7. INVESTMENT SECURITIES

The amortized cost and estimated fair values of investment securities available-for-sale at June 30, 2011 and December 31, 2010 were as follows:

Available-for-Sale

June 30, 2011

			Gross		Gross
	Aggregate		unrealized		unrealized holding losses
	fair		holding		Non-credit				Amortized
	value		gains		OTTI		Other		cost
U.S. Government agency securities	$	67,713	$	334		-	$	265	$	67,644
State and municipal securities		69,319		1,180		-		96		68,235
U.S. Government agencies and sponsored enterprises (GSEs) - residential:
Mortgage-backed securities		108,291		2,848		-		139		105,582
Collateralized mortgage obligations (CMOs)		74,245		1,763		-		34		72,516
Other debt securities		2,472		60	$	1,164		514		4,090
Equity securities		4,054		813		-		71		3,312
Total investment securities available-for-sale	$	326,094	$	6,998	$	1,164	$	1,119	$	321,379

December 31, 2010

			Gross		Gross
	Aggregate		unrealized		unrealized holding losses
	fair		holding		Non-credit				Amortized
	value		gains		OTTI		Other		cost
U.S. Government agency securities	$	66,448	$	241		-	$	869	$	67,076
State and municipal securities		63,588		675		-		514		63,427
U.S. Government agencies and sponsored enterprises (GSEs) - residential:
Mortgage-backed securities		78,801		2,438		-		311		76,674
Collateralized mortgage obligations (CMOs)		75,573		1,890		-		137		73,820
Other debt securities		2,384		69	$	1,224		550		4,089
Equity securities		3,770		667		-		43		3,146
Total investment securities available-for-sale	$	290,564	$	5,980	$	1,224	$	2,424	$	288,232

The amortized cost and estimated fair value of securities available-for-sale by contractual maturity at June 30, 2011 are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities are assigned to categories based on contractual maturity except for mortgage-backed securities and CMOs which are based on the estimated average life of these securities.

	Aggregate		Amortized
	fair value		cost
Due in one year or less	$	16,008	$	15,519
Due after one year through five years		199,693		195,441
Due after five years through ten years		57,329		57,010
Due after ten years		49,010		50,097
Equity securities		4,054		3,312
Total investment securities available-for-sale	$	326,094	$	321,379

Proceeds from sales of investment securities available-for-sale were $23,434,000 and $2,476,000 for the six months ended June 30, 2011 and 2010, respectively.

At June 30, 2011 and December 31, 2010, investment securities available-for-sale totaling $138,742,000 and $133,446,000, respectively, were pledged as collateral for repurchase agreements and deposits of public funds.

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

Six months ended June 30, 2011:

						Other-than-
	Gross		Gross			temporary
	realized		realized			impairment		Net gains
	gains		losses			losses		(losses)
Equity securities	$	141	$	-		$	-	$	141
Debt securities		248		(378	)		-		(130	)
Total	$	389	$	(378	)	$	-	$	11

Six months ended June 30, 2010:

						Other-than-
	Gross		Gross			temporary
	realized		realized			impairment			Net gains
	gains		losses			losses			(losses)
Equity securities	$	287	$	-		$	-		$	287
Debt securities		10		(2	)		(226	)		(218	)
Total	$	297	$	(2	)	$	(226	)	$	69

All OTTI writedowns on debt securities were on pooled trust preferred securities, which are included in the other debt securities category, held at the Bank.

The tax expense applicable to the net realized gains was $4,000 and $23,000 for the six months ended June 30, 2011 and 2010, respectively.

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

The table below presents a rollforward of the credit loss component recognized in earnings. The credit loss component of the amortized cost represents the difference between the present value of expected future cash flows and the amortized cost basis of the security prior to considering credit losses. The beginning balance represents the credit loss component for debt securities for which OTTI occurred prior to January 1, 2011. 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 2011. If we sell, intend to sell or believe we will be required to sell previously credit-impaired debt securities, the credit loss component would be reduced. The following table presents a summary of the cumulative credit-related other-than-temporary impairment charges recognized as components of earnings for debt securities still held by QNB:

	Three Months		Six Months
	Ended		Ended
	June 30, 2011		June 30, 2011
Balance, beginning of period	$	1,279	$	1,279
Additions:
Initial credit impairments		-		-
Subsequent credit impairments		-		-
Balance, end of period	$	1,279	$	1,279

The amortized cost and estimated fair values of investment securities held-to-maturity at June 30, 2011 and December 31, 2010 were as follows:

Held-To-Maturity

June 30, 2011

December 31, 2010

Gross

unrealized

Aggregate

unrealized

Aggregate

Amortized

holding

fair

Amortized

holding

fair

cost

gains

losses

value

cost

gains

losses

value

State and municipal securities

$ 1,842

$ 63

$ 1,905

$ 2,667

$ 62

$ 2,729

The amortized cost and estimated fair value of securities held-to-maturity by contractual maturity at June 30, 2011 are shown in the following table. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Aggregate		Amortized
	fair value		cost
Due in one year or less		-		-
Due after one year through five years	$	247	$	240
Due after five years through ten years		1,658		1,602
Due after ten years		-		-
Total investment securities held-to-maturity	$	1,905	$	1,842

There were no sales of investment securities classified as held-to-maturity during the six months ended June 30, 2011 or 2010.

The following table indicates the length of time individual securities have been in a continuous unrealized loss position at June 30, 2011 and December 31, 2010:

June 30, 2011

			Less than 12 months				12 months or longer				Total
	No. of		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	securities		value		losses		value		losses		value		losses
U.S. Government agencies		18	$	23,137	$	265		-		-	$	23,137	$	265
State and municipal securities		22		10,339		96		-		-		10,339		96
Mortgage-backed securities		24		28,883		139		-		-		28,883		139
Collateralized mortgage
obligations (CMOs)		6		6,802		34		-		-		6,802		34
Other debt securities		7		-		-	$	1,962	$	1,678		1,962		1,678
Equity		4		408		66		117		5		525		71
Total		81	$	69,569	$	600	$	2,079	$	1,683	$	71,648	$	2,283

December 31, 2010

			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 agencies		30	$	40,179	$	869		-		-	$	40,179	$	869
State and municipal securities		40		19,207		482	$	468	$	32		19,675		514
Mortgage-backed securities		19		21,999		311		-		-		21,999		311
Collateralized mortgage
obligations (CMOs)		7		6,918		137		-		-		6,918		137
Other debt securities		7		-		-		1,866		1,774		1,866		1,774
Equity securities		5		740		43		-		-		740		43
Total		108	$	89,043	$	1,842	$	2,334	$	1,806	$	91,377	$	3,648

Management evaluates debt securities, which are comprised of U.S. Government Agencies, state and municipalities, mortgage-backed securities, CMOs and other issuers, for other-than-temporary impairment and considers the current economic conditions, the length of time and the extent to which the fair value has been less than cost, interest rates and the bond rating of each security. The unrealized losses at June 30, 2011 in U.S. Government securities, state and municipal securities, mortgage-backed securities and CMOs are primarily the result of interest rate fluctuations. If held to maturity, these bonds will mature at par, and QNB will not realize a loss. The Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs.

All of the securities in the other debt securities category with unrealized losses greater than twelve months as of June 30, 2011 are pooled trust preferred security issues. QNB holds eight of these securities with an amortized cost of $3,640,000 and a fair value of $1,962,000. 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 as of June 30, 2011:

									Realized															Total
									OTTI			Total							Current		Actual			performing
									credit			Recognized					Current		number of		deferrals and			collateral as
									loss			OTTI			Moody's		number of		performing		defaults as a			a % of
		Book		Fair		Unreal-			(YTD			Credit			/Fitch		performing		insurance		% of total			outstanding
Deal	Class	value		value		ized loss				2011	)	Loss			ratings		banks		companies		collateral			bonds
PreTSL IV	Mezzanine*	$	243	$	213	$	(30	)	$	-		$	(1	)	Ca/CCC			4		-		27.1	%		124.1	%
PreTSL V	Mezzanine*		-		-		-			-			(118	)	Ba3/D			-		-		100.0	%		11.6	%
PreTSL VI	Mezzanine*		121		120		(1	)		-			(8	)	Ca/D			3		-		73.6	%		62.1	%
PreTSL XVII	Mezzanine		752		292		(460	)		-			(222	)	Ca/C			31		4		40.4	%		71.6	%
PreTSL XIX	Mezzanine		988		474		(514	)		-			-			C/C		38		13		27.5	%		81.4	%
PreTSL XXV	Mezzanine		766		341		(425	)		-			(222	)		C/C		39		8		36.7	%		72.2	%
PreTSL XXVI	Mezzanine		469		230		(239	)		-			(270	)		C/C		39		10		27.7	%		82.8	%
PreTSL XXVI	Mezzanine		301		292		(9	)		-			(438	)		C/C		39		10		27.7	%		82.8	%
		$	3,640	$	1,962	$	(1,678	)	$	-		$	(1,279	)

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

The market for these securities at June 30, 2011 is not active and markets for similar securities also are not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which pooled trust preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive and the market values for these securities (and any securities other than those issued or guaranteed by U.S. Government agencies) are depressed relative to historical levels. In today's market, a low market price for a particular bond may only provide evidence of a recent widening of corporate spreads in general versus being an indicator of credit problems with a particular issuer. Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are all factors contributing to the temporary impairment of these securities. Although these securities are classified as available-for-sale, the Company has the intent to hold the securities and does not believe it will be required to sell the securities before recovery occurs. As illustrated in the table above, these securities are comprised mainly of securities issued by banks, and to a lesser degree, insurance companies. QNB owns the mezzanine tranches of these securities.

On a quarterly basis we evaluate our debt securities for other-than-temporary impairment (OTTI), which involves the use of a third-party valuation firm to assist management with the valuation. When evaluating these investments a credit-related portion and a non-credit related portion of OTTI are determined. The credit related portion is recognized in earnings and represents the expected shortfall in future cash flows. The non-credit related portion is recognized in other comprehensive income and represents the difference between the fair value of the security and the amount of credit related impairment. In the six months ended June 30, 2011, no other-than-temporary impairment charges representing credit impairment were recognized on our pooled trust preferred collateralized debt obligations. A discounted cash flow analysis provides the best estimate of credit related OTTI for these securities. Additional information related to this analysis follows:

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

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

Estimate of Future Cash Flows – Cash flows are constructed in an INTEX desktop valuation model. INTEX is a proprietary cash flow model recognized as the industry standard for analyzing all types of structured debt products. It includes each deal's structural features updated with trustee information, including asset-by-asset detail, as it becomes available. The modeled cash flows are then used to determine if all the scheduled principal and interest payments of the investments will be returned. For purposes of the cash flow analysis, relatively modest rates of prepayment were forecasted (ranging from 0-2%). In addition to the base prepayment assumption, due to the recent enactment of the Dodd-Frank financial legislation additional prepayment analysis was performed. First, all fixed-rate trust preferred securities issued by banks with more than $15 billion in total assets at December 31, 2009 were identified. Next the holding companies' approximate cost of long-term funding given their rating and marketplace interest rates were estimated. The following assumption was made; any holding company that could refinance for a cost savings of more than 2% will refinance and will do so on January 1, 2013, or July 1, 2015 for bank holding company subsidiaries of foreign banking organizations that have relied on Supervision and Regulation Letter SR-01-1.

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

Probability of Default – A near-term probability of default is determined for each issuer based on its financial condition and is used to calculate the expected impact of future deferrals and defaults on the expected cash flows. Each issuer in the collateral pool is assigned a near-term probability of default based on individual performance and financial characteristics. Various studies suggest that the rate of bank failures between 1934 and 2008 were approximately 0.36%. Thus, in addition to the specific bank default assumptions used for the near term, future defaults on the individual banks in the analysis are assumed at 0.75% for 2012 (approximately two times historical levels) and for 2013 and beyond the rate used is calculated based upon a comparison of key financial ratios of active individual issuers without a short-term probability of default compared to all FDIC insured banks.