December 31, 2021 is liability sensitive. Management expects market interest rates to increase in the next 12 months, based on the economic environment and policy of the Federal Reserve.

The following table shows the estimated impact of changes in interest rates on net interest income as of December 31, 2021 and 2020 assuming instantaneous rate shocks, and consistent levels of assets and liabilities. Net interest income for the subsequent twelve months is projected to decrease when interest rates are higher than current rates.

Estimated change in net interest income

Change in interest rates December 31,

Computations of future effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results. Assets and liabilities may react differently than projected to changes in market interest rates. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while rates on other types of assets and liabilities may lag changes in market interest rates. Interest rate shifts may not be parallel.

Changes in interest rates can cause substantial changes in the amount of prepayments of loans and mortgage-backed securities, which may in turn affect QNB’s interest rate sensitivity position. Additionally, credit risk may rise if an interest rate increase adversely affects the ability of borrowers to service their debt.

QNB is not subject to foreign currency exchange or commodity price risk. At December 31, 2021, QNB did not have any hedging transactions in place such as interest rate swaps, caps or floors.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following audited financial statements are set forth in this Annual Report on Form 10-K on the following pages:

Consolidated Balance Sheets Page 54

Consolidated Statements of Income Page 55

Consolidated Statements of Comprehensive Income Page 56

Consolidated Statements of Shareholders’ Equity Page 57

Consolidated Statements of Cash Flows Page 58

Notes to Consolidated Financial Statements Page 59

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Management’s Report on Internal Control over Financial Reporting

March 14, 2022

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2021, in relation to criteria for effective internal control over financial reporting as described in “Internal Control Integrated Framework (2013),” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, management concludes that, as of December 31, 2021, the Company’s system of internal control over financial reporting is effective and meets the criteria of the “Internal Control Integrated Framework (2013).”

/s/ David W. Freeman /s/ Janice McCracken Erkes

David W. Freeman Janice McCracken Erkes

Chief Executive Officer Chief Financial Officer

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Report of Independent Registered Public Accounting Firm

To the shareholders and the Board of Directors of QNB Corp.:

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of QNB Corp. and subsidiary (the "Company") as of December 31, 2021 and 2020, the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows, for each of the three years in the period ended December 31, 2021, and the related notes (collectively referred to as the "consolidated financial statements"). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.