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 express 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, 2022 and 2021, overdrafts were $132,000 and $91,000, respectively.

QNB generally lends in Bucks, Lehigh, and Montgomery counties in southeastern Pennsylvania. 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, 2022, there was a concentration of loans to lessors of residential buildings and dwellings of 20.0% of total loans and to lessors of nonresidential buildings of 22.5% of total loans, compared with 18.0% and 24.2% of total loans, respectively, at December 31, 2021. These concentrations were primarily within the commercial real estate categories.

Under the CARES Act, QNB continues to provide customers experiencing financial hardship caused by the COVID-19 Pandemic, solutions to help them through this difficult period. At December 31, 2022, QNB had no modifications related to COVID-19. At December 31, 2021, QNB had modifications to one retail loan with a balance of $42,000 which was modified three times with deferred interest and principal payments totaling ten months and to one commercial loan with a balance of $290,000 which was modified once with deferred interest and principal payments totaling six months. Loans modified in 2021 and 2020 have all returned to a normal payment schedule.

At December 31, 2022 and 2021, QNB had four PPP loans totaling $2,329,000 and 98 PPP loans totaling $14,327,000, respectively, reported in gross commercial and industrial loans. The PPP loans are 100% guaranteed by the SBA. QNB received origination fees from the SBA ranging from a flat fee of $2,500 to one to five basis points which are recognized in interest income as a yield adjustment over the term of the loan. Net unearned (fees) costs include $39,000 and $482,000 in PPP net loan origination fees at December 31, 2022 and 2021, respectively.

QNB engages in a variety of lending activities, including commercial, residential real estate and consumer transactions. QNB 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 types of loans generally comes from the cash flow of the business or the ongoing conversions of assets, such as accounts receivable and inventory, to cash. 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 southeastern 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.

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.

QNB 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.

QNB 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.

QNB employs a ten-grade risk rating system related to the credit quality of commercial loans and loans to state and political subdivisions of which the first six 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.

QNB 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 and loans to state and political subdivisions at the time the loan is originated. Loans with risk ratings of one through five are reviewed annually based on the borrower’s fiscal year. Loans with risk ratings of six are reviewed every six to twelve months based on the dollar amount of the relationship with the borrower. Loans with risk ratings of seven through ten are reviewed at least quarterly, and as often as monthly, at management’s discretion. QNB 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 QNB’s internal risk rating system as of December 31, 2022 and 2021:

For retail loans, QNB 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, 2022 and 2021:

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, 2022 and 2021:

December 31, 2022	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	$	—	$	1,157	$	—	$	1,157	$	159,718	$	160,875
Construction		—		—		—		—		62,955		62,955
Secured by commercial real estate		—		—		—		—		518,070		518,070
Secured by residential real estate		—		—		13		13		103,406		103,419
State and political subdivisions		—		—		—		—		20,971		20,971
Retail:
1-4 family residential mortgages		703		168		216		1,087		104,567		105,654
Home equity loans and lines		95		—		—		95		63,485		63,580
Consumer		37		50		—		87		4,026		4,113
Total	$	835	$	1,375	$	229	$	2,439	$	1,037,198	$	1,039,637

December 31, 2021	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	$	2,288	$	1	$	596	$	2,885	$	145,725	$	148,610
Construction		—		—		—		—		55,855		55,855
Secured by commercial real estate		—		—		—		—		451,404		451,404
Secured by residential real estate		—		—		30		30		84,711		84,741
State and political subdivisions		—		—		—		—		19,775		19,775
Retail:
1-4 family residential mortgages		1,139		—		127		1,266		99,015		100,281
Home equity loans and lines		21		—		10		31		61,751		61,782
Consumer		20		11		—		31		4,668		4,699
Total	$	3,468	$	12	$	763	$	4,243	$	922,904	$	927,147

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, 2022 and 2021:

Activity in the allowance for loan losses for the years ended December 31, 2022, 2021 and 2020 are as follows:

Year ended December 31, 2022	Balance, beginning of period		Provision for (credit to) loan losses			Charge-offs			Recoveries		Balance, end of period
Commercial:
Commercial and industrial	$	3,368	$	(2,320	)	$	(38	)	$	306	$	1,316
Construction		363		392			—			—		755
Secured by commercial real estate		4,280		722			—			—		5,002
Secured by residential real estate		1,035		160			—			45		1,240
State and political subdivisions		69		25			—			—		94
Retail:
1-4 family residential mortgages		646		37			—			—		683
Home equity loans and lines		376		55			—			6		437
Consumer		542		82			(158	)		36		502
Unallocated		505		(3	)	N/A			N/A			502
Total	$	11,184	$	(850	)	$	(196	)	$	393	$	10,531

Year ended December 31, 2021	Balance, beginning of period		Provision for (credit to) loan losses			Charge-offs			Recoveries		Balance, end of period
Commercial:
Commercial and industrial	$	4,050	$	(774	)	$	—		$	92	$	3,368
Construction		346		17			—			—		363
Secured by commercial real estate		3,736		544			—			—		4,280
Secured by residential real estate		871		181			(38	)		21		1,035
State and political subdivisions		89		(20	)		—			—		69
Retail:
1-4 family residential mortgages		533		113			—			—		646
Home equity loans and lines		386		32			(49	)		7		376
Consumer		265		410			(176	)		43		542
Unallocated		550		(45	)	N/A			N/A			505
Total	$	10,826	$	458		$	(263	)	$	163	$	11,184

Year ended December 31, 2020	Balance, beginning of period		Provision for (credit to) loan losses			Charge-offs			Recoveries		Balance, end of period
Commercial:
Commercial and industrial	$	4,689	$	(411	)	$	(268	)	$	40	$	4,050
Construction		590		(244	)		—			—		346
Secured by commercial real estate		2,519		1,205			—			12		3,736
Secured by residential real estate		629		174			—			68		871
State and political subdivisions		115		(26	)		—			—		89
Retail:
1-4 family residential mortgages		549		(16	)		—			—		533
Home equity loans and lines		310		35			—			41		386
Consumer		230		239			(282	)		78		265
Unallocated		256		294		N/A			N/A			550
Total	$	9,887	$	1,250		$	(550	)	$	239	$	10,826

As previously discussed, QNB 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 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 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 and loans to state and political subdivisions 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, QNB 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 QNB’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.

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 QNB 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, extension of terms, 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.

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 $4,301,000 and $4,142,000 as of December 31, 2022 and 2021, respectively. Non-performing TDRs totaled $371,000 and $658,000 as of December 31, 2022 and 2021, 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, $0 and $0 during the years ended December 31, 2022, 2021 and 2020, respectively.

There were two newly identified TDRs during the year ended December 31, 2022: an extension of credit on an existing relationship that was already a TDR and one to ease cash-flow issues. There were no newly identified TDRs during the year ended December 31, 2021. As of December 31, 2022 and 2021, QNB had commitments of $5,000 and $2,000, respectively, to lend additional funds to customers with loans whose terms have been modified in troubled debt restructurings.

QNB had one loan secured by residential real estate with a recorded investment of $120,000 for which foreclosure proceedings were in process as of December 31, 2022. There was one mortgage loan secured by residential real estate with a recorded investment of $127,000 for which foreclosure proceedings were in process at December 31, 2021.

The following tables present the balance in the allowance of loan losses disaggregated on the basis of QNB’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 o QNB’s impairment methodology:

	Allowance for Loan Losses						Loans Receivable
December 31, 2022	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	$	1,316	$	125	$	1,191	$	160,875	$	1,821	$	159,054
Construction		755		—		755		62,955		—		62,955
Secured by commercial real estate		5,002		131		4,871		518,070		5,309		512,761
Secured by residential real estate		1,240		321		919		103,419		1,362		102,057
State and political subdivisions		94		—		94		20,971		—		20,971
Retail:
1-4 family residential mortgages		683		—		683		105,654		628		105,026
Home equity loans and lines		437		119		318		63,580		402		63,178
Consumer		502		—		502		4,113		45		4,068
Unallocated		502	N/A		N/A		N/A		N/A		N/A
Total	$	10,531	$	696	$	9,333	$	1,039,637	$	9,567	$	1,030,070

	Allowance for Loan Losses						Loans Receivable
December 31, 2021	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	$	3,368	$	2,090	$	1,278	$	148,610	$	3,517	$	145,093
Construction		363		—		363		55,855		—		55,855
Secured by commercial real estate		4,280		312		3,968		451,404		5,654		445,750
Secured by residential real estate		1,035		368		667		84,741		1,387		83,354
State and political subdivisions		69		—		69		19,775		—		19,775
Retail:
1-4 family residential mortgages		646		—		646		100,281		893		99,388
Home equity loans and lines		376		100		276		61,782		688		61,094
Consumer		542		3		539		4,699		53		4,646
Unallocated		505	N/A		N/A		N/A		N/A		N/A
Total	$	11,184	$	2,873	$	7,806	$	927,147	$	12,192	$	914,955

The following table summarizes additional information regarding impaired loans by loan portfolio class as of December 31, 2022 and 2021:

	December 31, 2022						December 31, 2021
	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	$	1,402	$	1,694			$	150	$	157
Construction		—		—				—		—
Secured by commercial real estate		2,198		2,608				2,361		2,702
Secured by residential real estate		430		482				715		768
Retail:
1-4 family residential mortgages		628		678				893		1,002
Home equity loans and lines		240		296				514		586
Consumer		45		62				—		—
Total	$	4,943	$	5,820			$	4,633	$	5,215

With an allowance recorded:
Commercial:
Commercial and industrial	$	419	$	601	$	125	$	3,367	$	3,825	$	2,090
Construction		—		—		—		—		—		—
Secured by commercial real estate		3,111		3,312		131		3,293		3,451		312
Secured by residential real estate		932		1,065		321		672		787		368
Retail:
1-4 family residential mortgages		—		—		—		—		—		—
Home equity loans and lines		162		191		119		174		193		100
Consumer		—		—		—		53		68		3
Total	$	4,624	$	5,169	$	696	$	7,559	$	8,324	$	2,873

Total:
Commercial:
Commercial and industrial	$	1,821	$	2,295	$	125	$	3,517	$	3,982	$	2,090
Construction		—		—		—		—		—		—
Secured by commercial real estate		5,309		5,920		131		5,654		6,153		312
Secured by residential real estate		1,362		1,547		321		1,387		1,555		368
Retail:
1-4 family residential mortgages		628		678		—		893		1,002		—
Home equity loans and lines		402		487		119		688		779		100
Consumer		45		62		—		53		68		3
Total	$	9,567	$	10,989	$	696	$	12,192	$	13,539	$	2,873

The following table presents additional information regarding the average recorded investment and interest income recognized on impaired loans for the years ended December 31, 2022, 2021 and 2020:

Year Ended December 31,	2022				2021				2020
	Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized		Average recorded investment		Interest income recognized
Commercial:
Commercial and industrial	$	3,001	$	10	$	3,782	$	5	$	5,204	$	5
Construction		—		—		—		—		—		—
Secured by commercial real estate		5,499		144		5,813		167		6,696		171
Secured by residential real estate		1,368		53		1,706		61		2,002		69
Retail:
1-4 family residential mortgages		871		6		902		6		819		10
Home equity loans and lines		486		1		738		—		680		1
Consumer		49		—		57		1		66		—
Total	$	11,274	$	214	$	12,998	$	240	$	15,467	$	256