Note 7 - Investment Securities

9 Months Ended

Sep. 30, 2015

Investments, Debt and Equity Securities [Abstract]

Investments in Debt and Marketable Equity Securities (and Certain Trading Assets) Disclosure [Text Block]

7. INVESTMENT SECURITIES

QNB engages 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 non-interest income. There were net realized and unrealized gains of $36,000 and $40,000 recorded for the three months ended September 30, 2015 and 2014, respectively. There were net realized and unrealized gains of $17,000 and $155,000 recorded for the nine months ended September 30, 2015 and 2014, respectively. Unrealized gains on trading activity related to trading securities still held at September 30, 2015 and December 31, 2014 totaled $29,000 and $24,000, respectively. Interest and dividends are included in interest income.

Trading securities, at fair value, at September 30, 2015 and December 31, 2014 were as follows:

	September 30,		December 31,
	2015		2014
State and municipal securities	$	3,625	$	4,207

The amortized cost and estimated fair values of investment securities available-for-sale at September 30, 2015 and December 31, 2014 were as follows:

			Gross		Gross
			unrealized		unrealized
	Fair		holding		holding			Amortized
September 30, 2015	value		gains		losses			cost
U.S. Government agency	$	57,490	$	308	$	(44	)	$	57,226
State and municipal		83,042		1,493		(85	)		81,634
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		133,281		1,793		(203	)		131,691
Collateralized mortgage obligations (CMOs)		73,034		494		(599	)		73,139
Pooled trust preferred		2,600		215		(1,024	)		3,409
Corporate debt		6,029		23		(11	)		6,017
Equity		7,092		309		(761	)		7,544
Total investment securities available-for-sale	$	362,568	$	4,635	$	(2,727	)	$	360,660

			Gross		Gross
			unrealized		unrealized
	Fair		holding		holding			Amortized
December 31, 2014	value		gains		losses			cost
U.S. Government agency	$	62,665	$	212	$	(472	)	$	62,925
State and municipal		72,569		1,500		(150	)		71,219
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		136,192		1,819		(466	)		134,839
Collateralized mortgage obligations (CMOs)		87,662		330		(1,300	)		88,632
Pooled trust preferred		2,439		160		(1,240	)		3,519
Corporate debt		6,037		30		-			6,007
Equity		7,655		1,022		(70	)		6,703
Total investment securities available-for-sale	$	375,219	$	5,073	$	(3,698	)	$	373,844

The amortized cost and estimated fair value of securities available-for-sale by contractual maturity at September 30, 2015 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 municipal securities that have been pre-refunded.

			Amortized
September 30, 2015	Fair value		cost
Due in one year or less	$	5,954	$	5,910
Due after one year through five years		245,136		243,167
Due after five years through ten years		82,140		81,254
Due after ten years		22,246		22,785
Equity securities		7,092		7,544
Total investment securities available-for-sale	$	362,568	$	360,660

For the three months ended September 30, 2015 and 2014, proceeds from sales of investment securities available-for-sale were approximately $685,000 and $534,000. Proceeds from sales of investment securities available-for-sale were approximately $27,480,000 and $19,504,000 for the nine months ended September 30, 2015 and 2014, respectively.

At September 30, 2015 and December 31, 2014, investment securities available-for-sale totaling approximately $238,281,000 and $206,774,000, 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 (“OTTI”) of these investments. Gains and losses on available-for-sale securities are computed on the specific identification method and included in non-interest income. Gross realized losses on equity and debt securities are net of other-than-temporary impairment charges:

	Three months ended September 30, 2015								Three months ended September 30, 2014
					Other-than-									Other-than-
	Gross		Gross		temporary				Gross		Gross			temporary
	realized		realized		impairment				realized		realized			impairment
	gains		losses		losses		Net gains		gains		losses			losses		Net gains
Equity securities	$	83	$	-	$	-	$	83	$	181	$	-		$	-	$	181
Debt securities		-		-		-		-		-		(1	)		-		(1	)
Total	$	83	$	-	$	-	$	83	$	181	$	(1	)	$	-	$	180

	Nine months ended September 30, 2015									Nine months ended September 30, 2014
						Other-than-									Other-than-
	Gross		Gross			temporary				Gross		Gross			temporary
	realized		realized			impairment				realized		realized			impairment
	gains		losses			losses		Net gains		gains		losses			losses		Net gains
Equity securities	$	713	$	(23	)	$	-	$	690	$	1,051	$	(6	)	$	-	$	1,045
Debt securities		154		(44	)		-		110		137		(95	)		-		42
Total	$	867	$	(67	)	$	-	$	800	$	1,188	$	(101	)	$	-	$	1,087

The tax expense applicable to the net realized gains for the nine-month periods ended September 30, 2015 and 2014 amounted to approximately $273,000 and $370,000, 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 following table presents a roll forward 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 on debt securities in the first nine months of 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:

Nine months ended September 30,	2015		2014
Balance, beginning of period	$	1,153	$	1,271
Additions:
Initial credit impairments		-		-
Subsequent credit impairments		-		-
Balance, end of period	$	1,153	$	1,271

The amortized cost and estimated fair values of investment securities held-to-maturity at September 30, 2015 and December 31, 2014 were as follows:

Held-To-Maturity

September 30, 2015

December 31, 2014

Gross

Gross

Gross

Gross

unrealized

unrealized

unrealized

unrealized

Amortized

holding

holding

Fair

Amortized

holding

holding

Fair

cost

gains

losses

value

cost

gains

losses

value

State and municipal securities

$

147

$

6

-

$

153

$

146

$

10

-

$

156

The amortized cost and estimated fair value of securities held-to-maturity by contractual maturity at September 30, 2015 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.

			Amortized
September 30, 2015	Fair value		cost
Due in one year or less
Due after one year through five years	$	153	$	147
Due after five years through ten years		-		-
Due after ten years		-		-
Total investment securities held-to-maturity	$	153	$	147

There were no sales of investment securities classified as held-to-maturity during the three and nine months ended September 30, 2015 or 2014.

The following table indicates the length of time individual securities have been in a continuous unrealized loss position at September 30, 2015 and December 31, 2014:

September 30, 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		11	$	10,330	$	(23	)	$	4,477	$	(21	)	$	14,807	$	(44	)
State and municipal		37		11,973		(58	)		2,688		(27	)		14,661		(85	)
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		24		34,497		(171	)		1,469		(32	)		35,966		(203	)
Collateralized mortgage obligations (CMOs)		30		5,259		(19	)		26,858		(580	)		32,117		(599	)
Pooled trust preferred		5		-		-			2,131		(1,024	)		2,131		(1,024	)
Corporate debt		2		2,003		(11	)		-		-			2,003		(11	)
Equity		23		5,232		(683	)		190		(78	)		5,422		(761	)
Total		132	$	69,294	$	(965	)	$	37,813	$	(1,762	)	$	107,107	$	(2,727	)

December 31, 2014
			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		29	$	15,466	$	(30	)	$	23,941	$	(442	)	$	39,407	$	(472	)
State and municipal		39		3,452		(31	)		11,964		(119	)		15,416		(150	)
U.S. Government agencies and sponsored enterprises (GSEs):
Mortgage-backed		34		6,521		(15	)		38,586		(451	)		45,107		(466	)
Collateralized mortgage obligations (CMOs)		51		2,003		(205	)		35,687		(1,095	)		37,690		(1,300	)
Pooled trust preferred		5		-		-			1,978		(1,240	)		1,978		(1,240	)
Equity		7		1,303		(70	)		-		-			1,303		(70	)
Total		165	$	28,745	$	(351	)	$	112,156	$	(3,347	)	$	140,901	$	(3,698	)

Management evaluates debt securities, which are comprised of U.S. Government agencies, state and municipalities, mortgage-backed securities, CMOs and corporate debt securities, 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 September 30, 2015 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. The Company 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. Management believes these equity securities will recover in the foreseeable future. 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.

QNB holds six pooled trust preferred securities as of September 30, 2015. These securities have a total amortized cost of approximately $3,409,000 and a fair value of $2,600,000. 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 September 30, 2015:

Deal	Class	Book value		Fair value		Unreal-ized gains (losses)			Realized OTTI credit loss (YTD 2015)		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	$	217	$	(26	)	$	-	$	(1	)	B1/BB		5		-		18.0	%		140.7	%
PreTSL XVII	Mezzanine		705		523		(182	)		-		(222	)	C/CC		33		5		26.7			91.2
PreTSL XIX	Mezzanine		987		554		(433	)		-		-		Caa3/CC		40		12		12.2			94.8
PreTSL XXV	Mezzanine		766		480		(286	)		-		(222	)	C/C		46		5		28.3			88.8
PreTSL XXVI	Mezzanine		454		357		(97	)		-		(270	)	Caa3/C		42		7		21.0			94.4
PreTSL XXVI	Mezzanine		254		469		215			-		(438	)	Caa3/C		42		7		21.0			94.4
		$	3,409	$	2,600	$	(809	)	$	-	$	(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 September 30, 2015 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 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. For the three and nine months ended September 30, 2015 and 2014, 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 INTEXcalc 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 of 1% were forecasted. In addition to the base prepayment assumption, due to the enactment of the Dodd-Frank Act additional prepayment analysis was performed. First, trust preferred securities issued by banks with more than $15 billion in total assets at December 31, 2009 were identified. The current credit rating of these institutions was reviewed and it was assumed that any issuer with an investment grade credit rating would prepay their issuance as soon as possible. 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. We then assumed any holding company that could refinance for a cost savings of more than 2% will refinance and will do so as soon as possible. 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.

● 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 any 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 generate additional capital either internally or externally.

● 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 for 2016 and beyond the rate used is calculated based on using the above mentioned thirty-six basis points and factoring that number based on a comparison of key financial ratios of active individual issuers without a short-term probability of default compared to all FDIC insured banks.

● Severity of Loss – In addition to the probability of default discussed above, a severity of loss (projected recovery) is determined in all cases. In the current analysis, the severity of loss ranges from 0% to 100% depending on the estimated credit worthiness of the individual issuer. Based on information from various published studies, a 95% severity of loss was utilized for defaults projected in 2016 and thereafter.

Based upon the analysis performed by management as of September 30, 2015, 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.