qnbc-10k_20161231.htm

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes ☐ No ☒

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [☒]

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of March 2, 2017, 3,415,350 shares of common stock of the registrant were outstanding. As of June 30, 2016, the aggregate market value of the common stock of the registrant held by non-affiliates was approximately $101,874,803 based upon the average bid and asked prices of the common stock as reported on the OTC BB.

Portions of registrant’s Proxy Statement for the annual meeting of its shareholders to be held May 23, 2017 are incorporated by reference in Part III of this report.

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

Shareholders should note that many factors, some of which are discussed elsewhere in this document and in the documents that are incorporated by reference, could affect the future financial results of QNB Corp. and its subsidiary and could cause those results to differ materially from those expressed in the forward looking statements contained or incorporated by reference in this document. These factors include, but are not limited to, the following:

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

QNB was incorporated under the laws of the Commonwealth of Pennsylvania on June 4, 1984. QNB is registered with the Board of Governors of the Federal Reserve System as a bank holding company under the Bank Holding Company Act of 1956 and conducts its business through its wholly-owned subsidiary, QNB Bank (the “Bank”).

Prior to December 28, 2007, the Bank was a national banking association organized in 1877 as The Quakertown National Bank, was chartered under the National Banking Act and was subject to Federal and state laws applicable to national banks. Effective December 28, 2007, the Bank became a Pennsylvania chartered commercial bank and changed its name to QNB Bank. The Bank, whose principal office is located in Quakertown, Bucks County, Pennsylvania operated eleven full-service community banking offices in Bucks, Montgomery and Lehigh counties in southeastern Pennsylvania as of December 31, 2016.

The Bank is engaged in the general commercial banking business and provides a full range of banking services to its customers. These banking services consist of, among other things, attracting deposits and using these funds in making commercial loans, residential mortgage loans, consumer loans, and purchasing investment securities. These deposits are in the form of time, demand and savings accounts. Time deposits include certificates of deposit and individual retirement accounts. The Bank’s demand and savings accounts include money market accounts, interest-bearing demand accounts (including a higher yielding checking account), club accounts, traditional statement savings accounts, and a higher yielding online savings account.

At December 31, 2016, QNB had total assets of $1,063,141,000, total loans of $633,079,000, total deposits of $913,355,000 and total shareholders’ equity of $93,567,000. For the year ended December 31, 2016, QNB reported net income of $8,924,000 compared to net income for the year ended December 31, 2015 of $8,233,000 and December 31, 2014 of $8,998,000.

At February 23, 2017, the Bank had 169 full-time employees and 17 part-time employees. The Bank’s employees have a customer-oriented philosophy emphasizing personal service and flexible solutions which together make achieving our customers’ goals possible. They maintain close contact with both the residents and local business people in the communities in which they serve, responding to changes in market conditions and customer requests in a timely manner.

The banking business is highly competitive, and the profitability of QNB depends principally upon the Bank’s ability to compete in its market area. QNB faces intense competition within its market, both in making loans and attracting deposits. Bucks, Lehigh, and Montgomery counties have a high concentration of financial institutions, including large national and regional banks, community banks, savings institutions and credit unions. Some of QNB’s competitors offer products and services that QNB currently does not offer, such as traditional trust services and full-service insurance.

In addition, as a result of consolidation in the banking industry, some of QNB’s competitors may enjoy advantages such as greater financial resources, a wider geographic presence, more favorable pricing alternatives and lower origination and operating costs. However, QNB has been able to compete effectively with other financial institutions by emphasizing the establishment of long-term relationships and customer loyalty. A strong focus on small-business solutions, providing fast local decision-making on loans, exceptional personal customer service and technology solutions, including internet- and mobile-banking, electronic bill pay and remote deposit capture, also enable QNB to compete successfully.

Competition for loans and deposits comes principally from commercial banks, savings institutions, credit unions and non-bank financial service providers. Factors in successfully competing for deposits include providing excellent customer service, convenient locations and hours of operation, attractive rates, low fees, and alternative delivery systems. One such delivery system is remote deposit capture for those commercial customers that are not conveniently located near one of our branches, or mobile banking for retail customers. Successful loan origination tends to depend not only on interest rate and terms of the loan but on being responsive and flexible to the customers’ needs. While many competitors within the Bank’s primary market have substantially higher legal lending limits, QNB often has the ability, through loan participations, to meet the larger lending needs of its customers.

QNB’s success is dependent to a significant degree on economic conditions in southeastern Pennsylvania, especially Bucks, Lehigh and Montgomery counties, which it defines as its primary market. The banking industry is affected by general economic conditions, including the effects of recession, unemployment, declining real estate values, inflation, trends in the national and global economies, and other factors beyond QNB’s control.

The business of financial institutions is affected not only by general economic conditions, but also by the policies of various governmental regulatory agencies, including the Federal Reserve Board. The Federal Reserve Board regulates money, credit conditions and interest rates to influence general economic conditions primarily through open market operations in U.S. government securities, changes in the discount rate on bank borrowings and changes in the reserve requirements against depository institutions’ deposits. These policies and regulations significantly affect the overall growth and distribution of loans, investments and deposits, as well as the interest rates charged on loans and the interest rates paid on deposits.

The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of financial institutions in the past and are expected to continue to have significant effects in the future. In view of the changing conditions in the economy and the financial markets in addition to the activities of monetary and fiscal authorities, the prediction of future changes in interest rates, credit availability or deposit levels is very challenging.

Banks and bank holding companies operate in a highly-regulated environment and are regularly examined by Federal and state regulatory authorities. Federal statutes that apply to QNB and its subsidiary include the Bank Holding Company Act of 1956 (“BHCA”), the Federal Reserve Act and the Federal Deposit Insurance Act (“FDIA”), as those statutes have been significantly amended by recent laws such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Gramm-Leach-Bliley Act (“GLBA”), and others. In general, these statutes regulate the corporate governance of the Bank and eligible business activities of QNB, and impose certain restrictions and limitations on such important matters as mergers and acquisitions, intercompany transactions, loans and dividends, and capital adequacy, among others. Other corporate governance requirements are imposed on QNB by Federal securities and other laws, including the Sarbanes-Oxley Act, described later.

The Company is under the jurisdiction of the Securities and Exchange Commission and of state securities commissions for matters relating to the offering and sale of its securities. In addition, the Company is subject to the Securities and Exchange Commission’s rules and regulations relating to periodic reporting, proxy solicitation and insider trading.

Set forth below is a brief summary of some of the significant regulatory concepts and recent laws that affect QNB and the Bank. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by references to the particular statutory or regulatory provisions themselves. Proposals to change banking laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies. QNB cannot determine the likelihood of passage or timing of any such proposals or legislation or the impact they may have on QNB and its subsidiary. A change in law, regulations or regulatory policy may have a material effect on QNB and its subsidiary.

QNB is registered as a bank holding company and is subject to the regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the BHCA. In addition, QNB Corp., as a Pennsylvania business corporation, is subject to the provisions of Section 115 of the Pennsylvania Banking Code of 1965 and the Pennsylvania Business Corporation Law of 1988, as amended.

Bank holding companies are required to file periodic reports with, and are subject to examination by, the Federal Reserve. The Federal Reserve’s regulations require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. As a result, the Federal Reserve, pursuant to its “source of strength” regulations, may require QNB to commit its resources to provide adequate capital funds to the Bank during periods of financial distress or adversity.

Federal Reserve approval may be required before QNB may begin to engage in any non-banking activity and before any non-banking business may be acquired by QNB.

Dividend payments made by the Bank to the Company are subject to the Pennsylvania Banking Code, the Federal Deposit Insurance Act, and the regulations of the FDIC. Under the Banking Code, no dividends may be paid except from “accumulated net earnings” (generally retained earnings). The Federal Reserve Board and the FDIC have formal and informal policies which provide that insured banks and bank holding companies should generally pay dividends only out of current operating earnings, with some exceptions. Under the FDIA, the Bank is prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy its minimum capital requirements. See also “Supervision and Regulation – Bank Regulation”.

In addition to the dividend restrictions described above, the banking regulators have the authority to prohibit or to limit the payment of dividends by the Bank if, in the banking regulator’s opinion, payment of a dividend would constitute an unsafe or unsound practice in light of the financial condition of the Bank.

Under Pennsylvania law, QNB may not pay a dividend, if, after giving effect thereto, it would be unable to pay its debts as they become due in the usual course of business and, after giving effect to the dividend, the total assets of QNB would be less than the sum of its total liabilities plus the amount that would be needed, if QNB were to be dissolved at the time of distribution, to satisfy the preferential rights upon dissolution of shareholders whose rights are superior to those receiving the dividend.

It is also the policy of the Federal Reserve that a bank holding company generally only pay dividends on common stock out of net income available to common shareholders over the past year and only if the prospective rate of earnings retention appears consistent with a bank holding company’s capital needs, asset quality, and overall financial condition. In the current financial and economic environment, the Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged dividend pay-out ratios at the 100% level unless both asset quality and capital are very strong. A bank holding company also should not maintain a dividend level that places undue pressure on the capital of such institution’s subsidiaries, or that may undermine the bank holding company’s ability to serve as a source of strength for such subsidiaries.

In July 2013, the Federal bank regulatory agencies adopted revisions to the agencies’ capital adequacy guidelines and prompt corrective action rules, which were designed to enhance such requirements and implement the revised standards of the Basel Committee on Banking Supervision, commonly referred to as Basel III. The final rules generally implemented higher minimum capital requirements, added a new common equity Tier 1 capital requirement, and established criteria that instruments must meet to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. The new minimum capital to risk-adjusted assets requirements are a common equity Tier 1 capital ratio of 4.5% (6.5% to be considered “well capitalized”) and a Tier 1 capital ratio of 6.0%, increased from 4.0% (and increased from 6.0% to 8.0% to be considered “well capitalized”); the total capital ratio remains at

8.0% under the new rules (10.0% to be considered “well capitalized”). Under the new rules, in order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity Tier 1 capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The new minimum capital requirements were effective on January 1, 2015. The capital contribution buffer requirements phase in over a three-year period beginning January 1, 2016.

Under these policies and subject to the restrictions applicable to the Bank, to remain “well-capitalized,” the Bank had approximately $16,738,000 available for payment of dividends to the Company at December 31, 2016.

Bank holding companies are required to comply with the Federal Reserve’s risk-based capital guidelines. The required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of total capital must be Tier 1 capital. Tier 1 capital consists principally of common shareholders’ equity, plus retained earnings, less certain intangible assets. The remainder of total capital may consist of the allowance for loan losses, which is considered Tier 2 capital. At December 31, 2016, QNB’s Tier 1 capital and total capital (Tier 1 and Tier 2 combined) and common equity Tier 1 equity ratios were 11.84% and 12.75%, and 11.84%, respectively.

Bank and thrift holding companies with assets of less than $15 billion as of December 31, 2009, such as the Company, will be permitted to include trust preferred securities that were issued before May 19, 2010, as Tier 1 capital; however, trust preferred securities issued by a bank or thrift holding company (other than those with assets of less than $500 million) after May 19, 2010, will no longer count as Tier 1 capital. Trust preferred securities still will be entitled to be treated as Tier 2 capital.

In addition to the risk-based capital guidelines, the Federal Reserve requires a bank holding company to maintain a minimum leverage ratio. This requires a minimum level of Tier 1 capital (as determined under the risk-based capital rules) to average total consolidated assets of 4% for those bank holding companies that have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. The Federal Reserve expects all other bank holding companies to maintain a ratio of at least 1% to 2% above the stated minimum. At December 31, 2016, QNB’s leverage ratio was 9.16%.

Pursuant to the prompt corrective action provisions of the FDIA, the Federal banking agencies have specified, by regulation, the levels at which an insured institution is considered well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, or critically undercapitalized. Under these regulations, an institution is considered well capitalized if it satisfies each of the following requirements:

At December 31, 2016, the Bank qualified as well capitalized under these regulatory standards. See Note 19 of the Notes to Consolidated Financial Statements included at Item 8 of this Report for additional information.

As a Pennsylvania chartered, insured commercial bank, the Bank is subject to extensive regulation and examination by the Pennsylvania Department of Banking and Securities (the Department) and by the FDIC, which insures its deposits to the maximum extent permitted by law.

The Federal and state laws and regulations applicable to banks regulate, among other things, the scope of their business, their investments, the reserves required to be kept against deposits, the timing of the availability of deposited funds, the nature and amount of collateral for certain loans, the activities of a bank with respect to mergers and consolidations, and the establishment of branches. The laws and regulations governing the Bank generally have been promulgated to protect depositors and not for the purpose of protecting QNB’s shareholders. This regulatory structure also gives the Federal and state banking agencies extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulation, whether by the Department, the FDIC or the United States Congress, could have a material impact on the Company, the Bank and their operations.

As a subsidiary bank of a bank holding company, the Bank is subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to QNB, on investments in the stock or other securities of QNB, and on taking such stock or securities as collateral for loans.

The Bank’s deposits are insured to the applicable limits as determined by the FDIC, which is currently $250,000 per depositor.

The FDIC utilizes a risk-based premium system that provides for quarterly assessments (billed in arrears) based on an insured institution’s ranking in one of four risk categories based on their examination ratings and capital ratios. Well-capitalized institutions with the CAMELS ratings of 1 or 2 are grouped in Risk Category I.

Beginning with the second quarter of 2011, as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the assessment base that the FDIC uses to calculate assessment premiums is a bank’s average assets minus average tangible equity. The FDIC is required under the Dodd-Frank Act to establish assessment rates that will allow the Deposit Insurance Fund to achieve a reserve ratio of 1.35% of Insurance Fund insured deposits by September 2020. In addition, the FDIC has established a “designated reserve ratio” of 2.0%, a target ratio that, until it is achieved, will not likely result in the FDIC reducing assessment rates. In attempting to achieve the mandated 1.35% ratio, the FDIC is required to implement assessment formulas that charge banks over $10 billion in consolidated assets (“large institutions”) more than banks below $10 billion (“small institutions”).

The FDIC Reserve Ratio is the total of the Deposit Insurance Fund (“DIF”) divided by the total estimated insured deposits of the industry. The reserve ratio reached 1.15% effective June 30, 2016, which prompted assessment changes. The assessment changes and corresponding legislative rulings are:

Effective July 1, 2016, changes took place to the pricing system for established (insured 5 or more years) small institutions, that appeared starting with the December 30, 2016 invoice. The new pricing system results in:

For the years ended December 31, 2016, 2015 and 2014, the Bank recorded $520,000, $579,000 and $620,000, respectively, in FDIC deposit insurance premium expense.

All insured institutions of the FDIC are required to pay assessments to fund interest payments on Financing Corporation (FICO) bonds. The Financing Corporation was created by Congress to issue bonds to finance the resolution of failed thrift institutions. Prior to 1997, only thrift institutions were subject to assessments to raise funds to pay the FICO bonds; however, beginning in 2000, commercial banks and thrifts are subject to the same assessment for FICO bonds. The FDIC has the authority to set the Financing Corporation assessment rate every quarter. The expense for 2016, 2015 and 2014 recorded by QNB was $48,000 $52,000 and $66,000, respectively. These assessments will continue until the Financing Corporation bonds mature from 2017 through 2019.

The Bank is a member of the Federal Home Loan Bank of Pittsburgh (FHLB), which is one of 11 regional Federal Home Loan Banks. Each Federal Home Loan Bank serves as a reserve or central bank for members within its assigned region. It is funded primarily from funds deposited by member institutions and proceeds from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans to members (i.e. advances) in accordance with policies and procedures established by the board of directors of the Federal Home Loan Bank. At December 31, 2016, the Bank had $7,321,000 of overnight FHLB advances outstanding.

The Bank is required to purchase and maintain stock in the FHLB as a condition of membership in an amount equal to 0.10% of its assets. In addition, each member is required to purchase and maintain activity-based stock of 4% of outstanding advances from the FHLB. At December 31, 2016, the Bank had $1,005,000 in stock of the FHLB.

Under the Community Reinvestment Act (“CRA”), as amended, the FDIC is required to assess all financial institutions that it regulates to determine whether these institutions are meeting the credit needs of the communities that they serve. The act focuses specifically on low and moderate income neighborhoods.

An institution’s record is considered during the evaluation of any application made by such institutions for, among other things:

The CRA, as amended, also requires that the regulatory agency make publicly available the evaluation of the Bank’s record of meeting the credit needs of its entire community, including low and moderate income neighborhoods. This evaluation includes a descriptive rating of either outstanding, satisfactory, needs to improve, or substantial noncompliance, and a statement describing the basis for the rating. The Bank’s most recent CRA rating was “Satisfactory”.

The USA Patriot Act strengthens the anti-money laundering provisions of the Bank Secrecy Act. The Act requires financial institutions to establish certain procedures to be able to identify and verify the identity of its customers. Specifically the Bank must have procedures in place to:

The Sarbanes-Oxley Act is intended to bolster public confidence in the nation’s capital markets by imposing new duties and penalties for non-compliance on public companies and their executives, directors, auditors, attorneys and securities analysts. Some of the more significant aspects of the Act include:

The Act also imposes requirements for corporate governance, auditor independence, accounting standards, audit committee member independence and increased authority, executive compensation, insider loans and whistleblower protection. As a result of the Act, QNB adopted a Code of Business Conduct and Ethics applicable to its CEO, CFO and Controller, which meets the requirements of the Act, to supplement its long-standing Code of Ethics, which applies to all directors and employees.

QNB’s Code of Business Conduct and Ethics can be found on the Bank’s website at www.qnbbank.com.

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act)

The Dodd-Frank Act was enacted on July 21, 2010. This law made significant changes to the bank regulatory structure and affects the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies.

The Dodd-Frank Act required various Federal agencies to adopt a broad range of new rules and regulations, and to prepare various studies and reports for Congress. The Federal agencies were given significant discretion in drafting such rules and regulations, and are still modifying many of the provisions. Consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for some time.

The Dodd-Frank Act created a new Consumer Financial Protection Bureau (“CFPB”) with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets such as the Bank will continue to be examined for compliance with the consumer laws by their primary bank regulators. The Dodd-Frank Act also weakened the Federal preemption rules that had been applicable for national banks and Federal savings associations, and gave state attorneys general the ability to enforce Federal consumer protection laws.

As mandated by the Dodd-Frank Act, in December 2013, the OCC, FRB, FDIC, and SEC issued a final rule implementing certain prohibitions and restrictions on the ability of a banking entity and non-bank financial company supervised by the FRB to engage in proprietary trading and have certain interests in, or relationships with, a hedge fund or private equity fund (the so-called "Volcker Rule"). The final rules also require regulated entities to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule, which must include making regular reports about those activities to regulators. Although the final rules provide some compliance and reporting exceptions based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Company. The final rules were effective April 1, 2014, with an extended effective date of July 2015. Under the final rules implementing the Volcker Rule, financial institutions are prohibited from owning certain covered funds. The Company has reviewed its securities holdings and does not believe that any qualify as impermissible holdings. If future regulatory interpretation requires us to divest of any such investments, it could cause us to recognize unexpected losses on the dispositions.

Many of the provisions of Dodd-Frank do not apply to the Bank, as it does not engage in many of the specific activities sought to be regulated by Dodd-Frank. Many of the provisions, however, such as the increased capital requirements that began in 2015 and the changes to FDIC insurance premiums already implemented, affected all banking entities. In addition, the financial crisis of 2008 and the enactment of the Dodd-Frank Act in response to that crisis has resulted in an era of increased regulatory oversight over all financial entities. The ultimate changes resulting from the Dodd-Frank Act may impact the profitability of our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage ratio requirements or otherwise adversely affect our business. These changes may also require us to invest significant management attention and resources to evaluate and make necessary changes in order to comply with new statutory and regulatory requirements.

Congress is often considering some financial industry legislation, and the Federal banking agencies routinely propose new regulations. The Company cannot predict the future effect any new legislation, or new rules adopted by Federal or state banking agencies, will have on the business of the Company and its subsidiaries. Given that the financial industry remains under stress and severe scrutiny, and given that the U.S. economy has not yet fully recovered to pre-crisis levels of activity, the Company expects that there will be significant legislation and regulatory actions that may materially affect the banking industry for the foreseeable future.

QNB’s principal executive offices are located at 320 West Broad Street, Quakertown, Pennsylvania. Its telephone number is (215) 538-5600. This annual report, including the exhibits and schedules filed as part of the annual report on Form 10-K, may be inspected at the public reference facility maintained by the Securities and Exchange Commission (SEC) at its public reference room at 100 F Street, NE, Washington, DC 20549 and copies of all, or any part thereof, may be obtained from that office upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference room, and you can request copies of the documents upon payment of a duplicating fee by writing to the SEC. In addition, the SEC maintains a website that contains reports, proxy and information statements and other information regarding registrants, including QNB, that file electronically with the SEC which can be accessed at www.sec.gov.

QNB also makes its periodic and current reports available, free of charge, on its website, www.qnbbank.com, as soon as reasonably practicable after such material is electronically filed with the SEC. Information available on the website is not a part of, and should not be incorporated into, this annual report on Form 10-K.

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.

1) Unfavorable economic and financial market conditions may adversely affect our financial condition and results of operations.

Over the past several years, concerns over the stability of the financial markets and the economy have resulted in decreased lending by some financial institutions to their customers and to each other. This market turmoil and tightening of credit led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition, results of operations and stock price. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the industry. In particular, we may face the following risks in connection with these events:

2) 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.

The yield curve for the various maturities of U.S. Treasury securities provides a fundamental barometer that gauges the prevailing interest rate profile and, simultaneously, acts as a guidepost for current loan and deposit pricing constraints. The slope of the yield curve is driven primarily by expectations for future interest rate increases and inflationary trends. A normal yield curve has a slope

that reflects lower costs for shorter-term financial instruments, accompanied by increases in costs for longer term instruments all along the maturity continuum.

Short-term interest rates are highly influenced by the monetary policy of the Federal Reserve. The Federal Open Market Committee, a committee of the Federal Reserve, targets the Federal funds rate, the overnight rate at which banks borrow or lend excess funds between financial institutions. This rate serves as a benchmark for the overnight money costs, and correspondingly influences the pricing of a significant portion of a bank’s deposit funding sources. Intermediate and longer-term interest rates, unlike the Federal funds rate, are more directly influenced by external market forces, including perceptions about future interest rates and inflation. These trends, in turn, influence the pricing on mid- and long-term loan commitments as well as deposits and bank borrowings that have scheduled maturities.

Generally speaking, a yield curve with a higher degree of slope provides more opportunity to increase the spread between earning asset yields and funding costs. It should be emphasized that while the yield curve is a critical benchmark in setting prices for various monetary assets and liabilities in banks, its influence is not exerted in a vacuum. Credit risk, market risk, competitive issues, and other factors must all be considered in the pricing of financial instruments. A steep or highly-sloped yield curve may be a precursor of higher interest rates or elevated inflation in the future, while a flat yield curve may be characteristic of a Federal Reserve policy designed to calm an overheated economy by tightening credit availability via increases in short-term rates. If other rates along the maturity spectrum do not rise correspondingly, the yield curve can be expected to flatten. This scenario may reflect an economic outlook that has little or no expectation of higher future interest rates or higher rates of inflation. For banks, the presence of a flat yield curve for a prolonged or sustained period could measurably lower expectations for expanding the net interest margin.

An inverted yield curve is the opposite of a normal yield curve and is characterized by short-term rates that are higher than longer-term rates. The presence of an inverted yield curve is considered to be an anomaly that is almost counterintuitive to the core business of banking. Inverted yield curves do not typically exist for more than a short period of time. In past economic cycles, the presence of an inverted yield curve has frequently foreshadowed a recession. The slow economic recovery that lasted many years may suppress future asset growth trends and/or increase the influence of other forms of risk, such as credit risk, which could hamper opportunities for revenue expansion and earnings growth in the near term.

3) 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.

4) 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.

At December 31, 2016, our lending limit per borrower was approximately $14,472,000. 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.

5) Our results of operations may be adversely affected by other-than-temporary impairment charges relating to our investment portfolio.

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, corporate debt securities and equity securities. QNB is exposed to the risk that the issuers of these securities may experience significant deterioration in credit quality which could impact the market value of such issuer’s securities. QNB periodically evaluates its investments 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.

The Bank holds six pooled trust preferred securities with an amortized cost of $2,909,000 and a fair value as of December 31, 2016 of $2,281,000. All of the trust preferred securities are available-for-sale securities and are carried at fair value. Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are all factors contributing to the temporary impairment of these securities. Although these securities are classified as available-for-sale, the Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs. These securities are comprised mainly of securities issued by banks, and to a lesser degree, insurance companies. QNB owns the mezzanine tranches of these securities, except for PreTSL IV which represents the senior-most obligation of the trust.

On a quarterly basis, we evaluate our debt securities for other-than-temporary impairment (“OTTI”), which involves the use of a third-party valuation firm to assist management with the valuation. When evaluating these investments, a credit related portion and a non-credit related portion of OTTI are determined. All of the pooled trust preferred collateralized debt obligations held by QNB are rated lower than AA and are measured for OTTI within the scope of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 325 (formerly known as EITF 99-20-1). QNB performs a discounted cash flow analysis on all of its impaired debt securities to determine if the amortized cost basis of an impaired security will be recovered. In determining whether a credit loss exists, QNB uses its best estimate of the present value of cash flows expected to be collected from the debt security and discounts them at the effective yield implicit in the security at the date of acquisition or the prospective yield for those securities with prior OTTI charges. The discounted cash flow analysis is considered to be the primary evidence when determining whether credit related other-than-temporary impairment exists. The credit related portion is recognized in earnings and represents the expected shortfall in future cash flows. The non-credit related portion is recognized in other comprehensive income and represents the difference between the book value and the fair value of the security less any current quarter credit related impairment. During 2016, 2015, and 2014, there were no charges representing the recognition of credit impairments on our investment in pooled trust preferred collateralized debt obligations.

The Company’s investment in marketable equity securities primarily consists of investments in large cap stock companies. These equity securities are analyzed for impairment on an ongoing basis. As a result of prolonged declines in some equity securities’ fair values, $192,000 of other-than-temporary impairment charges were taken in 2016, and $55,000 in charges were taken in 2015. There was no OTTI in the equity securities portfolio in 2014. QNB had 16 equity securities with unrealized losses of approximately $328,000 at December 31, 2016. The severity and duration of the impairment is consistent with current stock market developments. QNB evaluated the near-term prospects of the issuers in relation to the severity and duration of the impairment. Based on that evaluation and the Company’s ability and intent to hold those securities for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these equity securities to be other-than-temporarily impaired.

At December 31, 2016, the Bank had $1,005,000 in capital stock of the FHLB. 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.

6) Our assets at December 31, 2016 included a deferred tax asset and we may not be able to realize the full benefit of that asset.

As of December 31, 2016, QNB had a net deferred tax asset of $5,473,000. 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.

7) 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 the business infrastructure such as Internet connections and 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. Technological or financial difficulties of a third-party service provider could adversely affect the business to the extent those difficulties result in the interruption or discontinuation of services provided by that party.

8) 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.

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. 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.

9) 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.

10) We are subject to numerous government regulations and to examination and supervision by bank regulatory agencies, which could have an adverse impact on our business and operations.

The banking industry is heavily regulated under both Federal and state law. Banking regulations, designed primarily for the safety of depositors, may limit a financial institution’s growth and the return to its investors, by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, expansion of branch offices and the offering of securities. QNB is also subject to capitalization guidelines established by Federal law and could be subject to enforcement actions to the extent that its subsidiary bank is found, by regulatory examiners, to be undercapitalized. It is difficult to predict what additional changes, if any, will be made to existing Federal and state legislation and regulations or the effect that such changes may have on QNB’s future business and earnings prospects.

In response to the financial crisis that commenced in 2008, Congress has taken actions that are intended to strengthen confidence and encourage liquidity in financial institutions, and the FDIC has taken actions to increase insurance coverage on deposit accounts. The Dodd-Frank Act provides for the creation of a consumer protection division at the Board of Governors of the Federal Reserve System that will have broad authority to issue regulations governing the services and products we provide consumers. This additional regulation could increase our compliance costs and otherwise adversely impact our operations. That legislation also contains provisions that resulted in higher regulatory capital requirements and, over time, could result in higher loan loss provisions for the Bank, and may increase interest expense due to the ability to pay interest on all demand deposits.

The potential exists for additional Federal or state laws and regulations, or changes in policy, affecting many aspects of our operations, including capital levels, lending and funding practices, and liquidity standards. New laws and regulations may increase our costs of regulatory compliance and of doing business and otherwise affect our operations, and may significantly affect the markets in which we do business, the markets for and value of our loans and investments, the fees we can charge and our ongoing operations, costs and profitability.

11) We are required to pay FDIC insurance premiums, which could be increased in the future.

In order to maintain a strong funding position and restore reserve ratios of the deposit insurance fund, the FDIC has increased assessment rates of insured institutions, particularly those over $10 billion. The Company is generally unable to control the amount of premiums that the Bank is required to pay for FDIC insurance. If there are additional bank failures, or the cost of resolving prior failures exceeds expectations, the Bank may be required to pay higher FDIC premiums. Any future increases or required prepayments of FDIC insurance premiums may adversely impact the Company’s earnings and financial condition.

12) 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.

13) 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.

14) Acts of terrorism and other external events could impact our ability to conduct business.

Financial institutions have been, and continue to be, targets of terrorist threats aimed at compromising operating and communication systems. Such events could cause significant damage, impact the stability of our facilities and result in additional expenses, impair the ability of our borrowers to repay their loans, and result in the loss of revenue. While 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.

QNB Bank and QNB Corp.’s principal office is located at 15 North Third Street, Quakertown, Pennsylvania. QNB Bank conducts business from its principal office and ten other retail offices located in Bucks, Lehigh, and Montgomery counties in Pennsylvania. QNB Bank owns its principal office, three retail locations, its operations facility and a computer facility. QNB Bank leases its remaining seven retail 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.

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

QNB common stock is quoted on the over-the-counter bulletin board (OTCBB). QNB had approximately 668 shareholders of record as of March 2, 2017.

The following table sets forth the high and low bid and ask stock prices for QNB common stock on a quarterly basis during 2016 and 2015. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

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 19 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, 2016.

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.

Year ended December 31,	2016			2015			2014			2013			2012
Income and expense
Interest income	$	33,237		$	31,875		$	30,670		$	30,584		$	33,348
Interest expense		4,733			4,506			4,544			5,033			6,448
Net interest income		28,504			27,369			26,126			25,551			26,900
Provision for loan losses		30			200			400			400			900
Non-interest income		5,667			6,032			7,542			5,813			5,409
Non-interest expense		22,163			22,398			21,626			20,226			19,625
Income before income taxes		11,978			10,803			11,642			10,738			11,784
Provision for income taxes		3,054			2,570			2,644			2,346			2,609
Net income	$	8,924		$	8,233		$	8,998		$	8,392		$	9,175

Share and Per Share Data
Net income - basic	$	2.64		$	2.47		$	2.73		$	2.58		$	2.87
Net income - diluted		2.63			2.46			2.72			2.57			2.86
Book value		27.43			26.92			26.04			23.12			24.05
Cash dividends		1.20			1.16			1.12			1.08			1.04
Average common shares outstanding - basic		3,386,766			3,337,505			3,291,939			3,248,397			3,197,204
Average common shares outstanding - diluted		3,395,839			3,350,539			3,302,574			3,260,075			3,209,857

Balance Sheet at Year-end
Investment securities
Trading	$	3,596		$	4,189		$	4,207			—			—
Available-for-sale		390,475			361,915			375,219		$	388,670		$	401,502
Held-to-maturity		—			147			146			146			146
Restricted investment in bank stocks		1,017			508			647			1,764			2,244
Loans held-for-sale		789			987			380			—			1,616
Loans receivable		633,079			615,270			555,282			501,716			477,733
Allowance for loan losses		(7,394	)		(7,554	)		(8,001	)		(8,925	)		(9,772	)
Other earning assets		1,824			7,832			7,143			3,569			594
Total assets		1,063,141			1,020,936			977,135			932,883			919,874
Deposits		913,355			889,786			851,592			814,532			801,638
Borrowed funds		52,660			37,163			35,189			40,156			37,775
Shareholders' equity		93,567			90,443			86,354			75,625			77,623

Selected Financial Ratios
Net interest margin		3.03	%		3.05	%		3.07	%		3.09	%		3.36	%
Net income as a percentage of:
Average total assets		0.87			0.83			0.95			0.91			1.03
Average shareholders' equity		9.45			9.29			10.89			10.95			13.07
Average shareholders' equity to average total assets		9.16			8.97			8.72			8.30			7.86
Dividend payout ratio		45.56			47.03			40.99			41.81			36.25

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

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.

Net income for the year ended December 31, 2016 was $8,924,000, or $2.63 per share on a diluted basis. This compares to 2015 net income of $8,233,000, or $2.46 per share on a diluted basis and 2014 net income of $8,998,000, or $2.72 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 0.87%, 0.83% and 0.95% in 2016, 2015, and 2014, respectively, and return on average shareholders’ equity was 9.45%, 9.29% and 10.89%, respectively, during those same periods.

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

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, 2016, 2015, and 2014.

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.

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.

On a tax-equivalent basis, net interest income for 2016 increased $991,000, or 3.4%, to $30,145,000. The net interest margin, which declined to 3.03% was negatively impacted by declining yields on earning assets resulting from the prolonged low interest rate environment. The average rate earned on earning assets declined three basis points from 3.53% for 2015 to 3.50% for 2016 with the yield on loans declining by five basis points while the yield on investment securities remained steady at 2.42%. In comparison, the interest rate paid on total average interest-bearing liabilities increased by one basis point from 0.56% for 2015 to 0.57% for 2016 with the average rate paid on interest-bearing deposits increasing from 0.57% to 0.58% for the same time period, respectively.

Net interest income and net interest margin continue to be negatively impacted by declining yields on earning assets resulting from the prolonged low interest rate environment that banks have been operating in since 2008. At the beginning of this low interest rate cycle, funding costs declined at a faster pace and to a greater degree than rates on earning assets, resulting in an increasing net interest margin. However, this trend has reversed as funding costs have approached bottom while yields on earning assets continue to reprice lower, resulting in a decline in the net interest margin, despite two Federal Funds rate increases of 25 basis points each in December 2015 and 2016. The competitive local interest rate market for quality loans has also negatively impacted net interest income and net interest margin. Partially offsetting the impact of declining yields on earning assets was growth in earning assets, primarily loans. Average earning assets increased by $41,265,000, or 4.3%, to $995,846,000 for 2016, with average loans increasing $30,701,000, or 5.3%, to $605,040,000, while average investment securities increased $4,337,000, or 1.2%, to $359,310,000. However, with the growth in earning assets occurring primarily in the loan portfolio, the mix of earning assets changed, which also contributed to relative stability of the net interest margin, as investment securities generally earn a lower yield than loans. The growth in earning assets was also funded by a $28,740,000, or 3.3%, increase in average total deposits to $892,541,000, and the increase in short-term borrowing, primarily sweep accounts structured as repurchase agreements with our commercial customers, of $8,289,000, or 26.0%.

On a tax-equivalent basis, net interest income for 2015 increased $1,125,000, or 4.0%, to $29,154,000, with net interest margin declining two basis points, for the reasons detailed in the discussion above. The average rate earned on earning assets declined four basis points from 3.57% for 2014 to 3.53% for 2015, with the yield on loans declining by eleven basis points while the yield on investment securities decreased five basis points. In comparison, the interest rate paid on total average interest-bearing liabilities declined two basis points from 0.58% for 2014 to 0.56% for 2015, with the average rate paid on interest-bearing deposits declining from 0.58% to 0.57% over the same time period.

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

	2016								2015								2014
	Average			Average					Average			Average					Average			Average
	balance			rate			Interest		balance			rate			Interest		balance			rate			Interest
Assets
Trading securities	$	3,896			5.37	%	$	209	$	4,054			6.09	%	$	247	$	4,064			5.87	%	$	239
Investment securities (AFS & HTM):
U.S. Government agencies		61,376			1.83			1,126		52,572			1.62			850		60,080			1.52			915
State and municipal		73,121			4.04			2,954		73,482			4.14			3,043		77,153			4.36			3,367
Mortgage-backed and CMOs		202,279			1.98			4,005		207,549			1.97			4,098		210,336			2.03			4,276
Pooled trust preferred		3,141			0.23			7		3,484			0.33			11		3,519			0.17			6
Corporate debt		8,051			1.79			144		6,542			1.24			81		6,008			1.12			67
Equities		7,446			3.13			233		7,290			3.35			244		6,108			3.17			193
Total investment securities		355,414			2.38			8,469		350,919			2.37			8,327		363,204			2.43			8,824
Loans:
Commercial real estate		333,658			4.43			14,767		296,272			4.51			13,364		265,512			4.55			12,084
Residential real estate		45,233			3.89			1,759		39,575			4.09			1,618		34,123			4.21			1,436
Home equity loans		63,439			3.68			2,337		59,079			3.59			2,120		56,249			3.78			2,125
Commercial and industrial		111,390			4.26			4,749		122,294			4.14			5,061		113,155			4.35			4,921
Indirect lease financing		7,969			8.80			702		9,136			8.95			818		7,779			9.95			774
Consumer loans		4,713			5.20			245		4,034			5.37			216		3,749			5.60			210
Tax-exempt loans		38,638			3.80			1,468		43,949			4.00			1,758		43,560			4.21			1,834
Total loans, net of unearned income*		605,040			4.30			26,027		574,339			4.35			24,955		524,127			4.46			23,384
Other earning assets		31,496			0.55			173		25,269			0.52			131		21,431			0.59			126
Total earning assets		995,846			3.50			34,878		954,581			3.53			33,660		912,826			3.57			32,573
Cash and due from banks		14,243								12,063								11,621
Allowance for loan losses		(7,583	)							(7,860	)							(8,672	)
Other assets		28,692								29,110								32,089
Total assets	$	1,031,198							$	987,894							$	947,864

Liabilities and Shareholders' Equity
Interest-bearing deposits:
Interest-bearing demand	$	153,598			0.21	%	$	315	$	134,342			0.21	%	$	289	$	118,631			0.23	%	$	274
Municipals		102,060			0.34			351		115,975			0.34			389		120,540			0.33			399
Money market		71,256			0.27			192		65,413			0.24			158		58,333			0.22			126
Savings		229,779			0.40			923		217,561			0.37			806		208,629			0.37			770
Time		133,407			1.12			1,497		141,869			1.09			1,548		151,002			1.08			1,636
Time of $100,000 or more		94,862			1.37			1,301		92,495			1.30			1,199		91,522			1.26			1,155
Total interest-bearing deposits		784,962			0.58			4,579		767,655			0.57			4,389		748,657			0.58			4,360
Short-term borrowings		40,200			0.38			154		31,911			0.37			117		31,616			0.36			114
Long-term debt		—			—			—		—			—			—		1,452			4.76			70
Total interest-bearing liabilities		825,162			0.57			4,733		799,566			0.56			4,506		781,725			0.58			4,544
Non-interest-bearing deposits		107,579								96,146								80,427
Other liabilities		3,985								3,540								3,089
Shareholders' equity		94,472								88,642								82,623
Total liabilities and shareholders' equity	$	1,031,198							$	987,894							$	947,864
Net interest rate spread					2.93	%							2.97	%							2.99	%
Margin/net interest income					3.03	%	$	30,145					3.05	%	$	29,154					3.07	%	$	28,029

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

	2016 vs. 2015									2015 vs. 2014
	Due to change in:						Total			Due to change in:						Total
	Volume			Rate			Change			Volume			Rate			Change
Interest income:
Trading securities	$	(10	)	$	(28	)	$	(38	)	$	(1	)	$	9		$	8
Investment securities (AFS & HTM):
U.S. Government agencies		142			134			276			(115	)		50			(65	)
State and municipal		(15	)		(74	)		(89	)		(160	)		(164	)		(324	)
Mortgage-backed and CMOs		(105	)		12			(93	)		(56	)		(122	)		(178	)
Pooled trust preferred		(1	)		(3	)		(4	)		—			5			5
Corporate debt		19			44			63			6			8			14
Equities		5			(16	)		(11	)		38			13			51
Total investment securities (AFS & HTM)		45			97			142			(287	)		(210	)		(497	)
Loans:
Commercial real estate		1,686			(283	)		1,403			1,400			(120	)		1,280
Residential real estate		232			(91	)		141			230			(48	)		182
Home equity loans		157			60			217			107			(112	)		(5	)
Commercial and industrial		(451	)		139			(312	)		398			(258	)		140
Indirect lease financing		(104	)		(12	)		(116	)		135			(91	)		44
Consumer loans		37			(8	)		29			15			(9	)		6
Tax-exempt loans		(212	)		(78	)		(290	)		17			(93	)		(76	)
Total loans		1,345			(273	)		1,072			2,302			(731	)		1,571
Other earning assets		31			11			42			22			(17	)		5
Total interest income		1,411			(193	)		1,218			2,036			(949	)		1,087
Interest expense:
Interest-bearing demand		41			(15	)		26			37			(22	)		15
Municipals		(47	)		9			(38	)		(15	)		5			(10	)
Money market		15			19			34			15			17			32
Savings		45			72			117			33			3			36
Time		(93	)		42			(51	)		(99	)		11			(88	)
Time of $100,000 or more		31			71			102			12			32			44
Total interest-bearing deposits		(8	)		198			190			(17	)		46			29
Short-term borrowings		31			6			37			1			2			3
Long-term debt		—			—			—			(70	)		—			(70	)
Total interest expense		23			204			227			(86	)		48			(38	)
Net interest income	$	1,388		$	(397	)	$	991		$	2,122		$	(997	)	$	1,125

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 $1,218,000 to $34,878,000 for 2016, while total interest expense increased $227,000 to $4,733,000. Volume growth in earning assets contributed an additional $1,411,000 of interest income which was offset in part by a decline in interest income of $193,000 resulting from lower interest rates. With regard to interest expense, rate-related interest expense increased $204,000, while volume-related interest expense increased $23,000.

Interest income on trading, available-for-sale, and held-to-maturity investment securities increased $104,000 when comparing the two years. The increase in average balances contributed to $35,000 of the increase, while better rates contributed the remaining $69,000 increase. The average yield on the investment portfolio was 2.42% for both 2015 and 2016. The increase in the investment portfolio is

due to investment opportunities at a yield comparable to the overall portfolio yield in late 2016 compared with previous periods, as well as continuing increase in deposits.

Income on U.S. Government agency securities increased $276,000, due to an increase in average balances totaling $8,804,000. The yield on the portfolio increased by 21 basis points from 1.62% for 2015 to 1.83% for 2016, as investments in this sector had better yields than previously available. Most of the bonds in the agency portfolio have call features ranging from three months to three years, many of which were exercised as a result of the low interest rate environment.

Interest income on tax-exempt municipal securities decreased $89,000. Average balances, which declined $361,000, contributed $15,000 to the decrease in interest income and the ten basis point decline in yield from 4.14% in 2015 to 4.04% in 2016 contributed the remaining $74,000 reduction in interest income. QNB had purchased many municipal securities when rates were significantly higher. Many of these bonds have either reached maturity or their call dates and are being replaced with municipal bonds with lower yields. Typically, QNB purchased municipal bonds with 10-15 year maturities The yield on this portfolio is expected to continue to decline as there are $24,572,000 in municipal bonds with a tax-equivalent yield of 6.08% that are expected to be called or mature in 2017. The current yield on replacement bonds is well below this threshold.

All the mortgage-backed and collateralized mortgage obligations (“CMO”) securities owned by QNB are issued by U.S. Government agencies and sponsored enterprises (GSEs) 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 decreased $93,000 primarily due to a decrease of $5,270,000, or 2.5% in average balances The yield on the mortgage-backed and CMO portfolio improved by one basis point from 1.97% for 2015 to 1.98% for 2016. The historically low interest rate environment resulted in significant mortgage refinancing activity over the past several years, resulting in an increase in prepayments on these securities. Since many of these securities were purchased at a premium, prepayments result in a shorter amortization period of this premium and therefore a reduction in income.

Interest income on trading, available-for-sale, and held-to-maturity investment securities decreased $489,000 when comparing the two years. The $12,295,000 decrease in average balances contributed to $288,000 of the decrease, while falling rates contributed the remaining $201,000 decline. The average yield on the investment portfolio decreased five basis points from 2.47% for 2014 to 2.42% for 2015. The decrease in the investment portfolio is due to lower yielding investment opportunities in 2015 compared with previous periods, as well as higher demand for loans.

Income on U.S. Government agency securities decreased $65,000, due to a decline in average balances, even as the yield on the portfolio increased by ten basis points to 1.62% in 2015.

Interest income on tax-exempt municipal securities decreased $324,000. Average balances, which declined $3,671,000, or 4.8%, contributed $160,000 to the decrease in interest income and the 22 basis point decline in yield from 4.36% in 2014 to 4.14% in 2015 contributed the remaining $164,000 reduction in interest income.

Interest income on mortgage-backed securities and CMOs decreased $178,000 with a small decrease in average balances as well as lower rates contributing to the decline. Average balances decreased $2,787,000, or 1.3%, to $207,549,000 when comparing the two years, resulting in a $56,000 decline in interest income. The yield on the mortgage-backed and CMO portfolio decreased six basis points from 2.03% for 2014 to 1.97% for 2015, resulting in a $122,000 reduction in interest income.

The largest category of the loan portfolio is commercial real estate loans. This category of loans includes commercial purpose loans secured by either commercial properties such as office buildings, factories, warehouses, medical facilities and retail establishments, or residential real estate, usually the residence of the business owner or investment properties. The category also includes construction and land development loans. Income on commercial real estate loans increased $1,403,000. The increase in average balances of $37,386,000, or 12.6%, contributed an increase in interest income of $1,686,000. This was offset in part by an eight basis point decline in yield, from 4.51% in 2015 to 4.43% in 2016, which resulted in a decrease of interest income of $283,000.

Income on commercial and industrial loans, the second largest category, decreased $312,000 with the positive impact from an increase in yield offset by a decrease in average balances. Average commercial and industrial loans decreased $10,904,000, or 8.9%, to $111,390,000 for 2016, resulting in a $451,000 decrease in interest income. Average yield on these loans increased 12 basis points to 4.26% providing an additional $139,000 in interest income.

Tax-exempt loan income decreased $290,000 from 2015. When comparing the same periods, average balances decreased $5,311,000 to $38,638,000, which contributed a $212,000 decrease in interest income. With the decline in market interest rates QNB has renegotiated and rebid on many loans to municipalities over the past several years. As a result, the average yield on the tax-exempt loan portfolio has declined from 4.00% for 2015 to 3.80% for 2016, resulting in decreased interest income of $78,000.

Indirect lease financing receivables represent loans to small businesses that are collateralized by equipment. These loans tend to have higher risk characteristics, but generally provide higher rates of return. In October 2016, the Company sold its interest in these third-party originated finance contracts, recording a loss on sale of $223,000, which was essentially offset by a $220,000 reversal of the allowance for loan losses associated with this portfolio. The third party who had originated the leases and acted as primary servicer of the portfolio had recently sold his company and QNB did not have staff with the expertise needed to continue to service this portfolio, nor the ability to effectively repossess and resell equipment in case of borrower default. Therefore, based on management’s recommendation, QNB’s Board of Directors approved the sale of this portfolio in its entirety.

QNB strives to become the “local consumer lender of choice”, and to affect this QNB has refocused its retail lending efforts by strengthening the management of the area, adding new product offerings and by increasing marketing and promotion. The positive impact of this renewed focus has been year-over-year growth in balances in all three categories of retail lending: residential mortgage, home equity and consumer loans. Overall, interest income for retail lending increased $387,000 in 2016 compared with 2015, driven by the increase in average balances.

Income on home equity loans increased by $217,000 when comparing 2016 and 2015. During 2016 QNB offered attractive rates on both variable rate and fixed rate home equity loans, which contributed to an increase in average balances totaling $4,360,000, or 7.4%, to $63,439,000 when comparing 2016 and 2015. The yield on the home equity portfolio increased nine basis points to 3.68% when comparing the two years. The demand for home equity loans has improved along with the recovery in home values. We expect that the demand for home equity loans will continue.

Given the low yields on alternative investment securities, QNB retained certain 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 $5,658,000, or 14.3%, to $45,233,000 for 2016. The average yield on the residential real estate portfolio decreased by 20 basis points to 3.89% for 2016. Overall, interest income for this segment grew $141,000 in 2016.

Interest income on consumer loans increased $29,000. As with all other categories of retail loans, consumer loans at QNB experienced growth in average balances in 2016, with balances in this segment increasing $679,000. This growth in volume contributed $37,000 to the increase in income, while decline in yield from 5.37% in 2015 to 5.20% offset the volume increase by $8,000.

Income on commercial real estate loans increased $1,280,000. The increase in average balances of $30,760,000, or 11.6%, contributed an increase in interest income of $1,400,000. This was offset in part by a 4 basis point decline in yield, from 4.55% in 2014 to 4.51% in 2015, which resulted in a decrease of interest income of $120,000.

Income on commercial and industrial loans increased $140,000 with the positive impact from growth in balances offsetting the decline in yield. Average commercial and industrial loans increased $9,139,000, or 8.1%, to $122,294,000 for 2015, providing an additional $398,000 in interest income. Average yield on these loans decreased 21 basis points to 4.14%, resulting in a decrease in interest income of $258,000.

Tax-exempt loan income decreased $76,000 from 2014. When comparing the same periods, average balances increased $389,000 to $43,949,000, which contributed a $17,000 increase in interest income. The average yield on the tax-exempt loan portfolio declined from 4.21% for 2014 to 4.00% for 2015, resulting in decreased interest income of $93,000.

Indirect lease financing income was $818,000 for 2015, an increase of $44,000 when compared with the $774,000 reported for 2014. Average balances increased by $1,357,000, or 17.4%, resulting in $135,000 increase in income when comparing the two years. The yield on the portfolio decreased 100 basis points to 8.95% in 2015, offsetting the volume-related increase in income by $91,000.

Interest income for retail lending increased $183,000 in 2015 compared with 2014, driven by the increase in average balances. Income on home equity loans declined by $5,000 when comparing 2015 and 2014. Home equity loan average balances increased $2,830,000, or 5.0%, to $59,079,000 when comparing 2015 and 2014. The yield on the home equity portfolio, however, decreased 19 basis points to 3.59% when comparing the two years.

Average residential mortgage loans secured by first lien 1-4 family residential mortgages increased by $5,452,000, or 16.0%, to $39,575,000 for 2015. The average yield on the residential real estate portfolio decreased by twelve basis points to 4.09% for 2015. Overall, interest income for this segment grew $182,000 in 2015.

Interest income on consumer loans increased $6,000. Balances in this segment increased $285,000. This growth contributed $15,000 to the increase in income, while a decline in yield from 5.60% in 2014 to 5.37% offset the volume increase by $9,000.

Earning assets are funded primarily by deposits, which increased on average by $28,740,000, or 3.3%, to $892,541,000, when comparing 2016 and 2015. Total interest expense for 2016 was $4,733,000 compared with $4,506,000 for 2015, an increase of $227,000. Interest expense on total deposits increased $190,000 and interest expense on borrowed funds increased $37,000 when comparing the two years. The rate paid on both interest-bearing deposits and interest-bearing liabilities increased one basis point, when comparing the two periods. Deposit and borrowing yields are expected to increase as short-term interest rates begin to rise and the competition for deposits increases.

Consistent with the past several years, the growth in deposits during 2016 was centered in accounts with greater liquidity, including non-interest and interest-bearing demand, money market accounts, and savings deposits. Average non-interest-bearing demand accounts increased $11,433,000, or 11.9%, to $107,579,000 for 2016. QNB has been very successful in increasing business checking accounts as average balances in these accounts have increased by $10,336,000, or 13.5%, when comparing the two years. Average interest-bearing demand accounts increased $19,256,000, or 14.3%, to $153,598,000 for 2016 compared with 2015, with interest expense on interest-bearing demand accounts increasing $26,000 to $315,000 for 2016. The average rate paid remained unchanged at 0.21% for 2015 and 2016. Included in this category is QNB-Rewards checking, a higher-rate checking account product. The rate paid on balances up to $25,000 was 1.00% and 0.25% for balances over $25,000 in 2016. In order to receive the high rate a customer must receive an electronic statement, have one direct deposit or other ACH transaction and have at least 12 check card purchase transactions post and clear per statement cycle. If these qualifications are not met the rate paid for 2016 was 0.15%. For 2016, the average balance in this product was $44,918,000 and the related interest expense was $249,000 for an average cost of funds of 0.56%. In comparison, the average balance of the QNB-Rewards accounts for 2015 was $39,967,000 yielding 0.58%. The rates paid on the QNB-Rewards product, assuming qualifications are met, is still attractive relative to competitors’ offerings as well as other QNB products. This product also generates fee income through the use of the check card. The average balance of other interest-bearing demand accounts included in this category increased from $94,375,000 for 2015 to $108,680,000 for 2016. The average rate paid on these balances was 0.06% for both years.

Average money market accounts increased $5,843,000, or 8.9%, to $71,256,000 for 2016 compared with 2015. The increase in money market balances is a result of a shift in balances to more liquid accounts. Interest expense on money market accounts increased $34,000 to $192,000 for 2016 compared with 2015. The average interest rate paid on money market accounts was 0.27% for 2016, an increase of three basis points compared with 2015. The balances in this category primarily comprise Select money market accounts, a product that pays a tiered rate based on account balances. With the continuation of low short-term interest rates, balances remaining in these accounts for 2016 were at higher-yielding tiers.

Interest expense on municipal interest-bearing demand accounts decreased $38,000 to $351,000 for 2016. The average balance of municipal interest-bearing demand accounts decreased $13,915,000, or 12.0%, to $102,060,000, while the average interest rate paid on these accounts was 0.34% for both 2016 and 2015. Most of these accounts are indexed to the Federal funds rate with negotiated rate floors between 0.25% and 0.50%. 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.

During the second quarter of 2009, QNB introduced an online eSavings account to compete with other online savings accounts. This product was introduced at a yield of 1.85% and has been successful, with average balances growing $7,579,000, or 4.7%, to $168,360,000 in 2016 compared with $160,781,000 in 2015. The rate on this product was 0.50% during 2015 and was changed to 0.55% in late December 2016. The average cost of funds on these accounts was 0.46% for 2015 and 0.50% for 2016. 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 $4,639,000, or 8.2%, to $61,419,000. The average rate paid on total savings accounts was 0.40% for 2016, a three basis point increase from 2015 while interest expense increased $117,000, from $806,000 to $923,000 over the same period. The growth in balances appears to reflect the desire for liquidity and a better rate than short-term time deposits.

Interest expense on time deposits increased $51,000, to $2,798,000 in 2016, due to a six basis point increase in yield, from 1.17% in 2015 to 1.23% in 2016. This increase was partially offset by a decrease in average balances of $6,095,000 in 2016, to $228,269,000.

Similar to fixed-rate loans and investment securities, time deposits reprice over time and, therefore, have less of an immediate impact on costs in either a rising or falling rate environment. Unlike loans and investment securities, however, the maturity and repricing characteristics of time deposits tend to be shorter.

Approximately $95,803,000, or 42.5%, of time deposits at December 31, 2016 will reprice or mature over the next 12 months, compared with 43.9% of the portfolio at December 31, 2015. The average rate paid on these time deposits is approximately 0.72%. QNB has been attempting to extend the maturity of the time deposit portfolio by offering attractive rates at terms 36 months or greater, with moderate success. Given the short-term nature of these deposits, interest expense could increase if short-term time deposit rates were to increase suddenly or if customers select higher paying longer term time deposits.

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 2016 of $38,835,000 and $1,365,000, respectively. Interest expense on short-term borrowings increased by $37,000 to $154,000 when comparing the two years. During this period average balances increased $8,289,000 to $40,200,000 while the average rate paid increased one basis point, from 0.37% to 0.38%.

Total interest expense for 2015 was $4,506,000 compared with $4,544,000 for 2014, a decline of $38,000. Interest expense on total deposits increased $29,000 while interest expense on borrowed funds decreased $67,000 when comparing the two years. The rate paid on interest-bearing liabilities decreased two basis points from 0.58% for 2014 to 0.56% for 2015. During this same period, the rate paid on interest-bearing deposits decreased one basis point to 0.57%. Deposits, increased on average by $34,717,000, or 4.2%, to $863,801,000, when comparing 2015 and 2014.

Average non-interest-bearing demand accounts increased $15,719,000, or 19.5%, to $96,146,000 for 2015. Average balances for business checking accounts increased by $12,684,000, or 19.8%, when comparing the two years. Average interest-bearing demand accounts increased $15,711,000, or 13.2%, to $134,342,000 for 2015 compared with 2014 with interest expense on interest-bearing demand accounts increasing $15,000 to $289,000 for 2015. The average rate paid decreased two basis points from 0.23% for 2014 to 0.21% for 2015.

Interest expense on municipal interest-bearing demand accounts decreased $10,000 to $389,000 for 2015. The average balance of municipal interest-bearing demand accounts decreased $4,565,000, or 3.8%, to $115,975,000, while the average interest rate paid on these accounts increased from 0.33% for 2014 to 0.34% for 2015.

Average money market accounts increased $7,080,000, or 12.1%, to $65,413,000 for 2015 compared with 2014. Interest expense on money market accounts increased $32,000 to $158,000 for 2015 compared with 2014. The average interest rate paid on money market accounts was 0.22% for 2014 and 0.24% for 2015, an increase of two basis points.

Online eSavings average balances grew $4,718,000, or 3.0%, to $160,781,000 in 2015 compared with $156,063,000 in 2014. The rate on this product was 0.45% during 2014 and was changed to 0.50% in late December 2015. Traditional statement savings accounts and club accounts are also included in the savings category and increased $4,214,000, or 8.0%, to $56,780,000. The average rate paid on total savings accounts was 0.37% for 2014 and 2015, while interest expense increased $36,000, from $770,000 to $806,000 over the same period.

The repricing of time deposits at lower rates combined with the decline in average time deposit balances had the greatest impact on total interest expense in 2015. Total interest expense on time deposits decreased $44,000 to $2,747,000 for 2015. Average total time deposits decreased $8,160,000, or 3.4%, to $234,364,000 for 2015. The average rate paid on time deposits increased from 1.15% to 1.17% when comparing 2014 to 2015.

Sweep accounts structured as repurchase agreements with our commercial customers and overnight borrowings from the correspondent banks had average balances in 2015 of $31,364,000 and $547,000, respectively. Interest expense on short-term borrowings increased by $3,000 to $117,000 when comparing the two years. During this period average balances increased $295,000 to $31,911,000 while the average rate paid increased one basis point, from 0.36% to 0.37%.

Contributing to the decrease in total interest expense was a reduction in interest expense on long-term debt of $70,000. The average balance of long-term debt for 2014 was $1,452,000. The final portion of long-term debt taken out in April 2012 matured and was repaid on April 17, 2014. The rate on this long-term debt was 4.75%.

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 $30,000 for the twelve month period ended December 31, 2016, and $200,000 and $400,000 for the years ended December 31, 2015 and 2014, respectively. Excluding the $220,000 reversal in allowance for loan losses associated with the sale of the indirect lease finance portfolio, 2016 provision would have been $250,000. Net loan charge-offs were $190,000, or 0.03% of total average loans for 2016 compared with $647,000, or 0.11% of total average loans in 2015 and $1,324,000, or 0.25%, in 2014. The majority of the loans charged off during 2016 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 2017.

Non-interest income comparison
								Change from prior year
								$ Change						% Change
Year ended December 31,	2016			2015		2014		2016 to 2015			2015 to 2014			2016 to 2015			2015 to 2014
Fees for services to customers	$	1,621		$	1,657	$	1,687	$	(36	)	$	(30	)		-2.2	%		-1.8	%
ATM and debit card		1,651			1,571		1,485		80			86			5.1			5.8
Retail brokerage and advisory		603			686		657		(83	)		29			-12.1			4.4
Bank-owned life insurance		308			307		472		1			(165	)		0.3			-35.0
Merchant		334			298		299		36			(1	)		12.1			-0.3
Net (loss) gain on trading activities		(40	)		33		156		(73	)		(123	)		-221.2			-78.8
Net gain on sale of investment securities		674			783		1,112		(109	)		(329	)		-13.9			-29.6
Net gain on sale of loans		320			356		258		(36	)		98			-10.1			38.0
Loss on sale of indirect lease financing portfolio		(223	)		—		—		(223	)		—		NM			NM
Gain on sale of internet domain name		—			—		1,000		—			(1,000	)	NM				-100.0
Other		419			341		416		78			(75	)		22.9			-18.0
Total	$	5,667		$	6,032	$	7,542	$	(365	)	$	(1,510	)		-6.1	%		-20.0	%

QNB, through its core banking business, generates various fees and service charges. Total non-interest income includes service charges on deposit accounts, ATM and check card income, 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 $5,667,000 in 2016 compared with $6,032,000 in 2015, a decrease of $365,000. Excluding the loss on sale of indirect finance leasing portfolio of $223,000, the decline in non-interest income is $142,000, comparing 2016 to 2015.

Fees for services to customers are primarily comprised of service charges on deposit accounts. These fees were $1,621,000 for 2016, a decrease of $36,000, or 2.2%, from 2015. Overdraft income, which represented approximately 75% and 74% of total fees for services to customers in 2016 and 2015, respectively, decreased by $21,000, or 1.7%, when comparing 2016 to 2015. The decrease in overdraft income primarily reflects reduction in the number of overdraft occurrences as well as an increase in overdraft fees forgiven.

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 $1,651,000 in 2016, an increase of $80,000, or 5.1%, from the amount recorded in 2015. Debit card interchange income increased $85,000, or 5.6%, to $1,591,000 in 2016, while ATM surcharge income and monthly card fees income decreased $5,000, to $60,000. The growth in checking accounts and card usage among existing card-holders contributed to the increase in debit card income, including the QNB Rewards checking product, a high-yield checking account which requires, among other terms, the posting of a minimum of twelve debit card purchase transactions per statement cycle to receive the high interest rate.

Retail brokerage and advisory revenue was $603,000 for 2016 compared with $686,000 in 2015, a decline of $83,000, or 12.1%. The reduction in fee income is due to the increase in products with trailing fee income as opposed to upfront fees. QNB provides securities and advisory services under the name QNB Financial Services through Investment Professionals, Inc., an independent third party registered Broker/Dealer and Registered Investment Advisor. QNB receives 75% to 88% of the revenue generated, depending on volume, but is also responsible for salaries and expenses of two advisors who are QNB employees. In 2016, the net income provided by these services was $104,000, compared with $115,000 in net income for 2015.

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 minimize how low the earnings rate can go. Some of these policies are currently at their floor. Income on these policies during 2016 was $308,000, a slight increase when compared to $307,000 for 2015.

Merchant income represents fees charged to merchants for the Bank’s handling of credit card or charge sales. Merchant income was $334,000 for 2016, an increase of $36,000, or 12.1%, from the amount reported in 2015. The increase in merchant income is primarily a result of increased card sales from existing customers and the acquisition of 24 new merchant customers during 2016.

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 investment securities decreased $109,000 to $674,000 for the year ended December 31, 2016, compared with $783,000 for the year ended December 31, 2015, primarily due to market conditions which resulted in fewer opportunities for profitable sales in 2016 compared with 2015. The prolonged decline in market value of two equity securities resulted in recording $192,000 in other than temporary impairment in 2016. There were $55,000 in OTTI charges in 2015, related to the prolonged decline in market value of one equity security. Gains, net of other-than-temporary impairment, from equity securities were $566,000 and $636,000, in 2016 and 2015, respectively. With the strong performance in the U.S. equity markets during the first half of 2015 and the latter half of 2016, QNB elected to sell some equity holdings and recognize gains. Net gains on the sale of fixed income securities were $108,000 and $147,000 for 2016 and 2015, respectively. Both the 2016 and 2015 fixed income gains were primarily from the sale of fast paying, lower-yielding or odd-lot mortgage-backed and CMO securities as well as low yielding agency bonds that were likely to be called in the next two years. Net gain on trading securities declined $73,000, to a net loss of $40,000 in 2016, due to the increase in rates during fourth quarter 2016 and the volume of new municipal security issues during the year.

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 $320,000 and $356,000 for 2016 and 2015, respectively. Mortgage refinance activity decreased in 2016, as rate volatility prompted borrowers to delay borrowing. Proceeds from the sale of residential mortgages were $9,204,000 and $10,903,000 for the years ended December 31, 2016 and 2015, respectively. Included in the gains on the sale of residential mortgages in 2016 and 2015 are $69,000 and $80,000, 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 $125,000 for 2016 and $129,000 for 2015 is included in other non-interest income.

Other non-interest income was $419,000 for 2016, an increase of $78,000 from the amount recorded in 2015. Increased revenues from letters of credit, credit cards, title insurance company, sales tax refunds and reduced loss on sale for OREO, repossessed assets and furniture and equipment of $7,000, $9,000, $17,000, $47,000, and $19,000, respectively, were the primary contributors to the increase, when comparing 2016 to 2015.

Total non-interest income for the years ended December 31, 2015 and 2014 was $6,032,000 and $7,542,000, respectively, a decrease of $1,510,000, or 20.0%. Excluding the non-recurring items $1,000,000 gain on sale of an internet domain name sale and $158,000 life insurance benefit, QNB posted a decrease in non-interest income of $352,000, or 5.5%, for the twelve months ended of 2015, compared with the same period in 2014.

ATM and debit card income, retail brokerage and advisory income and net gain on sale of loans increased $86,000, $29,000, and $98,000, respectively, to $1,571,000, $686,000, and $356,000, respectively, when comparing the two periods. Mortgage refinance activity increased in 2015 compared to 2014, due to interest rate declines. Net gain on investment securities available for sale decreased $329,000 to $783,000 for the year ended December 31, 2015, compared with the same period in 2014. This is due in part to an impairment write down in the equity securities portfolio in 2015 totaling $55,000. Net gains on trading activity decreased $123,000 to $33,000 and represents realized and unrealized gains and losses, net of expenses, on the municipal bond trading account portfolio

that was started during the first quarter of 2014. Fees for services to customers decreased $30,000, or 1.8%, when comparing the year ended December 31, 2015 to prior year with the primary contributor reflective of higher volume of overdrafts.

Other non-interest income was $341,000 for 2015, a decrease of $75,000 from the amount recorded in 2014. Decreases in mortgage servicing income, letter of credit fees, title insurance, miscellaneous charges, losses on sale of OREO and repossessed equipment and rental income for an OREO property of $6,000, $11,000, $7,000, $20,000, $15,000, and $30,000, respectively, were the main contributors to the decrease.

Non-interest expense comparison
							Change from prior year
							$ Change						% Change
Year ended December 31,	2016		2015		2014		2016 to 2015			2015 to 2014			2016 to 2015			2015 to 2014
Salaries and employee benefits	$	12,011	$	12,076	$	11,649	$	(65	)	$	427			-0.5	%		3.7	%
Net occupancy		1,750		1,762		1,705		(12	)		57			-0.7			3.3
Furniture and equipment		1,753		1,726		1,753		27			(27	)		1.6			-1.5
Marketing		806		805		841		1			(36	)		0.1			-4.3
Third party services		1,691		1,703		1,677		(12	)		26			-0.7			1.6
Telephone, postage and supplies		752		731		730		21			1			2.9			0.1
State taxes		666		681		617		(15	)		64			-2.2			10.4
FDIC insurance premiums		568		631		686		(63	)		(55	)		-10.0			-8.0
Other		2,166		2,283		1,968		(117	)		315			-5.1			16.0
Total	$	22,163	$	22,398	$	21,626	$	(235	)	$	772			-1.0	%		3.6	%

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 $22,163,000 in 2016, a decrease of $235,000, or 1.0%, from the $22,398,000 recorded in 2015. 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. QNB’s efficiency ratios for 2016, 2015 and 2014 were 61.9%, 63.7%, and 60.8%, respectively.

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 2016 was $12,011,000, a decrease of $65,000 compared with $12,076,000 reported in 2015. Salary expense for 2016 was $9,518,000, a decrease of $21,000 compared with $9,539,000 reported in 2015. Included in salary expense in 2016 was incentive compensation plus related payroll taxes of $199,000, a $96,000 decrease over incentive compensation in 2015. Benefit expense for 2016 was $2,493,000, a decrease of $44,000, or 1.7%, from the amount recorded in 2015, with medical benefits decreasing $59,000, or 7.4%, due to insurance reimbursements for medical claims paid in prior periods and higher employee-paid share of health insurance. QNB self-funds medical insurance and also has Stop Loss insurance with a third-party insurance carrier which limits its claims expense. Payroll taxes and post-retirement life insurance expense increased $21,000 and $25,000, respectively, while retirement plan matching and safe harbor, and tuition reimbursements declined $28,000 and $13,000, respectively, in 2016. QNB utilized unvested forfeited 401k contributions to offset retirement plan matching in 2016.

Net occupancy and furniture and equipment expense increased $15,000, to $3,503,000 when comparing 2016 to 2015, due primarily to increased software and building maintenance, offset in part by lower depreciation, utilities and rental expense.

Marketing expense was $806,000 for 2016, a $1,000 increase from the expense recorded in 2015. Marketing expenses related to public relations and advertising increased $18,000 for the year ended December 31, 2016 compared with 2015, offset in part by decreased sales promotional expense. QNB contributions and sponsorships for not-for-profit organizations, events and clubs in the communities it serves is included in public relations expense.

Telephone, postage and supplies expense increased $21,000, or 2.9%, to $752,000 in 2016, compared with 2015. Supplies expense increased $8,000 in 2016, as additional supplies related to EMV chip debit card production, anticipated throughout 2017, were purchased in 2016. Telecommunications expense increased $25,000 due to upgrades in network infrastructure. Postage expense decreased $12,000, due to ongoing efforts to utilize digital delivery of various documents.

FDIC insurance premium expense decreased $63,000, or 10.0% in 2016, due to a change in the premium assessment formula announced by the FDIC in 2016, establishing reduced premium assessment formulas for small institutions. Small institutions, for FDIC premium assessments purposes, is defined as those with total consolidated assets less than $10 billion.

State tax expense represents the payment of the Pennsylvania Shares Tax, Pennsylvania sales and use tax and the Pennsylvania capital stock tax. State tax expense was $666,000 and $681,000 for the years 2016 and 2015, respectively. The Pennsylvania Shares Tax is based primarily on the equity of the Bank and comprises all but $1,000 of the expense in this category. Reduction in Pennsylvania Shares Tax is a result of a deduction utilized due to apportionment of income to New Jersey, and payment of New Jersey state income taxes.

Other operating expenses for the twelve months ended December 31, 2016 decreased $117,000, or 5.1%, primarily due to decreased debit card expenses. Debit card expenses in 2015 included a $208,000 contract termination fee related to card platform upgrades which occurred during 2016. Excluding this contract termination expense, debit card expenses increased $93,000, of which $61,000 was increased card loss expense, due to increased card compromises in 2016. QNB anticipates increased levels of card compromises for the near future.

Total non-interest expense was $22,398,000 for the year ended December 31, 2015, an increase of $772,000, or 3.6%, from the same period in 2014. Salaries and benefits expense increased $427,000, or 3.7%. Salary expense increased $574,000, or 6.4%, primarily due to higher salary expense of $561,000 with accrued incentive compensation comprising $13,000 of the remaining increase. Employee benefits costs decreased $147,000, or 5.5%, with medical insurance premiums decreasing $238,000, or 22.8%. Payroll taxes, life insurance premiums and retirement plan matching and safe harbor, and other benefits increased $91,000 in 2015, compared to 2014.

Net occupancy and furniture and equipment expense increased $30,000 to $3,488,000 when comparing 2015 to 2014, due primarily to increased software maintenance and rental expense, offset in part by lower depreciation expense.

Marketing expense was $805,000 for 2015, a decrease of $36,000, or 4.3%, from the $841,000 recorded in 2014. Marketing expenses related to public relations and sales promotion decreased $41,000 for the year ended December 31, 2015 compared to 2014, as the rebranding due to QNB’s domain name change was completed in 2014. This was offset in part by increases in advertising, market research and charitable contributions expense.

Telephone, postage and supplies expense was up slightly to $731,000 in 2015, compared to 2014. QNB’s spend on supplies decreased $12,000 in 2015, as additional supplies related to the rebranding were purchased in 2014.

State tax expense was $681,000 and $617,000 for the years 2015 and 2014, respectively. Pennsylvania Bank Shares Tax, the primary component of this category, is based primarily on the equity of the Bank.

Other operating expenses for the twelve months ended December 31, 2015 increased $315,000, or 16.0%, primarily due to increased third party services, collection costs and debit card expenses. Debit card expenses include a $208,000 contract termination fee related to card platform upgrades to occur during 2016.

Applicable income taxes and effective tax rates were $3,054,000, or 25.5%, for 2016 compared with $2,570,000, or 23.8%, for 2015. The higher effective tax rate year over year is predominately a result of tax-exempt income from loans and securities comprising a smaller proportional share of pre-tax income than the prior year. Full utilization of net operating loss carryforwards in prior years for QNB Corp. resulted in additional state income tax expense in 2016. For a more comprehensive analysis of income tax expense and deferred taxes, refer to Note 11 in the Notes to Consolidated Financial Statements.

Applicable income taxes and effective tax rates were $2,570,000, or 23.8% for 2015 and $2,644,000, or 22.7%, for 2014, predominately a result of tax-exempt income from loans and securities comprising a smaller proportional share of pre-tax income.

Total cash and cash equivalents decreased $6,270,000 from $16,991,000 at December 31, 2015 to $10,721,000 at December 31, 2016. QNB had interest bearing balances at the Federal Reserve Bank of $261,000 at December 31, 2016 compared with $6,402,000 at December 31, 2015. The low interest rate environment that has existed for approximately the past eight years resulted in a significant amount of agency and municipal bonds being called as well an increase in the amount of prepayments on mortgage-backed securities and CMOs. The rate uptick at the end of 2016 significantly slowed these prepayments, which is reflected in the reduced amount of cash held at the Federal Reserve Bank.

At December 31, 2016 and 2015, QNB had no Federal funds sold. With the Federal funds rate between 0.25% and 0.50%, excess funds for liquidity purposes are kept at the Federal Reserve which was paying 0.50% until the Federal Open Market Committee raised the targeted Fed Funds rate by 25 basis points in late December 2016. These funds carry a 0% risk weighting for risk-based capital calculation purposes.

At December 31, 2016, approximately 76% of QNB’s investment securities were either U.S. Government agency debt securities, U.S. Government agency issued mortgage-backed securities or CMOs. As of December 31, 2016, 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. Proceeds from the sale of investments were $32,573,000 in 2016 compared with $47,960,000 during 2015.

In addition to the proceeds from the sale of investment securities, proceeds from maturities, calls and prepayments of securities were $107,425,000 in 2016, compared with $94,372,000 in 2015. The significant amount of proceeds in both years reflects the low interest rate environment that has existed for approximately the past eight years, which resulted in a significant amount of agency and municipal bonds being called as well an increase in the amount of prepayments on mortgage-backed securities and CMOs. The increase of the investment portfolio as a percent of total assets in 2016 is due to reduced loan growth and continued deposit growth. During 2016, $174,943,000 of investment securities were purchased compared with $132,048,000 during 2015.

The balance of U.S. Government agency securities increased $14,871,000 to $76,650,000 at December 31, 2016, and represents 19.5% of the investment portfolio compared with 16.9% at December 31, 2015. Bond proceeds from called agency bonds was reinvested back into this portfolio because of the attractive yields relative to amortizing securities. The seasonal inflow of municipal deposits was invested in Agencies, as well. U.S. Government agency issued CMO and MBS balances grew $20,425,000 to $222,716,000 and represents 56.5% of the portfolio compared with 55.2% at December 31, 2015. These bonds provide monthly cash flow to be reinvested in either loans or other securities, potentially at higher yields as rates increase.

The balance of municipal securities decreased $7,252,000 to $75,891,000 -- $3,596,000 in trading and $72,295,000 in available for sale -- at December 31, 2016, representing 19.3% of the investment portfolio compared with 22.7% at December 31, 2015. 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. Thirty-five bonds with a book value of $12,820,000 were called or matured in 2016, and purchased municipal securities had significantly lower yields then the bonds they replaced, which contributed to the decline in the yield on the portfolio.

QNB owns collateralized debt obligations (“CDO”) in the form of pooled trust preferred securities. These securities are comprised mainly of securities issued by banks or bank holding companies, and to a lesser degree, insurance companies. In most cases, QNB owns the mezzanine tranches of these securities. These securities are structured so that the senior and mezzanine tranches are protected from defaults by over-collateralization and cash flow default protection provided by subordinated tranches. QNB holds six of these securities with an amortized cost of $2,909,000 and a fair value of $2,281,000 at December 31, 2016 and amortized cost of $3,291,000 and a fair value of $2,653,000 at December 31, 2015. All of the trust preferred securities are available-for-sale securities and are carried at fair value. There were no credit-related OTTI charges during 2016, 2015, or 2014 on these securities. Future estimates of fair value of these securities could require recording additional OTTI charges through earnings. QNB uses an independent third party to value these securities and to determine if credit-related OTTI exists. For additional detail on these securities see Notes 4 and 17 of the Notes to Consolidated Financial Statements.

QNB accounts for its investments by classifying securities into three categories. 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 and equity 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 and equity 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. Management determines the appropriate classification of securities at the time of purchase.

December 31, 2016	One year or less			After one year through five years			After five years through ten years			After ten years			Total
Investment Securities Available-for-Sale
U.S. Government agency:
Fair value	$	3,026		$	30,157		$	43,467			—		$	76,650
Weighted average yield		0.23	%		1.46	%		1.90	%		—			1.75	%
State and municipal:
Fair value		6,029			15,336			39,725		$	11,205			72,295
Weighted average yield		4.26	%		3.77	%		3.92	%		3.55	%		3.86	%
Mortgage-backed:
Fair value		54			79,406			65,841			—			145,301
Weighted average yield		3.48	%		2.21	%		2.11	%		—			2.16	%
Collateralized mortgage obligations (CMOs):
Fair value		343			44,523			32,549			—			77,415
Weighted average yield		1.83	%		1.93	%		1.93	%		—			1.93	%
Pooled trust preferred: ⁽¹⁾
Fair value		—			—			—			2,281			2,281
Weighted average yield		—			—			—			—			—
Corporate debt:
Fair value		—			7,017			1,013			—			8,030
Weighted average yield		—			1.90	%		1.81	%		—			1.89	%
Equity:
Fair value		—			—			—			8,503			8,503
Weighted average yield		—			—			—			3.21	%		3.21	%
Total fair value	$	9,452		$	176,439		$	182,595		$	21,989		$	390,475
Weighted average yield		2.88	%		2.13	%		2.41	%		2.97	%		2.33	%

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 34 percent and a Tax Equity and Financial Responsibility Act (TEFRA) adjustment of five basis points. Weighted average yields on investment securities available-for-sale are based on amortized cost.

In 2014, QNB established a small percentage of its investment portfolio as trading in an effort to boost yields and income. During the first quarter of 2014 QNB sold approximately $5,000,000 of available-for-sale municipal securities with the proceeds reinvested into a municipal trading account. QNB held trading securities of $3,596,000 and $4,189,000 with an additional $1,499,000 and $1,349,000 in a brokerage cash account at December 31, 2016 and December 31, 2015, respectively. QNB recorded a net loss of $40,000 for 2016 and net gains of $33,000 for 2015 and $156,000 for 2014, respectively, in non-interest income comprising realized and unrealized gains.

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, 2016, the fair value of investment securities available-for-sale was $390,475,000, or $5,693,000 below the amortized cost of $396,168,000. This compares to a fair value of $361,915,000, or $827,000 below the amortized cost of $362,742,000, at December 31, 2015. The available-for-sale portfolio, excluding equity securities and the pooled trust preferred securities, had a weighted average maturity of approximately 3.9 years at December 31, 2016 and 3.6 years at December 31, 2015. The weighted average tax-equivalent yield was 2.34% and 2.44% at December 31, 2016 and 2015, respectively.

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 securities held-to-maturity are recorded at amortized cost. At December 31, 2015, there was a single municipal security in the held-to-maturity portfolio with an amortized cost of $147,000 and fair value of $151,000. That bond matured in 2016.

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 loan, retail loan and indirect lease financing 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. At December 31, 2016, there were no concentrations of loans exceeding 10% of total loans other than disclosed in the Loan Portfolio table.

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 kinds of loans generally comes from the cash flow of the business or the ongoing conversions of assets, such as accounts receivable and inventory, to cash. 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, substantially all 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 declined in 2016 with $8,686,000 in residential mortgages originated for sale during 2016, compared with $11,154,000 for 2015. Refinancing drove the higher originations in 2015. There was $789,000 in residential mortgage loans held-for-sale at December 31, 2016, and $987,000 in residential mortgage loans held-for-sale at December 31, 2015. 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.

Total loans, excluding loans held-for-sale, at December 31, 2016 were $633,079,000, an increase of $17,809,000, or 2.9%, from December 31, 2015. This follows a 10.8% increase in outstanding loans in 2015. A key financial ratio, loans to deposits, improved slightly to 69.3% at December 31, 2016, compared with 69.1% at December 31, 2015. QNB continues to be committed to make loans available to credit worthy consumers and businesses.

The Allowance for Loan Losses Allocation table on page 39 shows the percentage composition of the loan portfolio over the past five years. There was very little change in the composition of the portfolio between the periods ended December 31, 2015 and 2016, with the exceptions of the divestiture of the indirect lease financing portfolio in 2016. Loans secured by commercial real estate represent the largest sector of the portfolio, increasing from 38.2% of the portfolio at December 31, 2015 to 40.3% of the portfolio at December 31, 2016, while balances in this sector grew by $20,017,000, or 8.5%, from $235,171,000 at December 31, 2015 to $255,188,000 at December 31, 2016. 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, hospitals, retirement and nursing home facilities, warehouses and 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 2016 compared with $84,000 in 2015 and $70,000 in 2014. The 2015 charge-offs were due primarily to the sale of collateral for impaired loans; 2014’s charge-off was for a single loan under agreement of sale.

Commercial loans secured by residential real estate increased by $5,567,000, or 8.8%, to $68,731,000 at December 31, 2016 and at 10.9% represent a slightly larger share of the overall portfolio than the 10.3% at December 31, 2015. 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. Charge-offs in this category have decreased over the past three years. Non-accrual commercial loans secured by residential real estate were $1,866,000, $1,803,000, and $1,467,000 at December 31, 2016, 2015, and 2014, respectively, and loan charge-offs were $120,000, $531,000, and $1,069,000, respectively, in 2016, 2015 and 2014. In 2016, approximately $96,000 of the $120,000 in charge-offs were out of market investment properties, compared with $279,000 of the $531,000 charge-offs in the same category for 2015.

Commercial and industrial loans, the second largest sector of the portfolio, experienced a decline in balances of $14,164,000, or 11.4%, to $110,233,000 at December 31, 2016. This followed growth in this category of $5,552,000, or 4.7%, in 2015. Commercial and industrial loans represented 17.4% of the portfolio at year-end 2016 compared with 20.2% at December 31, 2015. 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 unsecured. During 2016 nonaccrual commercial and industrial loan balances increased $1,365,000 to $4,798,000, due primarily to the financial difficulties and downgrade of one credit during 2016. In 2016, 2015, and 2014 charge-offs were $140,000, $56,000, and $17,000, respectively, and in 2014, recoveries in this segment were $67,000, exceeding the charge-offs.

Loan Portfolio
December 31,	2016		2015		2014		2013			2012
Commercial:
Commercial and industrial	$	110,233	$	124,397	$	118,845	$	111,339		$	100,063
Construction		39,268		27,372		23,471		15,929			11,061
Secured by commercial real estate		255,188		235,171		203,534		190,602			192,867
Secured by residential real estate		68,731		63,164		53,077		47,672			41,003
State and political subdivisions		35,260		40,285		44,104		33,773			34,256
Loans to depository institutions		—		—		—		1,250			3,250
Indirect lease financing		—		10,371		7,685		8,364			9,685
Retail:
1-4 family residential mortgages		47,124		42,833		37,147		29,730			28,733
Home equity loans and lines		71,525		67,384		63,213		59,977			54,860
Consumer		5,670		4,286		4,175		3,116			2,012
Total loans		632,999		615,263		555,251		501,752			477,790
Net unearned costs (fees)		80		7		31		(36	)		(57	)
Loans receivable	$	633,079	$	615,270	$	555,282	$	501,716		$	477,733

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

The following shows the amount of loans due after one year that have fixed interest rates and variable or adjustable interest rates at December 31, 2016:

Construction loans increased 43.5% from $27,372,000, or 4.4% of the portfolio at December 31, 2015, to $39,268,000, or 6.2% of the portfolio at December 31, 2016. 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. The growth in the portfolio in 2016 is related to construction loans for several

business expansions in the Bank’s market footprint. 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 $5,025,000, or 12.5%, from $40,285,000 at December 31, 2015 to $35,260,000 at December 31, 2016. This sector declined from 6.5% of the total loan portfolio at December 31, 2015 to 5.6% at December 31, 2016. With the decline in interest rates through most of 2016, many municipalities, counties and school districts refinanced their existing bonds or bank debt. As a result, QNB is getting an opportunity to bid on many of these local issues and has been successful in winning several of those bids. The refinancing activity has also resulted in a reduction in yield. QNB expects the balance in this category to increase in 2017 as some of the commitments for large projects won during 2016 may start to fund during the first quarter of 2017.

QNB desires to become the “local consumer lender of choice” and to affect this QNB has refocused its retail lending efforts by strengthening the management of the area, adding new product offerings and increasing marketing and promotion. This focus resulted in increased balances in home equity loans and lines of $4,141,000, or 6.1%, to $71,525,000 at December 31, 2016. During 2016, in an effort to increase demand, QNB offered very attractive rates on both variable and fixed rate home equity loans and lines. These promotional rates along with excellent customer service, including quick turnaround time, contributed to the growth in home equity balances. With continued improvement in home values as well as the local economy, it is expected that the demand for home equity loans will continue.

Consumer loan balances increased $1,384,000 to $5,670,000 at December 31, 2016. In 2013, QNB reentered the private student loan market through a relationship with iHelp. These student loans are either fixed or variable rate with the rate dependent on the credit scores of the student and/or the cosigner. Principal and interest protection is provided by ReliaMax, an insurance company for private student loans. As of December 31, 2016, the balance of student loans was $2,640,000, an increase of $1,484,000 compared with December 31, 2015.

QNB increased the balances of residential mortgage loans secured by first lien 1-4 family residential mortgages by $4,291,000, or 10.0%, to $47,124,000 at December 31, 2016. This followed an increase of $5,686,000, or 15.3%, between December 31, 2014 and December 31, 2015. In 2016, QNB retained some adjustable and fixed rate mortgages to borrowers with high credit scores and low loan-to-value ratios.

Non-performing assets include non-performing loans, OREO and repossessed assets and non-performing trust preferred securities. Non-performing assets totaled $14,219,000, or 1.34% of total assets at December 31, 2016, an $847,000 increase over the $13,372,000, or 1.31% of total assets at December 31, 2015. Included in non-performing assets in 2016 and 2015 is $2,281,000 and $2,653,000, respectively, of pooled trust preferred securities, discussed in the section titled “Investment Securities and Other Short-Term Investments”.

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 $11,938,000, or 1.89% of total loans at December 31, 2016 compared with $10,719,000, or 1.74% of total loans at December 31, 2015. Loans on non-accrual status were $10,119,000 at December 31, 2016 compared with $9,420,000 at December 31, 2015. Two large relationships totaling $2,632,000 were designated non-accrual in the fourth quarter of 2016. In cases where there is a collateral shortfall on non-accrual loans, specific impairment reserves have been established based on updated collateral values even if the borrower continues to pay in accordance with the terms of the agreement. Of the total amount of non-accrual loans at December 31, 2016, $7,749,000, or approximately 77% of the loans classified as non-accrual, are current or past due less than 30 days as of the end of the year.

QNB had no loans 90 days or more past due and still accruing at December 31, 2016, compared with one lease for $11,000 at December 31, 2015. Total loans that are 30 days or more past due increased $1,218,000 to $4,937,000, representing 0.78% of total loans at December 31, 2016 compared with 0.60% of total loans at December 31, 2015. 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 $1,819,000 and $1,288,000 at December 31, 2016 and 2015, respectively.

QNB held no OREO at December 31, 2015 or 2016. There were no repossessed assets as of December 31, 2015 or 2016.

Non-Performing Assets
December 31,	2016			2015			2014			2013			2012
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		—			—			—			—			—
Loans to depository institutions		—			—			—			—			—
Indirect lease financing		—		$	11			—			—			—
Retail:		—			—			—			—			—
1-4 family residential mortgages		—			—			—			—			—
Home equity loans and lines		—			—			—			—			—
Consumer		—			—			—		$	1			—
Total loans past due 90 days or more and accruing		—			11			—			1			—

Non-accrual loans
Commercial:
Commercial and industrial		4,798			3,433			2,171			3,956			6,174
Construction		—			—			337			1,319			2,480
Secured by commercial real estate		3,007			3,627			6,465			4,630			6,748
Secured by residential real estate		1,866			1,803			1,467			2,829			2,390
State and political subdivisions		—			—			—			—			1
Loans to depository institutions		—			—			—			—			—
Indirect lease financing		—			143			—			37			98
Retail:
1-4 family residential mortgages		266			287			225			401			335
Home equity loans and lines		89			127			104			265			346
Consumer		93			—			1			16			—
Total non-accrual loans		10,119			9,420			10,770			13,453			18,572

Troubled debt restructured loans, not included above		1,819			1,288			1,897			1,960			2,578
Other real estate owned		—			—			3,025			2,825			1,151
Repossessed assets		—			—			21			—			10
Non-accrual pooled trust preferred securities		2,281			2,653			2,439			2,069			1,962
Total non-performing assets	$	14,219		$	13,372		$	18,152		$	20,308		$	24,273
Total as a percent of total assets		1.34	%		1.31	%		1.86	%		2.18	%		2.64	%

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 December 31, 2016, substandard or doubtful loans totaled $22,204,000, a reduction of $5,121,000, or 18.7%, from the $27,325,000 reported as of December 31, 2015.

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 (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, continued to improve in 2016, and asset quality remained strong. The allowance level decreased from $7,554,000 at year-end 2015 to $7,394,000 at year-end 2016, which, stated as a percent of loans receivable, declined from 1.23% at December 31, 2015 to 1.17% at December 31, 2016.

Allowance for Loan Losses Allocation
December 31,	2016					2015					2014					2013					2012
	Amount		Percent gross loans			Amount		Percent gross loans			Amount		Percent gross loans			Amount		Percent gross loans			Amount		Percent gross loans
Balance at end of period applicable to:
Commercial:
Commercial and industrial	$	1,459		17.4	%	$	1,521		20.2	%	$	1,892		21.4	%	$	2,044		22.2	%	$	2,505		20.9	%
Construction		449	6.2				286	4.4				297	4.2				439	3.2				209	2.3
Secured by commercial real estate		2,646		40.3			2,411		38.2			2,700		36.7			2,898		38.0			3,795		40.4
Secured by residential real estate		1,760	10.9				1,812	10.3				1,630	9.6				1,632	9.5				1,230	8.6
State and political subdivisions		123	5.6				222	6.5				221	7.9				186	6.7				260	7.2
Loans to depository institutions		—		—			—		—			—		—			4		0.2			15		0.7
Indirect lease financing		—		—			164		1.7			93		1.4			103		1.7			168		2.0
Retail:
1-4 family residential mortgages		366		7.4			350		7.0			312		6.7			303		5.9			324		6.0
Home equity loans and lines		353		11.3			428		11.0			453		11.4			583		12.0			582		11.5
Consumer		76		0.9			76		0.7			85		0.7			64		0.6			27	0.4
Unallocated		162					284					318					669					657
Total	$	7,394		100.0	%	$	7,554		100.0	%	$	8,001		100.0	%	$	8,925		100.0	%	$	9,772		100.0	%

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 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, 2016 and 2015, the recorded investment in loans for which impairment has been identified totaled $15,006,000 and $14,941,000, respectively, of which $10,909,000 and $12,414,000, respectively, required no specific allowance for loan loss. The recorded investment in impaired loans requiring an allowance for loan losses was $4,097,000 and $2,527,000 at December 31, 2016 and 2015, respectively. At December 31, 2016 and 2015 the related allowance for loan losses associated with these loans was $1,198,000 and $974,000, 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.

Allowance for Loan Losses
	2016			2015			2014			2013			2012
Allowance for loan losses:
Balance, January 1	$	7,554		$	8,001		$	8,925		$	9,772		$	9,241

Charge-offs
Commercial:
Commercial and industrial		140			56			17			68			101
Construction		—			—			—			—			—
Secured by commercial real estate		—			84			70			639			85
Secured by residential real estate		120			531			1,069			401			111
State and political subdivisions		—			—			—			—			—
Indirect lease financing		52			21			39			2			85
Retail:
1-4 family residential mortgages		—			—			95			—			21
Home equity loans and lines		—			—			156			234			114
Consumer		92			95			167			77			64
Total charge-offs		404			787			1,613			1,421			581
Recoveries
Commercial:
Commercial and industrial		37			38			67			28			76
Construction		—			—			—			—			—
Secured by commercial real estate		8			9			3			1			76
Secured by residential real estate		112			26			48			60			—
State and political subdivisions		—			—			—			1			—
Indirect lease financing		9			16			14			30			36
Retail:
1-4 family residential mortgages		—			—			1			—			2
Home equity loans and lines		16			22			110			28			12
Consumer		32			29			46			26			10
Total recoveries		214			140			289			174			212
Net charge-offs		(190	)		(647	)		(1,324	)		(1,247	)		(369	)
Provision for loan losses		30			200			400			400			900
Balance, December 31	$	7,394		$	7,554		$	8,001		$	8,925		$	9,772

Total loans (excluding loans held-for-sale)
Average	$	604,757		$	574,015		$	523,825		$	482,112		$	480,068
Year-end		633,079			615,270			555,282			501,716			477,733

Ratios:
Net charge-offs to:
Average loans		0.03	%		0.11	%		0.25	%		0.26	%		0.08	%

QNB had net loan charge-offs of $190,000, or 0.03% of average loans for 2016 compared with $647,000, or 0.11% of average loans for 2015 and $1,324,000 or 0.25% of average loans for 2014. 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 trend in decreasing charge-offs for both retail and commercial loans from 2014 through 2016 was due to improvements in asset quality, credit monitoring and the improving economic environment.

Management believes the allowance for loan losses of $7,394,000 is adequate as of December 31, 2016, in relation to the estimate of known and inherent losses in the portfolio.

Premises and equipment, net of depreciation decreased $574,000 to $8,683,000 at December 31, 2016, as equipment purchases declined from $580,000 in 2015 to $317,000 in 2016.

Other assets, as presented in the table on page 31, increased $2,064,000 from $5,686,000 at December 31, 2015 to $7,750,000 at December 31, 2016. Most of the increase in other assets relates to a $1,829,000 increase to the deferred tax asset resulting from the change in fair value of the available-for-sale investment portfolio between December 31, 2015 and 2016. The detail of the net deferred tax asset can be found in Note 11 in the Notes to Consolidated Financial Statements.

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 (IRA’s) 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 $23,569,000, or 2.6%, to $913,355,000 at December 31, 2016. This follows an increase of $38,194,000, or 4.5%, between 2014 and 2015. The growth in deposits as well as the mix of deposits continues to be impacted by customers’ reactions to the industry, regulations and the interest rate environment. Many customers are looking for transaction accounts that provide liquidity and pay a reasonable amount of interest, in anticipation of increasing rates in 2017. However, despite the decline in overall time deposit balances, those maturing in 60 months have increased due to customers seeking a higher rate of interest and not being concerned about liquidity. Customers appear to be looking for the safety of FDIC insured deposits and the stability of a strong local community bank.

Contributing to the increase in total deposits was growth in non-interest bearing demand accounts, which increased $20,467,000, or 20.8%, to $119,010,000 at December 31, 2016. This followed growth of $11,623,000, or 13.4%, between December 31, 2014 and December 31, 2015. These deposits are primarily comprised of business 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 not only contributes to the increase in balances but also provides an opportunity for fee income.

Interest-bearing demand accounts, retail and business interest checking and municipal accounts decreased $19,171,000, or 7.0%, to $255,754,000 at December 31, 2016. All segments experienced growth in 2016 except municipal deposits and business interest checking, which declined $30,976,000, or 25.0%, to $92,767,000, and $1,569,000, or 8.5%, to $16,861,000, respectively. While 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.

Rewards checking balances increased from $45,208,000 at December 31, 2015 to $49,428,000 at December 31, 2016, and Select 50 balances increased from $69,744,000 to $77,959,000 over this same period. Personal interest-bearing balances also increased from $17,800,000 at December 31, 2015 to $18,739,000 at December 31, 2016. QNB continues to open a significant number of new checking accounts.

Total savings account balances increased $16,477,000, or 7.4%, to $238,247,000 at December 31, 2016. This increase is due primarily to an increase in the online eSavings account of $11,746,000, or 7.2%, to $174,319,000 at December 31, 2016. The eSavings account was introduced in 2009 to compete with competitors’ online savings products and currently yields 0.55%.

Total time deposit account balances were $225,582,000 at December 31, 2016, a decrease of $1,794,000, or 0.8%, from the amount reported at December 31, 2015. As time deposits matured during the past two years they were frequently reinvested in the high yielding and liquid Rewards or Select 50 checking, money market or eSavings accounts which, in many instances paid a rate higher than what was offered on short-term time deposits.

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 and online eSavings accounts are examples of such products.

Short-term borrowings comprising commercial sweep accounts and overnight FHLB borrowings grew $15,497,000, or 41.7%, to $52,660,000 at December 31, 2016. Commercial sweeps grew $8,176,000, or 22.0%, to $45,339,000 in 2016. The remainder of the increase related to $7,321,000 of overnight FHLB borrowings at December 31, 2016. QNB had no FHLB borrowings at December 31, 2015.

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.

An additional source of liquidity is provided by the Bank’s membership in the FHLB. At December 31, 2016, the Bank had a maximum borrowing capacity with the FHLB of approximately $240,878,000, net of the $7,321,000 outstanding at year-end 2016. The maximum borrowing capacity changes as a function of qualifying collateral assets. QNB had no FHLB borrowing at December 31, 2015. In addition, the Bank maintains four unsecured Federal funds lines with four correspondent banks totaling $46,000,000. At December 31, 2016 and 2015, there were no outstanding borrowings under these lines. Future availability under these lines is subject to the policies of the granting banks and may be withdrawn. As part of its contingency funding plan, QNB successfully tested its ability to borrow from these sources during the fourth quarter of 2016.

Total cash and cash equivalents, trading and available-for-sale securities and loans held-for-sale totaled $405,581,000 at December 31, 2016 and $384,082,000 at December 31, 2015. At December 31, 2016 and 2015, investment securities totaling $166,628,000 and $197,149,000, respectively, were pledged as collateral for repurchase agreements and public deposits. This increase in liquid sources is primarily the result of a $28,560,000 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. An increase in interest rates, however, would 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.

Other liabilities comprise accrued expenses including salaries, post-retirement life insurance benefits and income taxes, deferred revenue, and ATM/debit card processing clearing. This category increased $10,000 to $3,224,000 at December 31, 2016.

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

Total shareholders’ equity increased $3,124,000, or 3.5%, to $93,567,000 at December 31, 2016 with retained earnings -- net income less dividends paid -- contributing $4,858,000 and the dividend reinvestment and stock purchase plan, employee stock purchase plan and stock option plan contributing $1,389,000. Accumulated other comprehensive income decreased $3,211,000, resulting from the decrease in fair value of the available-for-sale investment portfolio caused by increasing interest rates at the end of 2016. QNB remains “well capitalized” based on FDIC requirements.

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, 2016 was $93,567,000, or 8.80% of total assets, compared with shareholders’ equity of

$90,443,000, or 8.86% of total assets, at December 31, 2015. Shareholders’ equity at December 31, 2016 included a negative adjustment of $3,757,000 related to unrealized holding losses, net of taxes, on investment securities available for sale. At December 31, 2015 shareholders’ equity included a negative adjustment of $546,000, related to unrealized holding losses, net of taxes, on investment securities available-for-sale. Excluding these adjustments, shareholders’ equity to total assets would have been 9.12% and 8.91% at December 31, 2016 and 2015, respectively.

Average shareholders’ equity and average total assets were $94,472,000 and $1,031,198,000 for 2016, an increase of 6.6% and 4.4%, respectively, from 2015 average equity and average total assets of $88,642,000 and $987,894,000, respectively. The ratio of average total equity to total average assets was 9.16% for 2016, compared with 8.97% for 2015.

QNB is subject to restrictions on the payment of dividends to its shareholders pursuant to the Pennsylvania Business Corporation Law 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, 2016, the retained earnings of the Bank, totaling $86,430,000 was available for dividends without prior regulatory approval, subject to the regulatory capital requirements discussed below. QNB paid dividends to its shareholders of $1.20 per share, $1.16 per share, and $1.12 per share, in 2016, 2015, and 2014, 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. The final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (“Basel III”) became effective for QNB on January 1, 2015, with full compliance with all the of final rule’s requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019.

Under the final rules, minimum requirements increased for both the quantity and quality of capital held by banks. The rules included a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raised the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, required a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and required a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets and increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented. The final rules also revised the definition and calculation of Tier 1 capital, Total Capital, and risk-weighted assets. QNB continues to monitor the effect of these new rules on the business, operations and capital levels of the Company and the Bank.

Continuing to impact risk-weighted assets is the $22,865,000 of risk-weighted assets due to mezzanine tranches of pooled trust preferred securities that were downgraded below investment grade during the first quarter of 2009. Although the amortized cost of these securities was only $2,909,000 at December 31, 2016, regulatory guidance required an additional $19,956,000 to be included in risk-weighted assets. The Bank utilized the method as outlined in the Call Report Instructions for an available-for-sale bond that has not triggered the Low Level Exposure (LLE) rule. The mezzanine tranches of CDOs that utilized this method of risk-weighting are five out of six pooled trust preferred securities (PreTSLs) held by the Bank as of December 31, 2016. The other pooled trust preferred security has only one tranche remaining so the treatment noted above does not apply.

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 at a discount. The Plan also allows participants to make additional cash purchases of stock at a discount. Stock purchases under the Plan contributed $983,000 and $871,000 to capital during 2016 and 2015, respectively.

The Board of Directors has authorized the repurchase of up to 100,000 shares of QNB’s common stock in open market or privately negotiated transactions. The repurchase authorization does not bear a termination date. As of December 31, 2016 and 2015, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000. There were no shares repurchased under the plan since the first quarter of 2009.

The Federal Deposit Insurance Corporation Improvement Act of 1991 established five capital level designations ranging from “well capitalized” to “critically undercapitalized.” At December 31, 2016 and 2015, 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.

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

The following table presents, as of December 31, 2016, 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 $59,000 at December 31, 2016 and 2015.

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.

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.

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, 2016 is liability sensitive. Management expects that market interest rates may gradually increase in the next 12 months, based on the economic environment and policy of the Board of Governors of the Federal Reserve System.

The following table shows the estimated impact of changes in interest rates on net interest income as of December 31, 2016 and 2015 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.

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, 2016 QNB did not have any hedging transactions in place such as interest rate swaps, caps or floors.

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

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 U.S. generally accepted accounting principles (“GAAP”) and predominant practices within the banking industry. The preparation of these consolidated financial statements requires QNB to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. QNB evaluates estimates on an on-going basis, including those related to the determination of the

allowance for loan losses, the determination of the valuation of other real estate owned, 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.

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

The Company follows 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.

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

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

Management emphasizes loan quality and close monitoring of potential problem credits. Credit risk identification and review processes are utilized in order to assess and monitor the degree of risk in the loan portfolio. QNB’s lending and credit administration staff are charged with reviewing the loan portfolio and identifying changes in the economy or in a borrower’s circumstances which may affect the ability to repay debt or the value of pledged collateral. A loan classification and review system exists that identifies those loans with a higher than normal risk of 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 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.

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.

At December 31, 2016, 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.

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.

The information required in response to this item is set forth in Item 7, above.

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

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, 2016, 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, 2016, the Company’s system of internal control over financial reporting is effective and meets the criteria of the “Internal Control Integrated Framework (2013).”

Baker Tilly Virchow Krause, LLP, an independent registered public accounting firm, has audited the Company’s consolidated financial statements as of and for the year ended December 31, 2016 and the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016, as stated in their reports, which are included herein.

We have audited QNB Corp. and subsidiary’s (the Company) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the entity are being made only in accordance with authorizations of management and directors of the entity; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Company as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016, and our report dated March 15, 2017 expressed an unqualified opinion on those consolidated financial statements.

We have audited the accompanying consolidated balance sheets of QNB Corp. and subsidiary (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of QNB Corp. and subsidiary as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), QNB Corp. and subsidiary’s internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 15, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

	(in thousands, except share data)
December 31,	2016			2015
Assets
Cash and due from banks	$	8,897		$	9,159
Interest-bearing deposits in banks		1,824			7,832
Total cash and cash equivalents		10,721			16,991

Investment securities
Trading		3,596			4,189
Available-for-sale (amortized cost $396,168 and $362,742)		390,475			361,915
Held-to-maturity (fair value $0 and $151)		—			147
Restricted investment in bank stocks		1,017			508
Loans held-for-sale		789			987
Loans receivable		633,079			615,270
Allowance for loan losses		(7,394	)		(7,554	)
Net loans		625,685			607,716
Bank-owned life insurance		11,297			10,978
Premises and equipment, net		8,683			9,257
Accrued interest receivable		3,128			2,562
Net deferred tax assets		5,473			3,673
Other assets		2,277			2,013
Total assets	$	1,063,141		$	1,020,936

Liabilities
Deposits
Demand, non-interest bearing	$	119,010		$	98,543
Interest-bearing demand		255,754			274,925
Money market		74,762			67,172
Savings		238,247			221,770
Time		131,370			135,251
Time of $100 or more		94,212			92,125
Total deposits		913,355			889,786
Short-term borrowings		52,660			37,163
Accrued interest payable		335			330
Other liabilities		3,224			3,214
Total liabilities		969,574			930,493

Shareholders' Equity
Common stock, par value $0.625 per share; authorized 10,000,000 shares; 3,576,270 shares and 3,524,363 shares issued; 3,411,701 and 3,359,794 shares outstanding		2,235			2,203
Surplus		17,418			15,973
Retained earnings		80,147			75,289
Accumulated other comprehensive loss, net of tax		(3,757	)		(546	)
Treasury stock, at cost; 164,569 shares		(2,476	)		(2,476	)
Total shareholders' equity		93,567			90,443
Total liabilities and shareholders' equity	$	1,063,141		$	1,020,936

The accompanying notes are an integral part of the consolidated financial statements.

	(in thousands, except per share data)
Year ended December 31,	2016			2015			2014
Interest income
Interest and fees on loans	$	25,525		$	24,356		$	22,759
Interest and dividends on investment securities (AFS & HTM):
Taxable		5,454			5,219			5,406
Tax-exempt		1,949			2,009			2,223
Interest on trading securities		138			163			158
Interest on interest-bearing balances and other interest income		171			128			124
Total interest income		33,237			31,875			30,670

Interest expense
Interest on deposits
Interest-bearing demand		666			678			673
Money market		192			158			126
Savings		923			806			770
Time		1,497			1,548			1,636
Time of $100 or more		1,301			1,199			1,155
Interest on short-term borrowings		154			117			114
Interest on long-term debt		—			—			70
Total interest expense		4,733			4,506			4,544
Net interest income		28,504			27,369			26,126
Provision for loan losses		30			200			400
Net interest income after provision for loan losses		28,474			27,169			25,726

Non-interest income
Total other-than-temporary impairment loss on investment securities		(192	)		(55	)		—
Less: Portion of loss recognized in other comprehensive income (before taxes)		—			—			—
Net other-than temporary impairment losses on investment securities		(192	)		(55	)		—
Net gain on sale of investment securities		866			838			1,112
Net gain on investment securities		674			783			1,112
Net (loss) gain on trading activities		(40	)		33			156
Fees for services to customers		1,621			1,657			1,687
ATM and debit card		1,651			1,571			1,485
Retail brokerage and advisory		603			686			657
Bank-owned life insurance		308			307			472
Merchant		334			298			299
Net gain on sale of loans		320			356			258
Loss on sale of indirect lease financing portfolio		(223	)		—			—
Gain on sale of internet domain name		—			—			1,000
Other		419			341			416
Total non-interest income		5,667			6,032			7,542

Non-interest expense
Salaries and employee benefits		12,011			12,076			11,649
Net occupancy		1,750			1,762			1,705
Furniture and equipment		1,753			1,726			1,753
Marketing		806			805			841
Third party services		1,691			1,703			1,677
Telephone, postage and supplies		752			731			730
State taxes		666			681			617
FDIC insurance premiums		568			631			686
Other		2,166			2,283			1,968
Total non-interest expense		22,163			22,398			21,626
Income before income taxes		11,978			10,803			11,642
Provision for income taxes		3,054			2,570			2,644
Net income	$	8,924		$	8,233		$	8,998
Earnings per share - basic	$	2.64		$	2.47		$	2.73
Earnings per share - diluted	$	2.63		$	2.46		$	2.72
Cash dividends per share	$	1.20		$	1.16		$	1.12

The accompanying notes are an integral part of the consolidated financial statements.

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

										Accumulated
	Number of									Other
	Shares		Common				Retained			Comprehensive			Treasury
(in thousands, except share and per share data)	Outstanding		Stock		Surplus		Earnings			Income (Loss)			Stock			Total
Balance, December 31, 2013		3,271,658	$	2,148	$	13,747	$	65,618		$	(3,412	)	$	(2,476	)	$	75,625
Net income				—		—		8,998			—			—			8,998
Other comprehensive income, net of tax				—		—		—			4,319			—			4,319
Cash dividends declared ($1.12 per share)				—		—		(3,688	)		—			—			(3,688	)
Stock issued in connection with dividend reinvestment and stock purchase plan		29,288		18		731		—			—			—			749
Stock issued for employee stock purchase plan		3,239		2		72		—			—			—			74
Stock issued for options exercised		12,473		8		157		—			—			—			165
Tax benefit of stock options exercised				—		29		—			—			—			29
Stock-based compensation expense				—		83		—			—			—			83
Balance, December 31, 2014		3,316,658	$	2,176	$	14,819	$	70,928		$	907		$	(2,476	)	$	86,354
Net income				—		—		8,233			—			—			8,233
Other comprehensive loss, net of tax				—		—		—			(1,453	)		—			(1,453	)
Cash dividends declared ($1.16 per share)				—		—		(3,872	)		—			—			(3,872	)
Stock issued in connection with dividend reinvestment and stock purchase plan		30,667		19		852		—			—			—			871
Stock issued for employee stock purchase plan		3,186		2		81		—			—			—			83
Stock issued for options exercised		9,283		6		115		—			—			—			121
Tax benefit of stock options exercised				—		21		—			—			—			21
Stock-based compensation expense				—		85		—			—			—			85
Balance, December 31, 2015		3,359,794	$	2,203	$	15,973	$	75,289		$	(546	)	$	(2,476	)	$	90,443
Net income				—		—		8,924			—			—			8,924
Other comprehensive loss, net of tax				—		—		—			(3,211	)		—			(3,211	)
Cash dividends declared ($1.20 per share)				—		—		(4,066	)		—			—			(4,066	)
Stock issued in connection with dividend reinvestment and stock purchase plan		31,595		19		964		—			—			—			983
Stock issued for employee stock purchase plan		2,932		2		79		—			—			—			81
Stock issued for options exercised		17,380		11		297		—			—			—			308
Tax benefit of stock options exercised				—		17		—			—			—			17
Stock-based compensation expense				—		88		—			—			—			88
Balance, December 31, 2016		3,411,701	$	2,235	$	17,418	$	80,147		$	(3,757	)	$	(2,476	)	$	93,567

The accompanying notes are an integral part of the consolidated financial statements.

	(in thousands)
Year ended December 31,	2016			2015			2014
Operating Activities
Net income	$	8,924		$	8,233		$	8,998
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		891			1,024			1,167
Provision for loan losses		30			200			400
Net gain on investment securities available-for-sale		(674	)		(783	)		(1,112	)
Net (gain) loss on sale of other real estate owned, repossessed assets and premises and equipment		(2	)		17			2
Net gain on sale of loans		(320	)		(356	)		(258	)
Loss on sale of indirect lease financing portfolio		223			—			—
Gain on sale of internet domain name		—			—			(1,000	)
Proceeds from sales of residential mortgages held-for-sale		9,204			10,903			6,589
Origination of residential mortgages held-for-sale		(8,686	)		(11,154	)		(6,711	)
Income on bank-owned life insurance		(308	)		(307	)		(472	)
Stock-based compensation expense		88			85			83
Net decrease (increase) in trading securities		593			18			(4,207	)
Deferred income tax (benefit) provision		(145	)		—			368
Net increase (decrease) in income taxes payable		48			77			(65	)
Net (increase) decrease in accrued interest receivable		(566	)		6			11
Amortization of mortgage servicing rights and change in valuation allowance		75			80			62
Net amortization of premiums and discounts on investment securities		1,846			2,094			2,148
Net increase (decrease) in accrued interest payable		5			(14	)		(48	)
Increase in other assets		(363	)		(71	)		(100	)
Increase (decrease) in other liabilities		469			(936	)		122
Net cash provided by operating activities		11,332			9,116			5,977
Investing Activities
Proceeds from payments, maturities and calls of investment securities available-for-sale		107,278			94,372			82,360
Proceeds from maturities of investment securities held-to-maturity		147			—			—
Proceeds from the sale of investment securities available-for-sale		32,573			47,960			29,972
Purchases of investment securities available-for-sale		(174,943	)		(132,048	)		(92,017	)
Proceeds from redemption of investment in restricted bank stock		1,482			1,319			3,673
Purchase of restricted bank stock		(1,991	)		(1,180	)		(2,556	)
Net increase in loans		(26,567	)		(60,850	)		(55,263	)
Proceeds from sale of indirect lease financing portfolio held for investment		8,345			—			—
Net purchases of premises and equipment		(317	)		(580	)		(995	)
Proceeds from sale of internet domain name		—			—			1,000
Redemption of bank-owned life insurance		—			—			234
Proceeds from sales of other real estate owned and repossessed assets		2			3,245			152
Net cash used in investing activities		(53,991	)		(47,762	)		(33,440	)
Financing Activities
Net increase in non-interest bearing deposits		20,467			11,623			10,933
Net increase in interest-bearing deposits		3,102			26,571			26,127
Net increase in short-term borrowings		15,497			1,974			33
Repayments of long-term debt		—			—			(5,000	)
Tax benefit from exercise of stock options		17			21			29
Cash dividends paid, net of reinvestment		(3,556	)		(3,445	)		(3,328	)
Proceeds from issuance of common stock		862			648			628
Net cash provided by financing activities		36,389			37,392			29,422
Increase in cash and cash equivalents		(6,270	)		(1,254	)		1,959
Cash and cash equivalents at beginning of year		16,991			18,245			16,286
Cash and cash equivalents at end of period	$	10,721		$	16,991		$	18,245
Supplemental Cash Flow Disclosures
Interest paid	$	4,728		$	4,520		$	4,592
Income taxes paid		3,132			2,479			2,310
Non-cash transactions:
Transfer of loans to repossessed assets or other real estate owned		—			215			373
Unsettled trades to purchase securities		—			494			1,355

The accompanying notes are an integral part of the consolidated financial statement.

QNB Corp. (the “Company”), through its wholly-owned subsidiary, QNB Bank (the “Bank”), has been serving the residents and businesses of Bucks, Lehigh, and Montgomery counties in Pennsylvania since 1877. The Bank is a locally managed community bank that provides a full range of commercial, retail banking and retail brokerage services. The Bank encounters vigorous competition for market share in the communities it serves from bank holding companies, other community banks, thrift institutions, credit unions and other non-bank financial organizations such as mutual fund companies, insurance companies and brokerage companies. The Company manages its business as a single operating segment.

The Bank is a Pennsylvania chartered commercial bank. The Company and the Bank are subject to regulations of certain state and Federal agencies. These regulatory agencies periodically examine the Company and the Bank for adherence to laws and regulations.

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, the Bank. The consolidated entity is referred to herein as “QNB”. All significant inter-company accounts and transactions have been eliminated in the consolidated financial statements.

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

These statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and predominant practices within the banking industry. The preparation of these consolidated financial statements requires QNB to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. QNB evaluates estimates on an on-going basis. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the determination of the valuation of other real estate owned, the fair value of financial instruments, other-than-temporary impairment of investment securities, the determination of impairment of restricted bank stock and the valuation of deferred tax assets 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.

Most of the Company’s activities are with customers located within Bucks, Montgomery and Lehigh Counties in southeastern Pennsylvania. Note 4 discusses the types of investment securities in which the Company invests. Note 5 discusses the types of lending in which the Company engages. The Company does not have any significant concentrations to any one industry or customer. Although the Company has a diversified loan portfolio, its debtors’ ability to honor their contracts is influenced by the region’s economy.

For purposes of the statement of cash flows, cash and cash equivalents consist of cash on hand, cash items in process of collection, amounts due from banks, interest-bearing deposits in the Federal Reserve Bank and other banks and Federal funds sold. QNB maintains a portion of its interest-bearing deposits at various commercial financial institutions. At times, the balances exceed the FDIC insured limits.

The Company engages in trading activities for its own account. Interest and dividends are included in interest income. Debt and equity securities that are bought and held principally for the purpose of selling in the near term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. In 2014, QNB sold approximately $5,000,000 in available-for-sale municipal securities and established a trading account with a broker consisting of municipal securities and a

brokerage cash account. At December 31, 2016 and 2015, the balance of municipal securities at fair value was $3,596,000 and $4,189,000, respectively, and the amount in the brokerage cash account was $1,499,000 and $1,349,000, respectively.

Investment 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. Interest and dividends are included in interest income. Debt and equity 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 in other comprehensive income or loss, a separate component of shareholders’ equity. Management determines the appropriate classification of securities at the time of purchase.

Available-for-sale securities include securities that management intends to use as part of its asset/liability management strategy and that may be sold in response to changes in credit ratings, changes in market interest rates and related changes in the securities’ prepayment risk or to meet liquidity needs.

Premiums and discounts on debt securities are recognized in interest income using a constant yield method. Gains and losses on sales of available-for-sale securities are recorded on the trade date and are computed on the specific identification method and included in non-interest income.

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 prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support realizable value equal to or greater than carrying value of the investment. For equity securities, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced to fair value and a corresponding charge to earnings is recognized.

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 would be amortized prospectively over the remaining life of the security based on the timing of future estimated cash flows of the security.

Restricted bank stock is comprised of restricted stock of the Federal Home Loan Bank of Pittsburgh (“FHLB”) in the amount of $1,005,000 and the Atlantic Community Bankers Bank in the amount of $12,000 at December 31, 2016. Federal law requires a member institution of the FHLB to hold stock of its district bank according to a predetermined formula. These restricted securities are carried at cost.

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

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

Non-performing assets are comprised of accruing loans past due 90 days or more, non-accrual loans and investment securities, restructured loans, other real estate owned and repossessed assets. Non-accrual loans and investment securities are those on which the accrual of interest has ceased. Loans and indirect lease financing loans are placed on non-accrual status immediately if, in the opinion of management, collection is doubtful, or when principal or interest is past due 90 days or more and collateral is insufficient to cover principal and interest. Interest accrued, but not collected at the date a loan is placed on non-accrual status, is reversed and charged against interest income. Subsequent cash receipts are applied either to the outstanding principal or recorded as interest income, depending on management’s assessment of the ultimate collectability of principal and interest. Loans are returned to an accrual status when the borrower’s ability to make periodic principal and interest payments has returned to normal (i.e. brought current with respect to principal or interest or restructured) and the paying capacity of the borrower and/or the underlying collateral is deemed sufficient to cover principal and interest.

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

Accounting for impairment in the performance of a loan is required when it is probable that all amounts, including both principal and interest, will not be collected in accordance with the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, at the loan’s observable market price or the fair value of the collateral if the loans are collateral dependent. Impairment criteria are applied to the loan portfolio exclusive of smaller homogeneous loans such as residential mortgage and consumer loans which are evaluated collectively for impairment.

Loans are fully charged-off or charged down to net realizable value (fair value of collateral less estimated costs to sell) when deemed uncollectible due to bankruptcy or other factors, or when they reach a defined number of days past due based on loan product, industry practice, terms and other factors.

Loans are considered past due when contractually required principal or interest payments have not been made on the due dates.

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

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

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

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

Management believes that it uses the best information available to make determinations about the adequacy of the allowance and that it has established its existing allowance for loan losses in accordance with GAAP. If circumstances differ substantially from the assumptions used in making determinations, future adjustments to the allowance for loan losses may be necessary and results of operations could be affected. Because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above.

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Servicing assets are recognized as separate assets when rights are acquired through the sale of financial assets. When mortgage loans are sold, a portion of the cost of originating the loan is allocated to the servicing rights based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The Company subsequently measures servicing rights using the amortization method where servicing rights are amortized in proportion to and over the period of estimated net servicing income. On a quarterly basis, an independent third party determines the fair value of QNB’s servicing assets. These assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranches. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the valuation allowance may be recorded as an increase to income. Capitalized servicing rights are reported in other assets and are amortized into other non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.

Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan and are recorded as other non-interest income when earned and netted against the amortization of mortgage servicing rights.

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. At both December 31, 2016 and 2015, the Company had no foreclosed assets.

Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are calculated principally on an accelerated or straight-line basis over the estimated useful lives of the assets, or the shorter of the estimated useful life or lease term for leasehold improvements, as follows:

Expenditures for maintenance and repairs are charged to operations as incurred. Gains or losses upon disposition are reflected in earnings as realized.

The Bank invests in bank-owned life insurance (“BOLI”) as a source of funding for employee benefit expenses. BOLI involves the purchasing of life insurance by the Bank on a select group of employees. The Bank is the owner and beneficiary of the policies. Income from the increase in cash surrender value of the policies as well as the receipt of death benefits is included in non-interest income on the consolidated statement of income. The BOLI policies are an asset that can be liquidated, if necessary, with associated tax costs. However, QNB intends to hold these policies and, accordingly, has not provided for deferred income taxes on the earnings from the increase in cash surrender value.

The Company follows the accounting guidance for postretirement benefit aspects of endorsement split-dollar life insurance arrangements which applies to life insurance arrangements that provide an employee with a specified benefit that is not limited to the employee’s active service period, including certain bank-owned life insurance policies. It requires an employer to recognize a liability and related compensation costs for future benefits that extend to postretirement periods. The expense recorded during 2016, 2015 and 2014 was approximately $94,000, $69,000 and $21,000, respectively, and is included in non-interest expense under salaries and benefits expense. The increase in 2016 is due to updated life expectancy assumptions for the actuarial calculations. The 2015 increase was a result of a reduction in the discount rate utilized to calculate the liability.

At December 31, 2016, QNB sponsored stock-based compensation plans, administered by a Board committee, under which both qualified and non-qualified stock options may be granted periodically to certain employees. QNB accounts for all awards granted under stock-based compensation plans in accordance with FASB 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.

Stock-based compensation expense was approximately $88,000, $85,000 and $83,000 for the years ended December 31, 2016, 2015 and 2014, respectively. There was no tax benefit recognized related to this compensation for the years ended December 31, 2016, 2015 and 2014.

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

The weighted average fair value per share of options granted during 2016, 2015 and 2014 was $3.79, $4.38 and $3.81, respectively. The risk-free interest rate was selected based upon yields of U.S. Treasury issues with a term equal to the expected life of the option being valued. Historical information was the primary basis for the selection of the expected dividend yield, expected volatility and expected lives of the options.

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.

In connection with the accounting guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions, QNB has evaluated its tax positions as of December 31, 2016. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that has more than a 50 percent likelihood of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. Under the “more-likely-than-not” threshold guidelines, QNB believes no significant uncertain tax positions exist, either individually or in the aggregate, that would give rise to the non-recognition of an existing tax benefit. As of December 31, 2016, QNB had no material unrecognized tax benefits or accrued interest and penalties. QNB’s policy is to account for interest as a component of interest expense and penalties as a component of other expense. The Company and its subsidiary are subject to U.S. Federal income tax as well as income tax of the Commonwealth of Pennsylvania and the State of New Jersey.

Basic earnings per share excludes any dilutive effects of options and is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share gives effect to all dilutive potential common shares that were outstanding during the period. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.

Comprehensive income (loss) is defined as the change in equity of a business entity during a period due to transactions and other events and circumstances, excluding those resulting from investments by and distributions to owners. Comprehensive income (loss) consists of net income and other comprehensive income (loss). For QNB, the primary component of other comprehensive income (loss) is the unrealized holding gains or losses on available-for-sale investment securities and unrealized losses on available-for-sale investment securities related to factors other than credit on debt securities.

The Company recognizes revenue in the consolidated statements of income as it is earned and when collectability is reasonably assured. The primary source of revenue is interest income from interest earning assets, which is recognized on the accrual basis of accounting using the effective interest method. The recognition of revenues from interest earning assets is based upon formulas from underlying loan agreements, securities contracts or other similar contracts. Non-interest income is recognized on the accrual basis of accounting as services are provided or as transactions occur. Non-interest income includes fees from brokerage and advisory service,

deposit accounts, merchant services, ATM and debit card fees, mortgage banking activities, and other miscellaneous services and transactions.

Advertising costs are recorded in the period they are incurred within operating expenses in non-interest expense in the consolidated statements of income.

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. The Company uses the same credit policies in making commitments and contractual obligations as it does for on-balance-sheet instruments. The Company reflects its estimate of credit risk for these instruments in other liabilities on the consolidated balance sheet with the corresponding expense recorded in other operating expenses in the consolidated statement of income.

QNB has evaluated events and transactions occurring subsequent to the balance sheet date of December 31, 2016 through the date the consolidated financial statements are being issued for items that should potentially be recognized or disclosed in these consolidated financial statements.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU was issued to help improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. The ASU’s core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This guidance does not apply to revenue associated with financial instruments, including loans, securities, and derivatives that are accounted for under other U.S. GAAP guidance. For that reason, we do not expect it to have a material impact on our consolidated results of operations for elements of the statement of income associated with financial instruments, including securities gains, interest income and interest expense. However, we do believe the new standard will result in new disclosure requirements. We are currently in the process of reviewing contracts to assess the impact of the new guidance on our service offerings that are in the scope of the guidance, included in non-interest income such as insurance commission fees, service charges, payment processing fees, trust services fees, and brokerage services fees. The Company is continuing to evaluate the effect of the new guidance on revenue sources other than financial instruments on our financial position and consolidated results of operations. The guidance is effective for the QNB’s financial statements beginning January 1, 2018. The guidance allows an entity to apply the new standard either retrospectively or through a cumulative effect adjustment as of January 1, 2018.

On January 5, 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This ASU was issued to enhance the reporting model for financial instruments to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. It will require the following:

This ASU is effective for public companies for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. If QNB had adopted this guidance on December 31, 2016 it would have resulted in an increase in net

income of $171,000. There would have been no impact on shareholder’s equity as the equity securities held by QNB are already recorded at fair value through accumulated other comprehensive income (loss).

On February 25, 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This new standard on accounting for leases introduces a lessee model that brings most leases on the balance sheet, but recognizes expenses in the income statement similar to how items are recorded today. The new standard eliminates the requirement in current U.S. GAAP for an entity to use bright-line tests in determining lease classification. The ASU also eliminates the current real estate-specific provisions and changes the guidance on sale-leaseback transactions, initial direct costs and lease executory costs for all entities. All entities will classify leases to determine how to recognize the related revenue and expense and this classification will affect amounts that lessors record on the balance sheet. The new guidance will be effective for public companies for annual periods beginning after December 15, 2018, and interim periods therein. Early adoption is permitted. QNB is evaluating the provisions of ASU 2016-02, but expects to report increased assets and liabilities as a result of reporting additional leases as a right-of-use asset and lease liabilities on the Company's consolidated statement of financial condition.

On March 15, 2016, the FASB issued ASU 2016-07, Investments – Equity Method and Joint Ventures (Topic 323), Simplifying the Transition to the Equity Method of Accounting. This ASU simplifies the equity method of accounting by eliminating the requirement to retrospectively apply the equity method to an investment that subsequently qualifies for such accounting as a result of an increase in the level of ownership interest or degree of influence. The ASU further requires that unrealized holding gains or losses in accumulated other comprehensive income related to an available-for-sale security that becomes eligible for the equity method be recognized in earnings as of the date on which the investment qualifies for the equity method. The guidance in the ASU is effective for all entities for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years; early adoption is permitted for all entities. QNB does not anticipate the adoption of this guidance will have a material impact on its consolidated financial statements.

On March 17, 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606), Principal versus Agent Considerations (Reporting Revenue Gross versus Net). This ASU amends the principal-versus agent implementation guidance and illustrations in the Board’s new revenue standard (ASU 2014-09). The FASB issued the ASU in response to concerns identified by stakeholders, including those related to (1) determining the appropriate unit of account under the revenue standard’s principal-versus-agent guidance and (2) applying the indicators of whether an entity is a principal or an agent in accordance with the revenue standard’s control principle. This ASU clarifies that an entity should evaluate whether it is the principal or the agent for each specified good or service promised in a contract with a customer. The ASU has the same effective date as the new revenue standard (as amended by the one-year deferral and the early adoption provisions in ASU 2015-14).

On March 30, 2016, the FASB issued ASU 2016-09, Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accounting. This ASU simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Entities will be required to recognize the income tax effects of awards in the income statement when awards vest or are settled which will eliminate additional-paid-in-capital or APIC pools. For public companies, the ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. QNB is evaluating this new standard, but does not anticipate the adoption of this guidance will have a material impact on its consolidated financial statements.

On June 16, 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326). The new guidance requires organizations to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts.

The new guidance affects organizations that hold financial assets and net investments in leases that are not accounted for at fair value with changes in fair value reported in net income. The new guidance affects loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash.

For public business entities that are U.S. Securities and Exchange Commission (SEC) filers, the new guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. QNB is currently assessing the potential impact on our consolidated financial statements; however, due to the significant differences in the revised guidance from existing GAAP, the implementation of this guidance may result in material changes in our accounting for credit losses on financial instruments.

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

There were 23,500, 21,000, and 28,700 stock options that were anti-dilutive as of December 31, 2016, 2015, and 2014 respectively. These stock options were not included in the above calculation.

On January 24, 2008, QNB announced that the Board of Directors authorized the repurchase of up to 50,000 shares of its common stock in open market or privately negotiated transactions. On February 9, 2009, the Board of Directors approved increasing the authorization to 100,000 shares. The repurchase authorization does not bear a termination date. There were no shares repurchased during the years ended December 31, 2016 or 2015. As of December 31, 2016 and 2015, 57,883 shares were repurchased under this authorization at an average price of $16.97 and a total cost of $982,000 and were recorded to Treasury stock.

Included in cash and cash equivalents are reserves in the form of deposits with the Federal Reserve Bank of Philadelphia. As of December 31, 2016 and 2015 QNB was not required to maintain reserves with the Federal Reserve Bank of Philadelphia.

Starting in 2014, QNB engaged in trading activities for its own account. Municipal securities that are held principally for resale in the near term are recorded in the trading account at fair value with changes in fair value recorded in net gain on trading activities in non-interest income. There were net realized and unrealized losses of $40,000 and gains of $33,000 for the years ended December 31, 2016 and 2015, respectively. Unrealized gains on trading activity related to trading securities still held at December 31, 2016 and 2015 totaled $69,000 and $31,000, respectively. Interest and dividends are included in interest income.

Trading securities, at fair value, at December 31, 2016 and 2015 were as follows:

The amortized cost and fair values of investment securities available-for-sale at December 31, 2016 and 2015 were as follows:

The amortized cost and fair value of securities available-for-sale by contractual maturity at December 31, 2016 are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities are assigned to categories based on contractual maturity except for mortgage-backed securities and CMOs which are based on the estimated average life of these securities and state and municipal securities which are based on pre-refunded date, if applicable.

Proceeds from sales of investment securities available-for-sale were $32,573,000, $47,960,000 and $29,972,000 for the years ended December 31, 2016, 2015, and 2014, respectively.

The following table presents information related to the Company’s gains and losses on the sales of equity and debt securities, and losses recognized for the other-than-temporary impairment (OTTI) of these investments.

December 31,	2016
						Other-than-
	Gross		Gross			temporary
	realized		realized			impairment
	gains		losses			losses			Net gains
Equity securities	$	758		—		$	(192	)	$	566
Debt securities		181	$	(73	)		—			108
Total	$	939	$	(73	)	$	(192	)	$	674


December 31,	2015
						Other-than-
	Gross		Gross			temporary
	realized		realized			impairment
	gains		losses			losses			Net gains
Equity securities	$	714	$	(23	)	$	(55	)	$	636
Debt securities		229		(82	)		—			147
Total	$	943	$	(105	)	$	(55	)	$	783


December 31,	2014
						Other-than-
	Gross		Gross			temporary
	realized		realized			impairment
	gains		losses			losses			Net gains
Equity securities	$	1,051	$	(6	)	$	—		$	1,045
Debt securities		310		(243	)		—			67
Total	$	1,361	$	(249	)	$	—		$	1,112

The tax expense applicable to the net realized gains were $229,000, $266,000 and $378,000 for the years ended December 31, 2016, 2015, and 2014, respectively.

There were no other-than-temporary impairment charges recognized for debt securities still held by QNB for the years ended December 31, 2016, 2015, or 2014.

QNB recognizes OTTI for debt securities classified as available-for-sale in accordance with FASB ASC 320, Investments – Debt and Equity Securities, which requires that we assess whether we intend to sell or it is more likely than not that the Company will be required to sell a security before recovery of its amortized cost basis less any current-period credit losses. For debt securities that are

considered other-than-temporarily impaired and that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, the amount of the impairment is separated into the amount that is credit related (credit loss component) and the amount due to all other factors. The credit loss component is recognized in earnings and is the difference between the security’s amortized cost basis and the present value of its expected future cash flows discounted at the security’s effective yield. The remaining difference between the security’s fair value and the present value of future expected cash flows is due to factors that are not credit related and, therefore, is not required to be recognized as a loss in the consolidated statement of income, but is recognized in other comprehensive income (loss). For equity securities, once a decline in value is determined to be other-than-temporary, the value of the equity security is reduced to fair value and a corresponding charge to earnings is recognized. QNB believes that we will fully collect the carrying value of securities on which we have recorded a non-credit related impairment in other comprehensive income (loss).

The following table presents a rollforward of the credit loss component recognized in earnings. The credit loss component of the amortized cost represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses. The beginning balance represents the credit loss component for debt securities for which OTTI occurred prior to the beginning of the year. Credit-impaired debt securities must be presented in two components based upon whether the current period is the first time the debt security was credit-impaired (initial credit impairment) or is not the first time the debt security was credit-impaired (subsequent credit impairments). No credit impairments were recognized in 2016, 2015, or 2014. The following table presents a summary of the cumulative credit-related other-than-temporary impairment charges recognized as components of earnings for debt securities still held by QNB:

There were no remaining held-to-maturity investment securities at December 31, 2016. The amortized cost and fair value of investment securities held-to-maturity at December 31, 2015 was as follows:

There were no sales of investment securities classified as held-to-maturity during 2016, 2015, or 2014.

At December 31, 2016 and 2015, investment securities available-for-sale totaling $166,628,000 and $197,149,000, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.

Securities that have been in a continuous unrealized loss position are as follows:

December 31, 2016
			Less than 12 months					12 months or longer					Total
	No. of		Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	securities		value		losses			value		losses			value		losses
U.S. Government agency		55	$	72,626	$	(2,118	)	$	—	$	—		$	72,626	$	(2,118	)
State and municipal		70		29,280		(398	)		—		—			29,280		(398	)
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		88		123,087		(2,241	)		—		—			123,087		(2,241	)
Collateralized mortgage obligations (CMOs)		68		56,853		(1,269	)		15,426		(577	)		72,279		(1,846	)
Pooled trust preferred		5		—		—			1,952		(891	)		1,952		(891	)
Corporate debt		4		4,002		(57	)		—		—			4,002		(57	)
Equity		16		2,985		(268	)		888		(60	)		3,873		(328	)
Total		306	$	288,833	$	(6,351	)	$	18,266	$	(1,528	)	$	307,099	$	(7,879	)

December 31, 2015
			Less than 12 months					12 months or longer					Total
	No. of		Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	securities		value		losses			value		losses			value		losses
U.S. Government agency		32	$	40,949	$	(418	)	$	4,426	$	(72	)	$	45,375	$	(490	)
State and municipal		20		6,646		(19	)		1,555		(12	)		8,201		(31	)
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		62		90,796		(871	)		1,403		(49	)		92,199		(920	)
Collateralized mortgage obligations (CMOs)		49		28,372		(261	)		26,354		(917	)		54,726		(1,178	)
Pooled trust preferred		5		—		—			2,193		(897	)		2,193		(897	)
Corporate debt		6		5,988		(95	)		—		—			5,988		(95	)
Equity		19		4,035		(695	)		193		(75	)		4,228		(770	)
Total		193	$	176,786	$	(2,359	)	$	36,124	$	(2,022	)	$	212,910	$	(4,381	)

Management evaluates debt securities, which are comprised of U.S. Government Agencies, state and municipalities, mortgage-backed securities, CMOs and other issuers, for OTTI and considers the current economic conditions, the length of time and the extent to which the fair value has been less than cost, interest rates and the bond rating of each security. The unrealized losses at December 31, 2016 in U.S. Government securities, state and municipal securities, mortgage-backed securities, CMOs and corporate debt securities are primarily the result of interest rate fluctuations. If held to maturity, these bonds will mature at par, and QNB will not realize a loss. QNB has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs.

The Company’s investment in marketable equity securities primarily consists of investments in large cap stock companies. These equity securities are analyzed for impairment on an ongoing basis. QNB evaluated the near-term prospects of the issuers in relation to the severity and duration of the impairment as well as the individual issuer’s financial condition, industry, geographic and legal environment. Based on that evaluation the Company recorded impairment charges of $192,000 to non-interest income for equity holdings during 2016. QNB has the ability and intent to hold the remaining securities in an unrealized loss position at December 31, 2016 and does not consider the remaining equity securities to be other-than-temporarily impaired.

QNB holds six pooled trust preferred securities as of December 31, 2016. These securities have a total amortized cost of $2,909,000 and a fair value of $2,281,000. Five of the six securities have been in an unrealized loss position for more than twelve months. All of the pooled trust preferred securities are available-for-sale securities and are carried at fair value.

The following table provides additional information related to pooled trust preferred securities (PreTSLs) as of December 31, 2016:

Deal	Class		Book value		Fair value		Unrealized gains (losses)			Realized OTTI credit loss (YTD 2016)		Total recognized OTTI credit loss			Moody's /Fitch ratings	Current number of performing banks		Current number of performing insurance companies		Actual deferrals and defaults as a % of total collateral			Total performing collateral as a % of outstanding bonds
PreTSL IV	Mezzanine	*	$	243	$	186	$	(57	)	$	—	$	(1	)	B1/BB		5		—		18.0	%		141.4	%
PreTSL XVII	Mezzanine			597		458		(139	)		—		(222	)	C/CC		34		5		21.7			100.0
PreTSL XIX	Mezzanine			848		467		(381	)		—		—		Caa1/CC		40		12		6.9			102.6
PreTSL XXV	Mezzanine			766		512		(254	)		—		(222	)	Ca/C		44		5		24.2			89.7
PreTSL XXVI	Mezzanine			389		329		(60	)		—		(270	)	Caa3/C		45		7		18.0			97.7
PreTSL XXVI	Mezzanine			66		329		263			—		(438	)	Caa3/C		45		7		18.0			97.7
Total			$	2,909	$	2,281	$	(628	)	$	—	$	(1,153	)

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

On January 14, 2014, Federal bank regulatory agencies released a final rule authorizing retention of pooled trust preferred securities backed primarily by bank-issued trust preferred securities which included the PreTSLs held by QNB. Due to the uncertainty invoked between the original release of the Volcker Rule and the final rule, there was a noticeable increase in trading activity. However, we believe most of these trades occurred under distress and do not represent trades made in an orderly market. Despite the trades that took place as discussed previously, the market for these securities at December 31, 2016 was not active and markets for similar securities also are not active. The new issue market is also inactive and the market values for these securities are depressed relative to historical levels. Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are all factors contributing to the temporary impairment of these securities. Although these securities are classified as available-for-sale, the Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs. As illustrated in the previous table, these securities are comprised mainly of securities issued by banks, and to a lesser degree, insurance companies. QNB owns the mezzanine tranches of these securities, except for PreTSL IV which represents the senior-most obligation of the trust.

On a quarterly basis we evaluate our trust preferred debt securities for other-than-temporary impairment (OTTI), which involves the use of a third-party valuation firm to assist management with the valuation. When evaluating these investments a credit-related portion and a non-credit related portion of impairment are determined. The credit related portion is recognized in earnings and represents the expected shortfall in future cash flows. The non-credit related portion is recognized in other comprehensive income and represents the difference between the book value and the fair value of the security less any current quarter credit related impairment. No other-than-temporary impairment charges representing credit impairment were recognized on our pooled trust preferred collateralized debt obligations for the years ended December 31, 2016, 2015, or 2014. A discounted cash flow analysis provides the best estimate of credit related OTTI for these securities. Additional information related to this analysis follows:

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

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

Based upon the analysis performed by management as of December 31, 2016, it is probable that we will collect all contractual principal and interest payments on one of our six pooled trust preferred securities, PreTSL XIX. The expected principal shortfall on the remaining pooled trust preferred securities has resulted in credit related other-than-temporary impairment charges in previous years. All of these pooled trust preferred securities held by QNB could be subject to additional write-downs in the future if additional deferrals and defaults occur.

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

Overdrafts are reclassified as loans and are included in consumer loans above and total loans on the balance sheet. At December 31, 2016 and 2015, overdrafts were $171,000 and $203,000, respectively.

QNB generally lends in its trade area which is comprised of Quakertown and the surrounding communities. To a large extent, QNB makes loans collateralized at least in part by real estate. Its lending activities could be affected by changes in the general economy, the regional economy, or real estate values. Other than disclosed in the table above, at December 31, 2016, there were no concentrations of loans exceeding 10% of total loans.

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

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

Indirect lease financing receivables represent loans to small businesses that are collateralized by equipment. These loans tend to have higher risk characteristics but generally provide higher rates of return. These loans are originated by a third party and purchased by QNB based on criteria specified by QNB. The criteria include minimum credit scores of the borrower, term of the lease, type and age of equipment financed and geographic area. The geographic area primarily represents states contiguous to Pennsylvania. QNB is not the lessor and does not service these loans. In October 2016, the Company sold its interest in these third-party originated lease financing receivables, recording a loss on sale of $223,000, which was essentially offset by a $220,000 reversal of the allowance for loan losses associated with this sold portfolio.

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

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

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

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

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

The following tables present the classes of the loan portfolio summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company’s internal risk rating system as of December 31, 2016 and 2015:

For retail loans, the Company evaluates credit quality based on the performance of the individual credits. The following tables present the recorded investment in the retail classes of the loan portfolio based on payment activity as of December 31, 2016 and 2015:

The performance and credit quality of the loan portfolio is also monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following table presents the classes of the loan portfolio (excluding deferred fees and costs) summarized by the past due status, regardless of whether the loan is on non-accrual status, as of December 31, 2016 and 2015:

The following tables disclose the recorded investment in loans receivable that are either on non-accrual status or past due 90 days or more and still accruing interest as of December 31, 2016 and 2015:

Activity in the allowance for loan losses for the years ended December 31, 2016, 2015 and 2014 are as follows:

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

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

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

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

price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

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

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

Performing TDRs (not reported as non-accrual or past due 90 days or more and still accruing) totaled $1,819,000 and $1,288,000 as of December 31, 2016 and 2015, respectively. Non-performing TDRs totaled $3,555,000 and $990,000 as of December 31, 2016 and 2015, respectively. All TDRs are included in impaired loans.

The following table illustrates the specific reserve for loan losses allocated to loans modified as TDRs. These specific reserves are included in the allowance for loan losses for loans individually evaluated for impairment. There were charge-offs resulting from loans modified as TDRs of $0, $5,000 and $909,000 during the years ended December 31, 2016, 2015 and 2014, respectively.

There were 16 newly identified TDRs during the year ended December 31, 2016. The TDR concessions involved extension of a maturity date, renewal of a line of credit and concessions to lower monthly payments which included interest only periods. As of December 31, 2016 and 2015, QNB had commitments of $30,000 and $1,919,000, respectively, to lend additional funds to customers with loans whose terms have been modified in troubled debt restructurings.

The following table presents loans, by loan class, modified as TDRs during the years ended December 31, 2016 and 2015. The pre-modification outstanding recorded investment disclosed represents the carrying amounts immediately prior to the modification of the loan. The post-modification outstanding recorded investment is net of loan repayments.

The following table presents loans modified as TDRs, included above, within the previous 12 months from December 31, 2016 and 2015, for which there was a payment default, past due 60 days or more, during the respective year end.

The company had no mortgages secured by residential real estate for which foreclosure proceedings were in process as of December 31, 2016. There were seven mortgage loans secured by residential real estate for which foreclosure proceedings were in process at December 31, 2015. The recorded investment was $197,000.

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

	Allowance for Loan Losses						Loans Receivable
December 31, 2016	Balance		Balance related to loans individually evaluated for impairment		Balance related to loans collectively evaluated for impairment		Balance		Balance individually evaluated for impairment		Balance collectively evaluated for impairment
Commercial:
Commercial and industrial	$	1,459	$	696	$	763	$	110,233	$	5,134	$	105,099
Construction		449		—		449		39,268		224		39,044
Secured by commercial real estate		2,646		—		2,646		255,188		6,383		248,805
Secured by residential real estate		1,760		494		1,266		68,731		2,313		66,418
State and political subdivisions		123		—		123		35,260		—		35,260
Retail:
1-4 family residential mortgages		366		8		358		47,124		748		46,376
Home equity loans and lines		353		—		353		71,525		111		71,414
Consumer		76		—		76		5,670		93		5,577
Unallocated		162	N/A		N/A		N/A		N/A		N/A
Total	$	7,394	$	1,198	$	6,034	$	632,999	$	15,006	$	617,993

	Allowance for Loan Losses						Loans Receivable
December 31, 2015	Balance		Balance related to loans individually evaluated for impairment		Balance related to loans collectively evaluated for impairment		Balance		Balance individually evaluated for impairment		Balance collectively evaluated for impairment
Commercial:
Commercial and industrial	$	1,521	$	712	$	809	$	124,397	$	4,586	$	119,811
Construction		286		—		286		27,372		364		27,008
Secured by commercial real estate		2,411		14		2,397		235,171		6,998		228,173
Secured by residential real estate		1,812		203		1,609		63,164		2,113		61,051
State and political subdivisions		222		—		222		40,285		—		40,285
Indirect lease financing		164		20		144		10,371		146		10,225
Retail:
1-4 family residential mortgages		350		25		325		42,833		583		42,250
Home equity loans and lines		428		—		428		67,384		151		67,233
Consumer		76		—		76		4,286		—		4,286
Unallocated		284	N/A		N/A		N/A		N/A		N/A
Total	$	7,554	$	974	$	6,296	$	615,263	$	14,941	$	600,322

The following table summarizes additional information in regards to impaired loans by loan portfolio class as of December 31, 2016 and 2015:

	December 31, 2016						December 31, 2015
	Recorded investment (after charge-offs)		Unpaid principal balance		Related allowance		Recorded investment (after charge-offs)		Unpaid principal balance		Related allowance
With no specific allowance recorded:
Commercial:
Commercial and industrial	$	2,482	$	2,862	$	—	$	3,629	$	3,923	$	—
Construction		224		234		—		364		364		—
Secured by commercial real estate		6,383		6,367		—		6,932		7,416		—
Secured by residential real estate		1,046		1,438		—		942		1,653		—
Indirect lease financing		—		—		—		3		3		—
Retail:
1-4 family residential mortgages		570		589		—		393		406		—
Home equity loans and lines		111		174		—		151		201		—
Consumer		93		95		—		—		—		—
Total	$	10,909	$	11,759	$	—	$	12,414	$	13,966	$	—

With an allowance recorded:
Commercial:
Commercial and industrial	$	2,652	$	2,812	$	696	$	957	$	1,086	$	712
Construction		—		—		—		—		—		—
Secured by commercial real estate		—		—		—		66		66		14
Secured by residential real estate		1,267		1,435		494		1,171		1,279		203
Indirect lease financing		—		—		—		143		145		20
Retail:
1-4 family residential mortgages		178		193		8		190		197		25
Home equity loans and lines		—		—		—		—		—		—
Consumer		—		—		—		—		—		—
Total	$	4,097	$	4,440	$	1,198	$	2,527	$	2,773	$	974

Total:
Commercial:
Commercial and industrial	$	5,134	$	5,674	$	696	$	4,586	$	5,009	$	712
Construction		224		234		—		364		364		—
Secured by commercial real estate		6,383		6,367		—		6,998		7,482		14
Secured by residential real estate		2,313		2,873		494		2,113		2,932		203
Indirect lease financing		—		—		—		146		148		20
Retail:
1-4 family residential mortgages		748		782		8		583		603		25
Home equity loans and lines		111		174		—		151		201		—
Consumer		93		95		—		—		—		—
Total	$	15,006	$	16,199	$	1,198	$	14,941	$	16,739	$	974

The following table presents additional information in regards to the average recorded investment and interest income recognized on impaired loans for the years ended December 31, 2016, 2015 and 2014:

Premises and equipment, stated at cost less accumulated depreciation and amortization, are summarized below:

Depreciation and amortization expense on premises and equipment amounted to $891,000, $1,024,000, and $1,167,000 for the years ended December 31, 2016, 2015 and 2014, respectively.

Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were $78,380,000 and $79,295,000 at December 31, 2016 and 2015, respectively.

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

The balance of these mortgage servicing rights are included in other assets at December 31, 2016 and 2015 and the fair value of these rights was $579,000 and $642,000, respectively. The fair value of servicing rights was determined using discount rates ranging from 14% to 16 % for 2016 and 10% to 12% for 2015.

The annual estimated amortization expense of intangible assets for each of the five succeeding fiscal years is as follows:

On November 26, 2014, QNB transferred its former internet domain name to a third party and recorded a gain of $1,000,000, as disclosed in a Form 8-K filing dated December 2, 2014. As a result of the purchase of an additional domain name, QNB recorded the purchase price of $8,000 as an intangible asset in other assets in 2014. This asset has no amortization expense as it has an indefinite life.

The aggregate amount of time deposits, including deposits in denominations of $100,000 or more, was $225,582,000 and $227,376,000 at December 31, 2016 and 2015, respectively. Time deposits that meet or exceed the FDIC insurance limit of $250,000 at December 31, 2016 and 2015 were $34,446,000 and $34,507,000, respectively.

At December 31, 2016, the scheduled maturities of time deposits were as follows:

The Bank has four unsecured Federal funds lines granted by correspondent banks totaling $46,000,000. Federal funds purchased under these lines were $0 at both December 31, 2016 and 2015.

FHLB advances are collateralized by certain mortgage loans and also require the purchase of FHLB capital stock, which is included within restricted investment in bank stock on the consolidated balance sheets. QNB’s FHLB stock is $1,005,000 and $496,000 at December 31, 2016 and 2015, respectively.

QNB has a maximum borrowing capacity with the FHLB of approximately $248,199,000. At December 31, 2016 QNB had $7,321,000 in borrowings outstanding with the FHLB reported in Note 9 as other short-term borrowings. QNB had no borrowings outstanding with the FHLB at December 31, 2015.

At December 31, 2016 and 2015, the tax effects of temporary differences that represent the significant portion of deferred tax assets and liabilities are as follows:

The ability to realize deferred tax assets is dependent upon a variety of factors, including the generation of future taxable income, the existence of taxes paid and recoverable, the reversal of deferred tax liabilities and tax planning strategies. Based upon these and other factors, management believes it is more likely than not that QNB will realize the benefits of the above deferred tax assets.

A reconciliation of the tax provision on income before taxes computed at the statutory rate of 34% and the actual tax provision was as follows:

The QNB Bank Retirement Savings Plan provides for elective employee contributions up to the maximum allowed by the IRS and a matching company contribution limited to t3%. In addition, the plan provides for safe harbor non-elective contributions of 5% of total compensation by QNB. QNB contributed a matching contribution of approximately $206,000, $240,000 and $224,000 for the years ended December 31, 2016, 2015, and 2014, respectively, and a safe harbor contribution of approximately $445,000 for 2016, $441,000 for 2015, and $421,000 for 2014.

QNB’s Employee Stock Purchase Plan (the Plan) offers eligible employees an opportunity to purchase shares of QNB Corp. common stock at a 10% discount from the lesser of fair market value on the first or last day of each offering period (as defined by the Plan). At the 2016 Annual Meeting, shareholders approved the 2016 Employee Stock Purchase Plan (the 2016 Plan), which authorizes the issuance of 30,000 shares. As of December 31, 2016, 1,392 shares were issued under the 2016 Plan. The 2016 Plan expires May 31, 2021. The 2011 Employee Stock Purchase Plan (the 2011 Plan), which was approved by shareholders at the 2011 Annual Meeting, expired May 31, 2016. A total of 17,516 shares were issued under the 2011 plan.

QNB has stock option plans (the Plans) administered by a committee which consists of three or more members of QNB’s Board of Directors. The Plans provide for the granting of either (i) Non-Qualified Stock Options (NQSOs) or (ii) Incentive Stock Options (ISOs). The exercise price of an option, as defined by the Plans, is the fair market value of QNB’s common stock at the date of grant. The Plans provide for the exercise either in cash or in securities of the Company or in any combination thereof.

The 1998 Plan authorized the issuance of 220,500 shares. The time period by which any option is exercisable under the Plan is determined by the Committee but shall not commence before the expiration of six months after the date of grant or continue beyond the expiration of ten years after the date the option is awarded. The granted options vest after a three-year period. As of December 31, 2016, there were 225,058 options granted, 60,244 options forfeited, 164,814 options exercised and 0 options outstanding under this Plan. The 1998 Plan expired March 10, 2008.

The 2005 Plan authorizes the issuance of 200,000 shares. The terms of the 2005 Plan are identical to the 1998 Plan except the options expire five years after the grant date. As of December 31, 2016, there were 184,200 options granted, 65,050 options forfeited, 68,700 options exercised and 50,450 options outstanding under this Plan. The 2005 Plan expired March 15, 2015.

The 2015 Plan authorizes the issuance of 300,000 shares. The terms of the 2015 Plan are identical to the 2005 plan. There were 23,500 options granted and outstanding and no options forfeited or exercised under this Plan as of December 31, 2016.

As of December 31, 2016, there was approximately $83,000 of unrecognized compensation cost related to unvested stock option awards granted. That cost is expected to be recognized over the next 26 months.

The tax benefits and intrinsic value related to total stock options exercised during 2016, 2015, and 2014 are as follows:

QNB has had, and may be expected to have in the future, banking transactions in the ordinary course of business with its executive officers, directors, principal shareholders, their immediate families and affiliated companies. The following table presents activity and amounts due from directors, principal officers, and their related interests. All of these transactions were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. These transactions did not involve more than normal risk of collectability or present any other unfavorable features.

The following table provides additional information regarding transactions with related parties.

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

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

Standby letters of credit are conditional commitments issued by the Bank to guarantee the financial or performance obligation of a customer to a third party. QNB’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making conditional obligations as it does for on-balance sheet instruments. These standby letters of credit expire within two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending other loan commitments. The Bank requires collateral and personal guarantees supporting these letters of credit as deemed necessary. The amount of collateral obtained for letters of credit and commitments to extend credit is based on management’s credit evaluation of the customer. Collateral varies, but may include real estate, accounts receivable, marketable securities, pledged deposits, inventory or equipment. Management believes that the proceeds obtained through a liquidation of such collateral and the enforcement of personal guarantees would be sufficient to cover the maximum potential amount of future payments required under the corresponding guarantees. The amount of the liability as of December 31, 2016 and 2015 for guarantees under standby letters of credit issued is not material.

QNB has committed to various operating leases for several of their branch and office facilities. Some of these leases include renewal options as well as specific provisions relating to rent increases. The minimum annual rental commitments under these leases outstanding at December 31, 2016 are as follows:

Some of the leases contain renewal options to extend the initial terms of the lease for periods ranging from one to ten years and certain leases allow for multiple extensions. With the exception of the renewals for a land lease related to a permanent branch site, the commitment for such renewals is not included above if they have not been exercised as of December 31, 2016. Rent expense under leases, which includes common area maintenance costs not included in the minimum lease payments above, for the years ended December 31, 2016, 2015 and 2014, was $606,000, $621,000 and $553,000, respectively.

The following shows the components of accumulated other comprehensive income (loss) during the periods ended December 31, 2016, 2015 and 2014:

The following table presents amounts reclassified out of accumulated other comprehensive income (loss) for the years ended December 31, 2016, 2015 and 2014:

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

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

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

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

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

December 31, 2016	Quoted prices in active markets for identical assets (Level 1)		Significant other observable input (Level 2)		Significant unobservable inputs (Level 3)		Balance at end of period
Recurring fair value measurements
Trading Securities
State and municipal securities	$	—	$	3,596	$	—	$	3,596

Securities available-for-sale
U.S. Government agency securities		—	$	76,650		—	$	76,650
State and municipal securities		—		72,295		—		72,295
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed securities		—		145,301		—		145,301
Collateralized mortgage obligations (CMOs)		—		77,415		—		77,415
Pooled trust preferred securities		—		—	$	2,281		2,281
Corporate debt securities		—		8,030		—		8,030
Equity securities	$	8,503		—		—		8,503
Total securities available-for-sale	$	8,503	$	379,691	$	2,281	$	390,475
Total recurring fair value measurements	$	8,503	$	383,287	$	2,281	$	394,071

Nonrecurring fair value measurements *
Impaired loans	$	—	$	—	$	2,899	$	2,899
Mortgage servicing rights		—		—		58		58
Total nonrecurring fair value measurements	$	—	$	—	$	2,957	$	2,957

December 31, 2015	Quoted prices in active markets for identical assets (Level 1)		Significant other observable input (Level 2)		Significant unobservable inputs (Level 3)		Balance at end of period
Recurring fair value measurements
Trading Securities
State and municipal securities	$	—	$	4,189	$	—	$	4,189

Securities available-for-sale
U.S. Government agency securities		—	$	61,779		—	$	61,779
State and municipal securities		—		78,954		—		78,954
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed securities		—		136,681		—		136,681
Collateralized mortgage obligations (CMOs)		—		65,610		—		65,610
Pooled trust preferred securities		—		—	$	2,653		2,653
Corporate debt securities		—		9,004		—		9,004
Equity securities	$	7,234		—		—		7,234
Total securities available-for-sale	$	7,234	$	352,028	$	2,653	$	361,915
Total recurring fair value measurements	$	7,234	$	356,217	$	2,653	$	366,104

Nonrecurring fair value measurements *
Impaired loans	$	—	$	—	$	1,698	$	1,698
Mortgage servicing rights		—		—		133		133
Total nonrecurring fair value measurements	$	—	$	—	$	1,831	$	1,831

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

The following table presents additional information about the securities available-for-sale measured at fair value on a recurring basis and for which QNB utilized significant unobservable inputs (Level 3 inputs) to determine fair value for the year ended December 31:

There were no transfers in and out of Level 1 and Level 2 fair value measurements during the years ended December 31, 2016 and 2015. There were also no transfers in or out of level 3 for the same periods. There were no losses included in earnings attributable to the change in unrealized gains or losses relating to the available-for-sale securities above with fair value measurements utilizing significant unobservable inputs for the years ended December 31, 2016 and 2015, respectively.

The Level 3 securities consist of six collateralized debt obligation securities, PreTSL securities, which are backed by trust preferred securities issued by banks, thrifts, and insurance companies. As discussed in Note 4, despite the fact that there were some trades during 2016, the market for these securities at December 31, 2016 was not active and markets for similar securities also are not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which PreTSLs trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive and there are currently very few market participants who are willing and or able to transact for these securities.

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

Due to the inactive market for these securities, the Bank engaged an independent third party to value the securities using a discounted cash flow analysis. The estimated cash flows are based on specific assumptions about defaults, deferrals and prepayments of the trust preferred securities underlying each PreTSL. The resulting collateral cash flows are allocated to the bond waterfall using the INTEXcalc valuation model. Default rates are calculated based upon a comparison of key financial ratios of active individual issuers without a short-term probability of default compared to all FDIC insured banks. The base loss severity assumption and long-term loss severity assumptions are modeled at 95%. The severity factor for near-term default is vectored to reflect the relative expected performance of the institutions modeled to default, with lower forecasted severities used for the higher quality institutions. Prepayments are modeled to take into account the disruption in the asset-backed securities marketplace and the lack of new pooled trust preferred issuances. For those institutions rated below investment grade the holding companies’ approximate cost of long-term funding given their rating and marketplace interest rate was estimated. The following assumption was made; any holding company that could refinance for a cost savings of more than 2% will refinance and will do so as soon as possible. Finally, for issuers not impacted by the Tier 1 regulatory capital legislation enacted by the Dodd-Frank Act, the issuers that have shown a recent history of prepayment of both floating rate and fixed rate issues were identified and it was assumed these issuers will prepay as soon as possible.

The internal rate of return is the pre-tax yield used to discount the best estimate of future cash flows after credit losses. The cash flows have been discounted using estimated market discount rates of 3-month LIBOR plus spreads ranging from 5.35% to 8.22%. The determination of appropriate market discount rates involved the consideration of the following:

The analysis of discount rates involved the review of corporate bond spreads for banks, U.S. Treasury yields, credit default swap rates for financial companies (utilized as a proxy for credit), the swap/LIBOR yield curve and the characteristics of the individual securities being valued. For a further discussion of PreTSL valuation, see Note 4, Investment Securities.

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

The following methods and assumptions were used to estimate the fair values of each major classification of financial instrument and non-financial asset at December 31, 2016 and 2015:

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

Investment securities: trading (carried at fair value), available-for-sale (carried at fair value) and held-to-maturity (carried at amortized cost): The fair value of securities are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1), or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices. Level 2 debt securities are valued by a third-party pricing service commonly used in the banking industry. Level 2 fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution date, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things. For certain securities which are not traded in active markets or are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments are generally based on available market evidence (Level 3). In the absence of such evidence, management’s best estimate is used. Management’s best estimate consists of both internal and external support on certain Level 3 investments. Cash flow models using a present value formula that includes assumptions market participants would use along with indicative exit pricing obtained from broker/dealers (where available) were used to support fair values of certain Level 3 investments.

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

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

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

Impaired Loans (generally carried at fair value): Impaired loans are loans in which the Company has measured impairment generally based on the fair value of the loan’s collateral. Fair value is generally determined based upon independent third-party appraisals of the properties, or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values, based upon the lowest level of input that is significant to the fair value measurements. Included in the fair value of impaired loans at December 31, 2016 and 2015 were $0 and $145,000, respectively, of loans that had no specific reserves required at year end; however, were partially charged-off at year end.

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

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

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

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

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

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

					Fair value measurements
December 31, 2016	Carrying amount		Fair value		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Financial assets
Cash and cash equivalents	$	10,721	$	10,721	$	10,721		—		—
Investment securities:
Trading		3,596		3,596		—	$	3,596		—
Available-for-sale		390,475		390,475		8,503		379,691	$	2,281
Restricted investment in bank stocks		1,017		1,017		—		1,017		—
Loans held-for-sale		789		789		—		789		—
Net loans		625,685		626,052		—		—		626,052
Mortgage servicing rights		498		579		—		—		579
Accrued interest receivable		3,128		3,128		—		3,128		—

Financial liabilities
Deposits with no stated maturities	$	687,773	$	687,773	$	687,773		—	$	—
Deposits with stated maturities		225,582		225,403		—	$	225,403		—
Short-term borrowings		52,660		52,660		52,660		—		—
Accrued interest payable		335		335		—		335		—

Off-balance sheet instruments
Commitments to extend credit	$	—	$	—	$	—	$	—	$	—
Standby letters of credit		—		—		—		—		—

					Fair value measurements
December 31, 2015	Carrying amount		Fair value		Quoted prices in active markets for identical assets (Level 1)		Significant other observable inputs (Level 2)		Significant unobservable inputs (Level 3)
Financial assets
Cash and cash equivalents	$	16,991	$	16,991	$	16,991		—		—
Investment securities:
Trading		4,189		4,189		—	$	4,189		—
Available-for-sale		361,915		361,915		7,234		352,028	$	2,653
Held-to-maturity		147		151		—		151		—
Restricted investment in bank stocks		508		508		—		508		—
Loans held-for-sale		987		1,004		—		1,004		—
Net loans		607,716		610,315		—		—		610,315
Mortgage servicing rights		504		642		—		—		642
Accrued interest receivable		2,562		2,562		—		2,562		—

Financial liabilities
Deposits with no stated maturities	$	662,410	$	662,410	$	662,410		—	$	—
Deposits with stated maturities		227,376		227,862		—	$	227,862		—
Short-term borrowings		37,163		37,163		37,163		—		—
Accrued interest payable		330		330		—		330		—

Off-balance sheet instruments
Commitments to extend credit	$	—	$	—	$	—	$	—	$	—
Standby letters of credit		—		—		—		—		—

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

Both the Company and the Bank are subject to regulatory capital requirements administered by Federal bank regulatory agencies. Failure to meet minimum capital requirements can initiate actions by regulators that could have an effect on the financial statements. Under the framework for prompt corrective action, both the Company and the Bank must meet capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items. The final rules implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (“Basel III”) became effective for QNB on January 1, 2015, with full compliance with all the of final rule’s requirements phased in over a multi-year schedule, to be fully phased-in by January 1, 2019.

Under the final rules, minimum requirements increased for both the quantity and quality of capital held by banks. The rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets and increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented. The final rules also revised the definition and calculation of Tier 1 capital, Total Capital, and risk-weighted assets.

The capital amounts and classification are also subject to qualitative judgments by the regulators. Management believes, as of December 31, 2016, that the Company and the Bank met capital adequacy requirements to which they were subject.

The Bank is presently considered to be “well capitalized” under the regulatory framework. To be categorized as well capitalized, the Company and the Bank must maintain minimum ratios set forth in the table below.

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

	Capital levels
	Actual					Adequately capitalized					Well capitalized
As of December 31, 2016	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total risk-based capital (to risk-weighted assets):
Consolidated	$	104,820		12.75	%	$	65,777		8.00	%	$	82,221		10.00	%
Bank		96,478	12.10				63,792	8.00				79,740	10.00

Tier I capital (to risk-weighted assets):
Consolidated		97,320	11.84				49,333	6.00				49,333	6.00
Bank		89,025	11.16				47,844	6.00				63,792	8.00

Common equity tier 1 capital (to risk-weighted assets):
Consolidated		97,320	11.84				36,999	4.50			N/A		N/A
Bank		89,025	11.16				35,883	4.50				51,831	6.50

Tier I capital (to average assets):
Consolidated		97,320	9.16				42,479	4.00			N/A		N/A
Bank		89,025	8.45				42,144	4.00				52,680	5.00

	Capital levels
	Actual					Adequately capitalized					Well capitalized
As of December 31, 2015	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total risk-based capital (to risk-weighted assets):
Consolidated	$	98,432		12.58	%	$	62,613		8.00	%	$	78,266		10.00	%
Bank		91,091	11.97				60,874	8.00				76,093	10.00

Tier I capital (to risk-weighted assets):
Consolidated		90,819	11.60				46,960	6.00				46,960	6.00
Bank		83,478	10.97				45,656	6.00				60,874	8.00

Common equity tier 1 capital (to risk-weighted assets):
Consolidated		90,819	11.60				35,220	4.50			N/A		N/A
Bank		83,478	10.97				34,242	4.50				49,460	6.50

Tier I capital (to average assets):
Consolidated		90,819	8.87				40,934	4.00			N/A		N/A
Bank		83,478	8.22				40,632	4.00				50,790	5.00

The unaudited quarterly results of operations for the years ended 2016 and 2015 are in the following table:

	Quarters Ended 2016									Quarters Ended 2015
	March 31		June 30		Sept. 30		Dec. 31			March 31		June 30		Sept. 30		Dec. 31
Interest income	$	8,280	$	8,184	$	8,287	$	8,486		$	7,807	$	7,746	$	8,138	$	8,184
Interest expense		1,159		1,165		1,202		1,207			1,120		1,104		1,123		1,159
Net interest income		7,121		7,019		7,085		7,279			6,687		6,642		7,015		7,025
Provision for (credit to) loan losses		125		—		—		(95	)		—		60		—		140
Non-interest income		1,576		1,374		1,644		1,073			1,677		1,599		1,493		1,263
Non-interest expense		5,519		5,593		5,616		5,435			5,527		5,664		5,573		5,634
Income before income taxes		3,053		2,800		3,113		3,012			2,837		2,517		2,935		2,514
Provision for income taxes		788		702		821		743			701		583		715		571
Net Income	$	2,265	$	2,098	$	2,292	$	2,269		$	2,136	$	1,934	$	2,220	$	1,943
Earnings Per Share - basic *	$	0.67	$	0.62	$	0.68	$	0.67		$	0.64	$	0.58	$	0.66	$	0.58
Earnings Per Share - diluted *	$	0.67	$	0.62	$	0.67	$	0.66		$	0.64	$	0.58	$	0.66	$	0.58

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Under the supervision and with the participation of QNB’s Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO (its principal executive officer and principal financial officer), management has evaluated the effectiveness of the design and operation of QNB’s disclosure controls and procedures as of December 31, 2016. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission, or the SEC, and that such information is accumulated and communicated to QNB’s management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

Based on and as of the date of such evaluation, our CEO and CFO concluded that the design and operation of our disclosure controls and procedures were effective as of the end of the period covered by this Report.

Information required by this item is set forth in Management’s Report and Report of Independent Registered Public Accounting Firm, both of which are incorporated by reference into this item.

On May 14, 2013, COSO issued an updated version of its Internal Control – Integrated Framework, referred to as the 2013 COSO Framework. Management’s assessment of the overall effectiveness of our internal controls over financial reporting for the year ended December 31, 2016 was based on the 2013 COSO Framework.

There were no changes to the Company’s internal controls over financial reporting (as defined in Rule 13a-15(f)) of the Securities Exchange Act) during the quarter ended December 31, 2016 that materially affected, or are reasonably likely to materially affect, the Company’s control over financial reporting.

The information required by Item 10 is incorporated by reference to information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2017 Annual Meeting of Shareholders under the captions:

The Company has adopted a Code of Business Conduct and Ethics applicable to its CEO, CFO and Controller as well as its long-standing Code of Ethics which applies to all directors and employees. The codes are available on the Company’s website at www.qnbbank.com.

The information required by Item 11 is incorporated by reference to the information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2017 Annual Meeting of Shareholders under the captions:

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table summarizes QNB’s equity compensation plan information as of December 31, 2016. Information is included for both equity compensation plans approved by QNB shareholders and equity compensation plans not approved by QNB shareholders.

Additional information required by Item 12 is incorporated by reference to the information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2017 Annual Meeting of Shareholders under the captions:

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by Item 13 is incorporated by reference to the information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2017 Annual Meeting of Shareholders under the captions:

The information required by Item 14 is incorporated by reference to the information appearing in QNB Corp.’s definitive proxy statement to be used in connection with the 2017 Annual Meeting of Shareholders under the captions:

The following financial statements are included by reference in Part II, Item 8 hereof.

The financial statement schedules required by this Item are omitted because the information is either inapplicable, not required or is in the consolidated financial statements as a part of this Report.

3. The following exhibits are incorporated by reference herein or filed with this Form 10-K:

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report is signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

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

15 North Third Street, P.O. Box 9005 Quakertown, PA	18951-9005
(Address of Principal Executive Offices)	(Zip Code)

Title of each class	Name of each exchange on which registered
None	N/A

PART I		PAGE

Item 1	Business	3

Item 1A	Risk Factors	10

Item 1B	Unresolved Staff Comments	14

Item 2	Properties	14

Item 3	Legal Proceedings	15

Item 4	Mine Safety Disclosures	15

PART II

Item 5	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	16


Item 6	Selected Financial Data	18

Item 7	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

Item 7A	Quantitative and Qualitative Disclosures about Market Risk	48

Item 8	Financial Statements and Supplementary Data	49

Item 9	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	100

Item 9A	Controls and Procedures	100

Item 9B	Other Information	100

PART III

Item 10	Directors, Executive Officers and Corporate Governance	101

Item 11	Executive Compensation	101

Item 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	101

Item 13	Certain Relationships and Related Transactions, and Director Independence	102

Item 14	Principal Accounting Fees and Services	102

PART IV

Item 15	Exhibits, Financial Statement Schedules	102

•	Quakertown, PA - Downtown Office - 15 North Third Street	Owned

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

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

•	Quakertown, PA - Country Square Office - 240 South West End Boulevard	Leased

•	Quakertown, PA - Quakertown Commons Branch - 901 South West End Boulevard	Leased

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

•	Pennsburg, PA - Pennsburg Square Branch - 410-420 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 Business Office – 1410 West Street Road	Leased

									Cash
	High				Low				dividend
	Bid		Ask		Bid		Ask		per share
2016
First Quarter	$	31.25	$	32.24	$	29.25	$	29.50	$	0.30
Second Quarter		32.00		33.50		29.90		30.40		0.30
Third Quarter		35.00		39.00		32.15		33.25		0.30
Fourth Quarter		36.60		37.00		29.27		33.95		0.30

2015
First Quarter	$	29.25	$	30.13	$	28.05	$	28.35	$	0.29
Second Quarter		30.05		40.00		28.80		28.90		0.29
Third Quarter		30.11		34.00		29.12		29.25		0.29
Fourth Quarter		30.60		33.00		29.27		29.35		0.29

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plan		Maximum Number of Shares that may yet be Purchased Under the Plan

October 1, 2016 through October 31, 2016		—		—		—		42,117
November 1, 2016 through November 30, 2016		—		—		—		42,117
December 1, 2016 through December 31, 2016		—		—		—		42,117
Total		—		—		—		42,117

	Period Ending
Index	12/31/11		12/31/12		12/31/13		12/31/14		12/31/15		12/31/16
QNB Corp.		100.00		109.80		123.79		145.38		166.99		196.79
NASDAQ Composite		100.00		117.45		164.57		188.84		201.98		219.89
SNL Bank $500M-$1B		100.00		128.21		166.25		182.39		205.86		277.96
SNL Mid-Atlantic Bank		100.00		133.96		180.57		196.72		204.10		259.43
SNL Bank Pink > $500M		100.00		110.28		134.03		157.12		174.30		203.22

Investment Portfolio History
December 31,	2016		2015		2014
Trading Securities
State and municipal	$	3,596	$	4,189	$	4,207
Total trading securities	$	3,596	$	4,189	$	4,207
Investment Securities Available-for-Sale
U.S. Government agency	$	76,650	$	61,779	$	62,665
State and municipal		72,295		78,954		72,569
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		145,301		136,681		136,192
Collateralized mortgage obligations (CMOs)		77,415		65,610		87,662
Pooled trust preferred		2,281		2,653		2,439
Corporate debt		8,030		9,004		6,037
Equity		8,503		7,234		7,655
Total investment securities available-for-sale	$	390,475	$	361,915	$	375,219
Investment Securities Held-to-Maturity
State and municipal	$	—	$	147	$	146
Total investment securities held-to-maturity	$	—	$	147	$	146
Total investment securities	$	394,071	$	366,251	$	379,572

Loan Maturities and Interest Sensitivity
December 31, 2016	One year or less		After one year through five years		After five years		Total
Commercial:
Commercial and industrial	$	58,003	$	34,998	$	17,232	$	110,233
Construction		15,286		11,453		12,529		39,268
Secured by commercial real estate		2,023		9,177		243,988		255,188
Secured by residential real estate		1,832		5,906		60,993		68,731
State and political subdivisions		106		4,867		30,287		35,260
Retail:
1-4 family residential mortgages		1,285		255		45,584		47,124
Home equity loans and lines		5,457		6,041		60,027		71,525
Consumer		539		1,939		3,192		5,670
Total	$	84,531	$	74,636	$	473,832	$	632,999

Loans at year-end	0.03		0.11		0.24		0.25		0.08
Allowance for loan losses	2.57		8.56		16.55		13.97		3.78
Provision for loan losses	633.33		323.50		331.00		311.75		41.00

Allowance for loan losses to:
Average loans	1.22	%	1.32	%	1.53	%	1.85	%	2.04	%
Loans at year-end	1.17		1.23		1.44		1.78		2.05

Maturity of Time Deposits of $100,000 or More
Year ended December 31,	2016		2015		2014
Three months or less	$	11,618	$	12,124	$	9,599
Over three months through six months		8,211		11,624		9,043
Over six months through twelve months		15,970		13,691		24,207
Over twelve months		58,413		54,686		51,571
Total	$	94,212	$	92,125	$	94,420

Average Deposits by Major Classification
	2016					2015					2014
	Balance		Rate			Balance		Rate			Balance		Rate
Demand, non-interest bearing	$	107,579		—		$	96,146		—		$	80,427		—
Interest-bearing demand		153,598		0.21	%		134,342		0.21	%		118,631		0.23	%
Municipals interest-bearing demand		102,060		0.34			115,975		0.34			120,540		0.33
Money market		71,256		0.27			65,413		0.24			58,333		0.22
Savings		229,779		0.40			217,561		0.37			208,629		0.37
Time		133,407		1.12			141,869		1.09			151,002		1.08
Time of $100,000 or more		94,862		1.37			92,495		1.30			91,522		1.26
Total	$	892,541		0.51	%	$	863,801		0.51	%	$	829,084		0.53	%

Capital Analysis
December 31,	2016			2015
Regulatory Capital
Shareholders' equity	$	93,567		$	90,443
Net unrealized securities losses, net of tax		3,757			546
Net unrealized losses on available-for-sale equity securities, net of tax		—			(167	)
Disallowed goodwill and other disallowed intangible assets		(4	)		(3	)
Common equity tier I capital		97,320			90,819

Tier 1 capital		97,320			90,819
Allowable portion: Allowance for loan losses and reserve for unfunded commitments		7,453			7,613
Unrealized gains on equity securities, net of tax		47			—
Total regulatory capital	$	104,820		$	98,432
Risk-weighted assets	$	822,210		$	782,662
Quarterly average assets for leverage capital purposes	$	1,061,976		$	1,023,362

Capital Ratios
December 31,	2016			2015
Common equity tier I capital / risk-weighted assets		11.84	%		11.60	%
Tier 1 capital/risk-weighted assets		11.84	%		11.60	%
Total regulatory capital / risk-weighted assets		12.75	%		12.58	%
Tier 1 capital/average assets (leverage ratio)		9.16	%		8.87	%

December 31, 2016	One year or less		After one year through three years		After three years through five years		After five years		Total
Time deposits	$	95,803	$	53,965	$	75,814		—	$	225,582
Short-term borrowings		52,660		—		—		—		52,660
Operating leases		470		811		466	$	3,180		4,927
Commitments to extend credit ^(a)		163,076		62,011		3,511		48,618		277,216
Standby letters of credit		16,191		166		—		133		16,490
Total	$	328,200	$	116,953	$	79,791	$	51,931	$	576,875

Estimated change in net interest income
Change in interest rates	December 31,
(basis points)	2016			2015
+300		-10.4	%		-11.1	%
+200		-6.8	%		-7.5	%
+100		-3.3	%		-3.8	%
-100	*NM			*NM


Report of Independent Registered Public Accounting Firm	Page 51
Consolidated Balance Sheets	Page 53
Consolidated Statements of Income	Page 54
Consolidated Statements of Comprehensive Income	Page 55
Consolidated Statements of Shareholders’ Equity	Page 56
Consolidated Statements of Cash Flows	Page 57
Notes to Consolidated Financial Statements	Page 58

/s/ David W. Freeman		/s/ Janice McCracken Erkes
David W. Freeman		Janice McCracken Erkes
Chief Executive Officer		Chief Financial Officer

Buildings		10 to 39 years
Furniture and equipment		3 to 10 years
Leasehold improvements		2 to 30 years

			Amortized
December 31, 2016	Fair value		cost
Due in one year or less	$	9,452	$	9,400
Due after one year through five years		176,439		177,748
Due after five years through ten years		182,595		186,496
Due after ten years		13,486		14,280
Equity securities		8,503		8,244
Total investment securities available-for-sale	$	390,475	$	396,168

December 31, 2016	Pass		Special mention		Substandard		Doubtful		Total
Commercial:
Commercial and industrial	$	102,396	$	686	$	7,151	$	—	$	110,233
Construction		39,259		—		9		—		39,268
Secured by commercial real estate		238,290		5,185		11,713		—		255,188
Secured by residential real estate		65,169		231		3,331		—		68,731
State and political subdivisions		35,260		—		—		—		35,260
Total	$	480,374	$	6,102	$	22,204	$	—	$	508,680

December 31, 2016	Performing		Non-performing		Total
Retail:
1-4 family residential mortgages	$	46,858	$	266	$	47,124
Home equity loans and lines		71,436		89		71,525
Consumer		5,577		93		5,670
Total	$	123,871	$	448	$	124,319

December 31, 2016	30-59 days past due		60-89 days past due		90 days or more past due		Total past due loans		Current		Total loans receivable
Commercial:
Commercial and industrial	$	463		—		—	$	463	$	109,770	$	110,233
Construction		214		—		—		214		39,054		39,268
Secured by commercial real estate		64	$	395	$	1,596		2,055		253,133		255,188
Secured by residential real estate		—		—		285		285		68,446		68,731
State and political subdivisions		—		—		—		—		35,260		35,260
Retail:
1-4 family residential mortgages		1,459		323		—		1,782		45,342		47,124
Home equity loans and lines		107		15		—		122		71,403		71,525
Consumer		14		2		—		16		5,654		5,670
Total	$	2,321	$	735	$	1,881	$	4,937	$	628,062	$	632,999

December 31, 2016	90 days or more past due (still accruing)		Non-accrual
Commercial:
Commercial and industrial	$	—	$	4,798
Construction		—		—
Secured by commercial real estate		—		3,007
Secured by residential real estate		—		1,866
State and political subdivisions		—		—
Retail:
1-4 family residential mortgages		—		266
Home equity loans and lines		—		89
Consumer		—		93
Total	$	—	$	10,119

Year ended December 31, 2016	Balance, beginning of period		Provision for (credit to) loan losses			Charge-offs			Recoveries		Balance, end of period
Commercial:
Commercial and industrial	$	1,521	$	41		$	(140	)	$	37	$	1,459
Construction		286		163			—			—		449
Secured by commercial real estate		2,411		227			—			8		2,646
Secured by residential real estate		1,812		(44	)		(120	)		112		1,760
State and political subdivisions		222		(99	)		—			—		123
Indirect lease financing		164		(121	)		(52	)		9		—
Retail:
1-4 family residential mortgages		350		16			—			—		366
Home equity loans and lines		428		(91	)		—			16		353
Consumer		76		60			(92	)		32		76
Unallocated		284		(122	)	N/A			N/A			162
Total	$	7,554	$	30		$	(404	)	$	214	$	7,394

Year ended December 31, 2015	Balance, beginning of period		Provision for (credit to) loan losses			Charge-offs			Recoveries		Balance, end of period
Commercial:
Commercial and industrial	$	1,892	$	(353	)	$	(56	)	$	38	$	1,521
Construction		297		(11	)		—			—		286
Secured by commercial real estate		2,700		(214	)		(84	)		9		2,411
Secured by residential real estate		1,630		687			(531	)		26		1,812
State and political subdivisions		221		1			—			—		222
Indirect lease financing		93		76			(21	)		16		164
Retail:
1-4 family residential mortgages		312		38			—			—		350
Home equity loans and lines		453		(47	)		—			22		428
Consumer		85		57			(95	)		29		76
Unallocated		318		(34	)	N/A			N/A			284
Total	$	8,001	$	200		$	(787	)	$	140	$	7,554

Year ended December 31, 2014	Balance, beginning of period		Provision for (credit to) loan losses			Charge-offs			Recoveries		Balance, end of period
Commercial:
Commercial and industrial	$	2,044	$	(202	)	$	(17	)	$	67	$	1,892
Construction		439		(142	)		—			—		297
Secured by commercial real estate		2,898		(131	)		(70	)		3		2,700
Secured by residential real estate		1,632		1,019			(1,069	)		48		1,630
State and political subdivisions		186		35			—			—		221
Loans to depository institutions		4		(4	)		—			—		—
Indirect lease financing		103		15			(39	)		14		93
Retail:
1-4 family residential mortgages		303		103			(95	)		1		312
Home equity loans and lines		583		(84	)		(156	)		110		453
Consumer		64		142			(167	)		46		85
Unallocated		669		(351	)	N/A			N/A			318
Total	$	8,925	$	400		$	(1,613	)	$	289	$	8,001

2017	$	95,803
2018		34,019
2019		19,946
2020		30,752
2021		45,062
Thereafter		—
Total time deposits	$	225,582

December 31,	Securities sold under agreements to repurchase^(a)			Other short - term borrowings ^(b)
2016
Balance	$	45,339		$	7,321
Maximum indebtedness at any month end		45,339			7,321
Daily average indebtedness outstanding		38,835			1,365
Average rate paid for the year		0.37	%		0.66	%
Average rate on period-end borrowings		0.38			0.77

2015
Balance	$	37,163			—
Maximum indebtedness at any month end		37,163			—
Daily average indebtedness outstanding		31,364		$	547
Average rate paid for the year		0.37	%		0.34	%
Average rate on period-end borrowings		0.37			—

	Number of options			Weighted average exercise price		Weighted average remaining contractual term (in years)		Aggregate intrinsic value
Outstanding at December 31, 2013		115,800		$	23.51
Exercised		(20,050	)		17.82
Forfeited		(27,375	)		29.66
Granted		20,000			25.16
Outstanding at December 31, 2014		88,375		$	23.27
Exercised		(13,750	)		18.11
Forfeited		(12,750	)		31.80
Granted		21,000			29.25
Outstanding at December 31, 2015		82,875			24.33
Exercised		(22,700	)		20.90
Forfeited		(9,725	)		25.60
Granted		23,500			30.40
Outstanding at December 31, 2016		73,950		$	27.14		2.62	$	640
Exercisable at December 31, 2016		18,825		$	22.52		0.69	$	250

	Options outstanding		Exercise price		Remaining life (in years)		Options exercisable		Exercise price
		6,950	$	21.35		0.07		6,950	$	21.35
		11,875		23.20		1.06		11,875		23.20
		13,775		25.16		2.08		—		—
		17,850		29.25		3.08		—		—
		23,500		30.40		4.13		—		—
Outstanding at December 31, 2016		73,950	$	27.14		2.62		18,825	$	22.52

Balance, December 31, 2015	$	11,122
New loans		8,869
Repayments		(12,144	)
Balance, December 31, 2016	$	7,847

	Minimum lease payments
2017	$	470
2018		418
2019		393
2020		273
2021		193
Thereafter		3,180
Total	$	4,927

	Amount reclassified from accumulated other comprehensive income (loss)
Details about accumulated other comprehensive income (loss)	2016			2015			2014			Affected line item in statement of income
Unrealized net holding gains on available-for-sale securities	$	866		$	838		$	1,112		Net gain on sale of investment securities
Other-than-temporary impairment losses on investment securities		(192	)		(55	)		—		Net other-than-temporary impairment losses on investment securities
		674			783			1,112
Tax effect		(229	)		(266	)		(378	)	Provision for income taxes
Total reclassification out of accumulated other comprehensive income (loss), net of tax	$	445		$	517		$	734		Net of tax

	Fair value measurements using significant unobservable inputs (Level 3)
Securities available-for-sale	2016			2015
Balance, beginning of year	$	2,653		$	2,439
Payments received		(381	)		(228	)
Total gains or losses (realized/unrealized)
Included in earnings		—			—
Included in other comprehensive income		9			442
Transfers in and/or out of Level 3		—			—
Balance, end of year	$	2,281		$	2,653