Form 10-KSB

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Was0TZs1w76l8K24FBGjfAPNQnX3CDZuAfEI/Dg7O2xUSotdTWI4WJ5LDwgsgHti Erqxz+PhtCIylRLfhPjrow== 0000916641-03-000871.txt : 20030331 0000916641-03-000871.hdr.sgml : 20030331 20030331092957 ACCESSION NUMBER: 0000916641-03-000871 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CARDINAL BANKSHARES CORP CENTRAL INDEX KEY: 0001022759 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 541804471 STATE OF INCORPORATION: VA FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-28780 FILM NUMBER: 03627372 BUSINESS ADDRESS: STREET 1: P O BOX 215 CITY: FLOYD STATE: VA ZIP: 24091 BUSINESS PHONE: 5407454191 10KSB 1 d10ksb.htm FORM 10-KSB Form 10-KSB

U.S. Securities And Exchange Commission
Washington, D.C. 20549

Form 10-KSB

(Mark One)

x		Annual Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 (Fee required)

		For the fiscal year ended December 31, 2002

or

o	Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 (No fee required)

	For the transition period from ________to ________

	Commission file no. 0-28780

Cardinal Bankshares Corporation

(Name of small business issuer in its charter)

Virginia			54-1804471

(State or other jurisdiction of incorporation or organization)			(IRS Employer Identification No.)

101 Jacksonville Circle Floyd, Virginia			24091

(Address of principal executive offices)			(Zip Code)

(540) 745-4191

Issuer’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $10.00 per share

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 past 90 days.

Yes

Check if there is no disclosure of delinquent filers in response to Item 405 of regulation S-B is not contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB.

The issuer’s revenues for its most recent fiscal year were $12,211,000.

The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $28,177,103 as of March 20, 2003.

1,535,733 shares of the Issuer’s common stock were issued and outstanding as of March 20, 2003.

Transitional Small Business Disclosure Format. (Check one):

Yes

DOCUMENTS INCORPORATED BY REFERENCE

The annual report to security holders for fiscal year ended December 31, 2002 is incorporated by reference into Form 10-KSB Part II, Items 7 and 8, and Part III, Item 13. The issuer’s Proxy Statement for the 2003 Annual Meeting is incorporated by reference into Form 10-KSB Part III, Items 9, 10, 11 and 12.

PART I

ITEM 1.		DESCRIPTION OF BUSINESS

	(A) BUSINESS DEVELOPMENT

	Cardinal Bankshares Corporation (the Company) was incorporated as a Virginia corporation on March 12, 1996 to acquire the stock of Bank of Floyd (the Bank). The Bank was acquired by the Company on June 30, 1996.

	The Bank was organized as a state chartered bank on February 24, 1951 through the consummation of a plan of consolidation between two state chartered community banks then operating in Floyd County, Virginia.

	The Bank and its wholly-owned subsidiary, FBC, Inc., are incorporated and operate under the laws of the Commonwealth of Virginia. As a state chartered Federal Reserve member, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions and the Federal Reserve. FBC, Inc.’s assets and operations consist primarily of annuity sales and minority interests in title insurance companies.

	(B) DESCRIPTION OF THE BUSINESS

	The principle business of the Company and Bank is to provide comprehensive individual and corporate banking services through the Bank’s main office in Floyd, Virginia, and branch offices in Hillsville, Christiansburg, Roanoke and Willis, Virginia. The Bank’s wholly-owned subsidiary, FBC, Inc., has interests in Virginia Title Center, LLC as well as Virginia Bankers Insurance Center, LLC, both of which act as title insurance companies. FBC, Inc. also has an interest in VBA Investment Services, LLC.

	(1) SERVICES

	The Bank is a full service retail commercial bank offering a wide range of services, including demand and time deposits as well as installment, mortgage and other consumer lending services. The Bank makes seasonal and term commercial loans, both alone and in conjunction with other banks or governmental agencies.

	(2) COMPETITIVE CONDITIONS

	The bank business is highly competitive. The Company competes as a financial intermediary with other commercial banks, savings and loan associations, credit unions and money market mutual funds operating in its trade area and elsewhere. As of December 31, 2002, there were two commercial banks (one of which is the Bank) operating a total of three offices in Floyd County, Virginia. The competing institution is not locally owned.

	Floyd County generates approximately 80% of the Bank’s total deposits. In the other parts of the Bank’s trade area (the Virginia counties of Roanoke, Montgomery, and Carroll and the City of Roanoke, Virginia), there are a number of locally owned community banks, statewide banking organizations, and affiliate banks of southeast regional bank holding companies in operation.

	(3) MATERIAL CUSTOMERS

	Deposits are derived from a broad base of customers in its trade area. No material portion of deposits have been obtained from a single person or a few persons (including Federal, State, and local governments and agencies thereunder), the loss of which would have a materially adverse effect on the business of the Bank.

	The majority of loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company’s market area. The majority of such customers are depositors. The Company generally does not extend credit to any single borrower or group of related borrowers in excess of approximately $2 million. Although the Company has a reasonably diversified loan portfolio, it has a loan concentration relating to customers who are motel and bed-and-breakfast owners and operators. Total loans and loan commitments to this industrial group amounted to approximately $17.7 million and $16.6 million at December 31, 2002 and 2001, respectively.

	(4) RIGHTS

	No patents, trademarks, licenses, franchises or concessions held are of material significance to the Company.

	(5) NEW SERVICES

	The Company has expended no material dollars on research activities relating to new lines of business in the last two years. However, in the year 2003, the Company will continue to weigh the opportunities now available after passage of the Gramm-Leach-Bliley Act in 1999. Some of the products and services that now may be offered by the Company are property, casualty, life, automobile, disability, and group insurance products as well as brokerage services and others.

	(6) ENVIRONMENTAL LAWS

	Compliance with Federal, State, or Local provisions regulating the discharge of materials into the environment has not had, nor is it expected to have in the future, a material effect upon the Company’s capital expenditures, earnings or competitive position.

	(7) EMPLOYEES

	The Bank had 21 officers, 45 full-time employees and 3 part-time employees as of December 31, 2002. Employee relations have been good.

ITEM 2.		DESCRIPTION OF PROPERTY

	The present headquarters of the Company consists of a three-story brick building, with approximately 21,200 square feet of floor space located at 101 Jacksonville Circle, Floyd, Virginia. The Bank also owns its branch offices in Hillsville and Roanoke, Virginia, which have drive-up facilities. The Bank’s Willis and Christiansburg, Virginia offices operate from leased facilities.

	The Bank also owns a three-story brick building adjacent to its main office which serves as the Bank’s conference room, training room and which provides space for expansion of the financial services now offered.

ITEM 3.		LEGAL PROCEEDINGS

	Neither the Company nor the Bank or its subsidiary are a party to, nor is any of their property the subject of, any material pending legal proceedings incidental to the business of the Company or the Bank or its subsidiary.

ITEM 4.		SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS

	No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

PART II

ITEM 5.		MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

	(A)		Beginning in 1997, the Company’s stock was traded on the OTC Bulletin Board under the symbol CDBK. Prior to 1997, no active public market existed for the common stock of the bank. Transfer of the common stock occurred from time to time, but management had no direct access to the prices realized in those trades. Based on information available to the Bank concerning such trading, the following table shows the trading ranges of the Common Stock for the previous five years. The table has been adjusted for the effects of a 3-for-1 stock split in 2001.

Year	High		Low

2002	$	23.47	$	14.80
2001	$	16.00	$	12.00
2000	$	12.25	$	10.33
1999	$	17.00	$	13.33
1998	$	18.00	$	16.17

	(B)		The approximate number of holders of the Bank’s 1,535,733 Common Stock Securities as of December 31, 2002, is 710.

	(C)		Dividends paid for 2002 were $0.45 and 2001 were $0.42 per share owned. The Company’s ability to declare and pay dividends in the future are dependent upon its consolidated net income, fiscal and general business condition. Subject to these considerations, as well as, laws and regulations governing the payment of dividends, the Company may declare dividends at the discretion of the Board of Directors only. The Company currently expects that dividends will continue to be paid in the foreseeable future.

ITEM 6.		MANAGEMENT’S DISCUSSION AND ANALYSIS

	The information required by Item 6 of Form 10-KSB appears in the Company’s Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference.

ITEM 7.		FINANCIAL STATEMENTS

	The information required by Item 7 of Form 10-KSB appears in the Company’s 2002 Annual Report to Stockholders and is incorporated herein by reference.

ITEM 8.		CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

	NONE



ITEM 9.		DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS: COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

	The information required by Item 9 of Form 10-KSB appears in the Company’s Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference.

ITEM 10.		EXECUTIVE COMPENSATION

	The information required by Item 10 of Form 10-KSB appears in the Company’s Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference.

ITEM 11.		SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

	The information required by Item 11 of Form 10-KSB appears in the Company’s Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference.

ITEM 12.		CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

	The information required by Item 12 of Form 10-KSB appears in the Company’s Proxy Statement for the 2003 Annual Meeting and is incorporated herein by reference.

PART IV

ITEM 13.		EXHIBITS AND REPORTS ON FORM 8-K

	(a)		The following documents are filed as part of the report:

					2002 Annual Report To Stockholders Pages (s)*

		1.	Financial Statements:

	Independent Auditors’ Report					4

	Consolidated Balance Sheets - December 31, 2002 and 2001					5

	Consolidated Statements of Income - Years ended December 31, 2002, 2001 and 2000					6

	Consolidated Statements of Stockholders’ Equity - Years ended December 31, 2002, 2001 and 2000					7

	Consolidated Statements of Cash Flows - Years ended December 31, 2002, 2001 and 2000					8

	Notes to Consolidated Financial Statements					9-26

* Incorporated by reference from the indicated pages of the 2002 Annual Report to Stockholders

		2.		Financial Statement Schedules:

				All schedules are omitted as the required information is inapplicable or the information is presented in the Consolidated Financial Statements or related notes.

		3.		Exhibits:

				The exhibits filed as part of this report and exhibits incorporated herein by reference to other documents are listed in the Index to Exhibits to this Annual Report on Form 10-KSB.

				REPORTS ON FORM 8-K filed during the fourth quarter of 2002:

				None.

ITEM 13.	EXHIBITS AND REPORTS ON FORM 8-K, CONTINUED

		EXHIBITS

		See Item 13(a)3 above.

		FINANCIAL STATEMENT SCHEDULES

		See Item 13(a)2 above.

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

CARDINAL BANKSHARES CORPORATION

/s/ RONALD LEON MOORE		/s/ RAY A. FLEMING

Ronald Leon Moore Chairman, President and Chief Executive Officer		Ray A. Fleming Executive Vice President and Chief Financial Officer
Date: March 26, 2003		Date: March 26, 2003

In accordance with the Exchange Act, this report has to be signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date


/s/ RONALD LEON MOORE	Director, Chairman, President &	March 26, 2003
	Chief Executive Officer
Ronald Leon Moore


/s/ K. VENSON BOLT	Director	March 26, 2003

K. Venson Bolt


/s/ JOSEPH HOWARD CONDUFF	Director	March 26, 2003

Joseph Howard Conduff


/s/ W. R. GARDNER, JR.	Director	March 26, 2003

W. R. Gardner, Jr.


/s/ C. W. HARMAN	Director	March 26, 2003

C. W. Harman


/s/ KEVIN D. MITCHELL	Director	March 26, 2003

Kevin D. Mitchell


/s/ DORSEY H. THOMPSON	Director	March 26, 2003

Dorsey H. Thompson

CERTIFICATION

I, Ronald Leon Moore, certify that:

1.	I have reviewed this annual report on Form 10-KSB of Cardinal Bankshares Corporation;

2.	Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

	a)		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

	b)		evaluated the effectiveness of the registrant’s disclosures controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

	c)		presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.	The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 26, 2003				/s/ RONALD LEON MOORE

				Ronald Leon Moore Chairman, President & Chief Executive Officer

CERTIFICATION

I, Ray A. Fleming, certify that:

1.	I have reviewed this annual report on Form 10-KSB of Cardinal Bankshares Corporation;

2.	Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3.	Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;

4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

	a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared;

	b)	evaluated the effectiveness of the registrant’s disclosures controls and procedures as of a date within 90 days prior to the filing date of this annual report (the “Evaluation Date”); and

	c)	presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.	The registrant’s other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: March 26, 2003			/s/ RAY A. FLEMING

			Ray A. Fleming Executive Vice President & Chief Financial Officer

CERTIFICATION
(Pursuant to 18 U.S.C. Section 1350)

The undersigned hereby certifies that (i) the foregoing Annual Report on Form 10-KSB filed by March 31, 2003 (the “Registrant”) for the year ended December 31, 2002, fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and (ii) the information contained in that Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

Date: March 26, 2003	/s/ RONALD LEON MOORE

	Ronald Leon Moore Chairman, President & Chief Executive Officer

Date: March 26, 2003	/s/ RAY A. FLEMING

	Ray A. Fleming Executive Vice President & Chief Financial Officer

INDEX TO EXHIBITS

Exhibit No.	Description	Page No. In Equential System

13.1	2002 Annual Report to Stock-holders (Such Report, except to the extent incorporated herein by reference, is being furnished for the information of the Commission only and is not deemed to be filed as part of this Report on Form 10-KSB)	—

EX-13.1 3 dex131.txt EXHIBIT 13.1 EXHIBIT 13.1 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES 2002 ANNUAL REPORT TABLE OF CONTENTS Selected Historical Financial Information.................................. 2 Letter to Shareholders..................................................... 3 Independent Auditor's Report............................................... 4 Consolidated Balance Sheets................................................ 5 Consolidated Statements of Income.......................................... 6 Consolidated Statements of Changes in Stockholders' Equity................. 7 Consolidated Statements of Cash Flows...................................... 8 Notes to Consolidated Financial Statements................................. 9 Management's Discussion of Financial Condition and Results of Operations... 27 Staff...................................................................... 45 Directors and Officers..................................................... 46 Stockholder Information.................................................... 47 MARKET FOR THE COMPANY'S COMMON STOCK, RELATED STOCKHOLDER MATTERS, STOCK PRICES AND DIVIDENDS The Company's common stock is traded on the OTC Bulletin Board under the symbol CDBK. As of December 31, 2002, the Company had issued and outstanding 1,535,733 shares of common stock which were held by approximately 710 stockholders of record. Set forth below are the high and low (bid quotations/sales prices), known to the management of the Company, for each quarter in the last three fiscal years, adjusted for a 3-for-1 stock split, effected in the form of a dividend, on April 25, 2001. 2002 2001 2000 ----------------- ----------------- ----------------- HIGH LOW HIGH LOW HIGH LOW ------- ------- ------- ------- ------- ------- First Quarter $ 17.00 $ 14.80 $ 13.33 $ 12.00 $ 12.25 $ 12.25 Second Quarter 23.00 15.25 15.00 12.67 10.33 10.33 Third Quarter 23.30 22.50 15.25 13.00 10.50 10.50 Fourth Quarter 23.47 22.35 16.00 15.00 11.33 11.33 Cash dividends paid in 2002, 2001 and 2000, were $691 thousand, $645 thousand, and $582 thousand, respectively. CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES SELECTED HISTORICAL FINANCIAL INFORMATION

- ---------- /1/ Adjusted for the effects of a 3-for-1 stock split, effected in the form of a dividend, in 2001. 2 CARDINAL BANKSHARES CORPORATION Post Office Box 215 Floyd, Virginia 24091 To Our Shareholders, Customers and Friends: It gives me great pleasure to report to you that 2002 was another record year for Cardinal Bankshares Corporation. To reflect on what was the most profitable year in our Company's history is particularly satisfying; especially considering the year was saddled with a very sluggish economy and unsettling business climate. Net income for 2002 was $2.4 million, up from $2.1 million earned in 2001. Net income per diluted share increased 14.0 percent to $1.55 compared to $1.36 for the prior year. These results produced returns on average assets of 1.29 percent and on average stockholders' equity of 10.63 percent. Total assets at year-end were $189.4 million, up almost 2 percent even with the lackluster business growth primarily attributable to the overall state of our economy. Total deposits at year-end were $165.4 million. Stockholders' equity on December 31, 2002 was $23.2 million and our book value per share was $15.12. The Company's capital position remains strong, and at year-end the equity to assets and risk-based capital ratios were 12.26 percent and 19.80 percent, respectively. Sharing the success of our Company with you, our shareholders, has remained a high priority at Cardinal Bankshares. This commitment is evidenced by the consistent growth in dividends, which your Board of Directors raised for the 11th consecutive year during 2002, with an increase of 7.1 percent compared to 2001. The growth and success experienced in 2002 is the result of the level of support given by you, our shareholders, customers and friends, and to the dedicated officers and staff whose honesty, integrity and hard work have made this organization what it is today. Our thanks are extended to each of you for your support and for your continued confidence in Cardinal Bankshares Corporation. Sincerely, /s/Leon Moore - ------------- Leon Moore Chairman, President & Chief Executive Officer 3 INDEPENDENT AUDITOR'S REPORT Board of Directors and Stockholders Cardinal Bankshares Corporation Floyd, Virginia We have audited the consolidated balance sheets of Cardinal Bankshares Corporation and subsidiaries as of December 31, 2002 and 2001 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 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 Cardinal Bankshares Corporation and subsidiaries at December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. /s/Larrowe & Company, PLC - ------------------------- Larrowe & Company, PLC Galax, Virginia January 10, 2003, except for Note 17, as to which the date is February 26, 2003 4 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS

See Notes to Consolidated Financial Statements 5 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME

See Notes to Consolidated Financial Statements 6 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

See Notes to Consolidated Financial Statements 7 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS

See Notes to Consolidated Financial Statements 8 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION Cardinal Bankshares Corporation (the "Company") was incorporated as a Virginia corporation on March 12, 1996 to acquire the stock of Bank of Floyd (the "Bank"). The Bank was acquired by the Company on June 30, 1996. Bank of Floyd and its wholly-owned subsidiary, FBC, Inc., are incorporated and operate under the laws of the Commonwealth of Virginia. As a state chartered Federal Reserve member, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions and the Federal Reserve. The Bank serves the counties of Floyd, Carroll, Montgomery, and Roanoke, Virginia and the City of Roanoke, Virginia, through five banking offices. FBC, Inc.'s assets and operations consist primarily of annuity sales and minority interests in an insurance company and a title insurance company. The accounting and financial reporting policies of the Company conform to generally accepted accounting principles and general practices within the financial services industry. Following is a summary of the more significant policies. PRINCIPLES OF CONSOLIDATION The consolidated financial statements of the Company include the accounts of the Company, the Bank and FBC, Inc. All material intercompany transactions and balances have been eliminated. CRITICAL ACCOUNTING POLICIES The notes to the Company's audited consolidated financial statements contain a summary of significant accounting policies. Management believes the policies with respect to the methodology for the determination of the allowance for loan losses involves a high degree of complexity. Management must make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could cause reported results to differ materially. These critical policies and their application are periodically reviewed with the Audit Committee and Board of Directors. BUSINESS SEGMENTS The Company reports its activities as a single business segment. In determining proper segment definition, the Company considers the materiality of the potential segment and components of the business about which financial information is available and regularly evaluated, relative to resource allocation and performance assessment. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions in the application of certain of its accounting policies that affect the reported amounts of assets and liabilities, and the disclosure of contingent assets and liabilities, at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. As a result of unanticipated events or circumstances, actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and foreclosed real estate losses, management obtains independent appraisals for significant properties. The majority of the Company's loan portfolio consists of loans in Southwest Virginia. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The regional economy is diverse, but is influenced by the agricultural, textile and governmental segments. 9 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED USE OF ESTIMATES, CONTINUED While management uses available information to recognize loan and foreclosed real estate losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Company's allowances for loan and foreclosed real estate losses. Such agencies may require additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the allowances for loan and foreclosed real estate losses may change materially in the near term. CASH AND CASH EQUIVALENTS For purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption "cash and due from banks." TRADING SECURITIES The Company does not hold securities for short-term resale and therefore does not maintain a trading securities portfolio. SECURITIES HELD TO MATURITY Bonds, notes, and debentures for which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity or to call dates. SECURITIES AVAILABLE FOR SALE Available for sale securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities not classified as held to maturity securities. Unrealized holding gains and losses, net of tax, on available for sale securities are reported as a net amount in a separate component of stockholders' equity. Realized gains and losses on the sale of available for sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity or to call dates. Declines in the fair value of individual held to maturity and available for sale securities below cost, that are other than temporary, are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses. LOANS RECEIVABLE Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off, are reported at their outstanding principal amount adjusted for charge-offs, the allowance for loan losses, deferred fees or costs on originated loans, and unamortized premiums or discounts on purchased loans. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield of the related loan. Discounts and premiums on any purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on any purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method. 10 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED LOANS RECEIVABLE, CONTINUED Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received. When facts and circumstances indicate the borrower has regained the ability to meet required payments, the loan is returned to accrual status. Past due status of the loan is determined based on contractual terms. ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. 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 and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, 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 loans for impairment disclosures. PROPERTY AND EQUIPMENT Land is carried at cost. Bank premises, furniture and equipment are carried at cost, less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives: YEARS ----- Buildings and improvements 20-40 Furniture and equipment 5-20 FORECLOSED PROPERTIES Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less cost to sell at the date of foreclosure. After foreclosure, valuations are periodically performed by management and the real estate is 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 operations on foreclosed real estate. The historical average holding period for such properties is in excess of 23 months. 11 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED PENSION PLAN A noncontributory defined benefit pension plan is provided for all employees who meet eligibility requirements. To be eligible, an employee must be 21 years of age and have completed one year of service. Plan benefits are based on final average compensation and years of service. The plan is funded in compliance with the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986, as amended. TRANSFERS OF FINANCIAL ASSETS 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. INCOME TAXES Provision for income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities) and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred taxes assets and liabilities are adjusted through the provision for income taxes. Deferred income tax liability relating to unrealized appreciation (or the deferred tax asset in the case of unrealized depreciation) on investment securities available for sale is recorded in other liabilities (assets). Such unrealized appreciation or depreciation is recorded as an adjustment to equity in the financial statements and not included in income determination until realized. Accordingly, the resulting deferred income tax liability or asset is also recorded as an adjustment to equity. BASIC EARNINGS PER SHARE Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding during the period, after giving retroactive effect to stock splits and stock dividends. DILUTED EARNINGS PER SHARE The computation of diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares. For the years presented, the Company has no potentially dilutive securities outstanding. COMPREHENSIVE INCOME Annual comprehensive income reflects the change in the Company's equity during the year arising from transactions and events other than investments by, and distributions to, stockholders. It consists of net income plus certain other changes in assets and liabilities that are reported as separate components of stockholders' equity rather than as income or expense. 12 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED FINANCIAL INSTRUMENTS Derivatives that are used as part of the asset/liability management process are linked to specific assets or liabilities and have high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. In addition, forwards and option contracts must reduce an exposure's risk, and for hedges of anticipatory transactions, the significant terms and characteristics of the transaction must be identified and the transactions must be probable of occurring. All derivative financial instruments held or issued by the Bank are held or issued for purposes other than trading. In the ordinary course of business the Company has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and commercial and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. The Company does not utilize interest-rate exchange agreements or interest-rate futures contracts. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Cash and due from banks: The carrying amounts reported in the balance sheet for these items approximate their fair values. Interest-bearing deposits with banks: Fair values for time deposits are estimated using a discounted cash flow analysis that applies interest rates currently offered on certificates to a schedule of aggregated contractual maturities on such time deposits. Federal funds sold: The carrying amounts reported in the balance sheet for these items approximate their fair values. Available for sale, held to maturity and restricted equity securities: Fair values for securities, excluding restricted equity securities, are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying values of restricted equity securities approximate fair values. Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable. The carrying amount of accrued interest receivable approximates its fair value. Deposit liabilities: The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value. 13 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED Short-term and long-term debt: The carrying amounts of short-term debt approximate their fair values. The fair values for long-term debt are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms. Other liabilities: For fixed-rate loan commitments, fair value considers the difference between current levels of interest rates and the committed rates. The carrying amounts of other liabilities approximates fair value. RECLASSIFICATION Certain reclassifications have been made to the prior years' financial statements to place them on a comparable basis with the current year. Net income and stockholders' equity previously reported were not affected by these reclassifications. NOTE 2. RESTRICTIONS ON CASH AND DUE FROM BANKS To comply with banking regulations, the Company is required to maintain certain average cash reserve balances. The daily average cash reserve requirement was approximately $980 thousand and $857 thousand for the two week periods including December 31, 2002 and 2001, respectively. NOTE 3. SECURITIES Debt and equity securities have been classified in the consolidated balance sheets according to management's intent. The carrying amount of securities and their approximate fair values at December 31 follow:

14 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 3. SECURITIES, CONTINUED

Restricted equity securities consist of investments in stock of the Federal Home Loan Bank of Atlanta ("FHLB") and The Federal Reserve of Richmond (Federal Reserve), which are upstream correspondents of the Bank. The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow from it. The Bank is required to hold that stock so long as it borrows from the FHLB. The Federal Reserve requires banks to purchase stock as a condition of membership in the Federal Reserve system. Investment securities with amortized cost of approximately $11.2 million and $10.5 million at December 31, 2002 and 2001, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law. Gross realized gains and losses for the years ended December 31 are as follows: (IN THOUSANDS) 2002 2001 2000 - ---------------------------------------------- -------- --------- -------- Realized gains, available for sale securities $ 24 $ 44 $ - Realized losses, available for sale securities - - - -------- --------- -------- $ 24 $ 44 $ - ======== ========= ======== The scheduled maturities of debt securities available for sale and held to maturity at December 31, 2002, were as follows:

For mortgage-backed securities, the Company reports maturities based on anticipated lives. Actual results may differ due to interest rate fluctuations. 15 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4. LOANS RECEIVABLE The major components of loans in the Consolidated Balance Sheets are summarized below:

NOTE 5. ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses are as follows:

The following is a summary of information pertaining to impaired loans at December 31:

The Company is not committed to lend additional funds to debtors whose loans have been modified. 16 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 6. BANK PREMISES AND EQUIPMENT Bank premises and equipment included in the Consolidated Balance Sheets are as follows: DECEMBER 31, (IN THOUSANDS) 2002 2001 - --------------------------- --------------- ---------------- Land $ 378 $ 378 Bank premises 2,684 2,683 Furniture and equipment 2,147 2,028 --------------- ---------------- Total 5,209 5,089 Less accumulated depreciation (3,049) (2,787) --------------- ---------------- Bank premises and equipment, net $ 2,160 $ 2,302 =============== ================ The Bank has entered into long-term leases for two of its branch banking facilities under agreements accounted for as operating leases. These leases expire between 2003 and 2006, including the exercise of renewal options ranging from two to three years. Future minimum lease payments total $9 thousand annually. Rental expense for 2002, 2001 and 2000 was $9 thousand, $9 thousand and $8 thousand, respectively. NOTE 7. MATURITIES OF CERTIFICATES The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2002 and 2001 was $23.2 million and $26.5 million, respectively. At December 31, 2002, the scheduled maturities of time deposits are as follows: (IN THOUSANDS) ---------------- 2003 $ 59,929 2004 16,721 2005 8,622 2006 3,722 2007 8,210 ---------------- Total $ 97,204 ================ NOTE 8. BORROWINGS The Company has established various credit facilities to provide additional liquidity if and as needed. These include unsecured lines of credit with correspondent banks totaling $10.3 million and a secured line of credit with the Federal Home Loan Bank of Atlanta of approximately $22 million. Additional amounts are available from the Federal Home Loan Bank, with additional collateral. At December 31, 2002 and 2001, there were no amounts outstanding under these agreements. 17 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 9. EMPLOYEE BENEFIT PLAN The Bank has a qualified noncontributory, defined benefit pension plan which covers substantially all of its employees. The benefits are primarily based on years of service and earnings. The following is a summary of the plan's funded status:

18 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 10. DEFERRED COMPENSATION AND LIFE INSURANCE Deferred compensation plans have been adopted for certain members of the Board of Directors for future compensation upon retirement. Under plan provisions aggregate annual payments ranging from $2 thousand to $8 thousand are payable for ten years certain, generally beginning at age 65. Liability accrued for compensation deferred under the plan amounts to $110 thousand and $114 thousand at December 31, 2002 and 2001, respectively. Charges to income are based on present value of future cash payments, discounted at 8%, and amounted to $14 thousand, $12 thousand and $9 thousand for 2002, 2001 and 2000, respectively. The Bank is owner and beneficiary of life insurance policies on these directors. Policy cash values, net of policy loans, totaled $72 thousand and $55 thousand at December 31, 2002 and 2001, respectively. In 2002, the Bank adopted a supplemental executive retirement plan to provide benefits for a member of management. Under plan provisions, aggregate fixed payments of $45 thousand are payable for 20 years certain, beginning in 2007. The liability is calculated by discounting the anticipated future cash flows at 6.10%. The liability accrued for this obligation was $76 thousand at December 31, 2002. Changes to income are based on changes in the cash value of insurance which funds the liability. NOTE 11. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of the Company's financial instruments are as follows:

19 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 12. INCOME TAXES The components of income tax expense (benefit) are as follows:

A reconciliation of the expected income tax expense computed by applying the federal statutory rate of 34% to income included in the consolidated statements of income follows:

The tax effects of temporary timing differences that give rise to significant portions of the net deferred tax assets and deferred tax liabilities are presented below:

NOTE 13. COMMITMENTS AND CONTINGENCIES LITIGATION In the normal course of business, the Company is involved in various legal proceedings. After consultation with legal counsel, management believes that any liability resulting from such proceedings will not be material to the consolidated financial statements. 20 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 13. COMMITMENTS AND CONTINGENCIES, CONTINUED FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK The Company is party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, credit risk in excess of the amount recognized in the consolidated balance sheets. The Company's exposure to loan loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments. A summary of commitments at December 31 is as follows: DECEMBER 31, (IN THOUSANDS) 2002 2001 - -------------------------- --------------- ---------------- Commitments to extend credit $ 7,537 $ 10,495 Standby letters of credit 659 809 --------------- ---------------- $ 8,196 $ 11,304 =============== ================ 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 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. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income producing commercial properties. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Collateral held varies as specified above and is required in instances which the Company deems necessary. CONCENTRATIONS OF CREDIT RISK The majority of the Company's loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company's market area. The majority of such customers are depositors of the Bank. Investments in state and municipal securities involve governmental entities within and outside the Company's market area. The concentrations of credit by type of loan are set forth in the Loans Receivable note. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Standby letters of credit are granted primarily to commercial borrowers. The Company, as a matter of policy, does not extend credit to any single borrower or group of related borrowers in excess of approximately $2 million. Although the Company has a reasonably diversified loan portfolio, a substantial portion of its debtors' ability to honor their contracts is dependent upon economic conditions in and around Floyd, Carroll, Montgomery, and Roanoke Counties and the City of Roanoke, Virginia. A significant amount of the real estate loans set forth in the Loans Receivable note are secured by commercial real estate. In addition, the Company has a loan concentration relating to customers who are motel, hotel, and bed-and-breakfast owners and operators. Total loans and loan commitments to this industrial group amounted to approximately $17.7 million and $16.6 million at December 31, 2002 and 2001, respectively. The Company has cash and cash equivalents on deposit with financial institutions which exceed federally-insured limits. 21 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 14. REGULATORY MATTERS DIVIDENDS The Company's dividend payments are made from dividends received from the Bank. The Bank, as a Virginia banking corporation, may pay dividends only out of its retained earnings. However, regulatory authorities may limit payment of dividends by any bank when it is determined that such a limitation is in the public interest and is necessary to ensure financial soundness of the Bank. INTERCOMPANY TRANSACTIONS The Bank's legal lending limit on loans to the Company are governed by Federal Reserve Act 23A, and differ from legal lending limits on loans to external customers. Generally, a bank may lend up to 10% of its capital and surplus to its Parent, if the loan is secured. If collateral is in the form of stocks, bonds, debentures or similar obligations, it must have a market value when the loan is made of at least 20% more than the amount of the loan, and if obligations of a state or political subdivision or agency thereof, it must have a market value of at least 10% more than the amount of the loan. If such loans are secured by obligations of the United States or agencies thereof, or by notes, drafts, bills of exchange or bankers' acceptances eligible for rediscount or purchase by a Federal Reserve Bank, requirements for collateral in excess of the loan amount do not apply. Under this definition, the legal lending limit for the Bank on loans to the Company was approximately $1.4 million at December 31, 2002. No 23A transactions were deemed to exist between the Company and the Bank at December 31, 2002. CAPITAL REQUIREMENTS The Company is subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets, as all those terms are defined in the regulations. Management believes, as of December 31, 2002, that the Bank meets all capital adequacy requirements to which it is subject. As of December 31, 2002, the most recent notification from the Federal Reserve categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. 22 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 14. REGULATORY RESTRICTIONS, CONTINUED CAPITAL REQUIREMENTS, CONTINUED The Company and the Bank's actual capital amounts and ratios are also presented in the following table.

23 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 15. TRANSACTIONS WITH RELATED PARTIES The Company has entered into transactions with its directors, significant shareholders and their affiliates (related parties). Such transactions were made in the ordinary course of business on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. Aggregate loan transactions with related parties were as follows: DECEMBER 31, (IN THOUSANDS) 2002 2001 - -------------------------- --------------- ---------------- Balance, Beginning $ 874 $ 873 Additions 340 841 Repayments (190) (840) Relationship changes 153 - --------------- ---------------- Balance, Ending $ 1,177 $ 874 =============== ================ NOTE 16. PARENT COMPANY FINANCIAL INFORMATION Condensed financial information of Cardinal Bankshares Corporation is presented as follows: BALANCE SHEETS

24 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 16. PARENT COMPANY FINANCIAL INFORMATION, CONTINUED STATEMENTS OF INCOME

STATEMENTS OF CASH FLOWS

25 CARDINAL BANKSHARES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 17. SUBSEQUENT EVENTS During 2002, the Company entered into an agreement to merge with MountainBank Financial Corporation, the holding company for MountainBank headquartered in Hendersonville, North Carolina. At the Company's special meeting held on February 26, 2003, the Company's stockholders failed to ratify and approve the agreement and the merger. 26 MANAGEMENT'S DISCUSSION AND ANALYSIS OVERVIEW Management's Discussion and Analysis is provided to assist in the understanding and evaluation of Cardinal Bankshares Corporation's financial condition and its results of operations. The following discussion should be read in conjunction with the Corporation's consolidated financial statements. Certain previously reported amounts have been reclassified to conform to current presentations. Cardinal Bankshares Corporation, the parent company of Bank of Floyd, currently operates five offices in Floyd, Montgomery, Roanoke and Carroll Counties of Virginia. The main office is in Floyd with a limited service office in Willis. The Roanoke office is in the Cave Spring area of Roanoke County. The Hillsville office is located in Carroll County on Route 52 in Hillsville, Virginia. Montgomery County is served by the branch in Christiansburg, Virginia. The individual market conditions of each county vary from rural to urban with Floyd County being the most rural and Roanoke the most urban. Each has its own growth pattern which varies in intensity. Bank of Floyd and bank personnel work with local government leaders in an effort to attract industry to Floyd County. Cardinal Bankshares reported net income for the year 2002 of $2.4 million, an increase of 14.1% over the $2.1 million reported in 2001. Net income per diluted share was $1.55, or $.19 above the $1.36 reported for the prior year. Net interest income, on a taxable equivalent basis, was $6.8 million, an increase of $329 thousand from $6.4 million in 2001, driven primarily by the combination of the increase in average loans outstanding, and lower rates paid on deposit accounts when compared to the prior year. Noninterest income grew by 35.7% to $806 thousand for 2002 compared to $594 thousand for 2001. Noninterest expense increased by 6.5% to $3.8 million compared to $3.5 million in 2001. Earning assets averaged $175.5 million, compared to $165.3 million in 2001, an increase of 6.1%. Total loans increased by $2.5 million to $108.9 million on average. Real estate loan categories acccounted for the majority of the loan growth. Securities declined $3.7 million on average in 2002. Federal funds sold and deposits in other banks inceased $6.2 million and $5.1 million, respectively, on average. Interest-bearing liabilities averaged $141.1 million, up $8.9 million or 6.8% from 2001. Savings deposits accounted for a significant portion of the growth in interest-bearing liabilities. Stockholders' equity grew 7.1% to an average of $22.5 million in 2002 from $21.0 million in 2001. The return on average equity increased 66 basis points to 10.63% for 2002. The book value per share was $15.12 at December 31, 2002, compared to $13.97 at year-end 2001, representing an increase of 8.2%. 27 MANAGEMENT'S DISCUSSION AND ANALYSIS TABLE 1. AVERAGE BALANCES AND INTEREST RATES (TAXABLE EQUIVALENT BASIS)

YEARS ENDED DECEMBER 31, (IN THOUSANDS) 2000 ------------------------------------ INTEREST AVERAGE INCOME/ YIELD/ BALANCE EXPENSE COST --------- --------- --------- ASSETS: Interest-earning assets: Deposits in other banks $ 394 $ 24 6.09% Taxable investment securities 35,992 2,349 6.53% Nontaxable investment securities 20,139 1,286 6.39% Federal funds sold 4,503 275 6.11% Loans 89,752 8,021 8.94% --------- --------- --------- Total interest-earning assets 150,780 11,955 7.93% --------- --------- --------- Noninterest-earning assets: Cash and due from banks 2,472 Premises and equipment 2,513 Other assets 5,188 Allowance for loan losses (1,255) --------- Total assets $ 159,698 ========= LIABILITIES AND STOCKHOLDERS' EQUITY: Interest-bearing liabilities: Interest checking $ 10,673 249 2.34% Savings deposits 20,614 688 3.34% Time deposits 73,696 4,143 5.62% Large denomination deposits 17,216 902 5.24% Federal Home Loan Bank borrowings - - - --------- --------- --------- Total interest-bearing liabilities 122,199 5,982 4.90% --------- --------- --------- Noninterest-bearing liabilities: Demand deposits 17,518 Other liabilities 1,372 --------- Total liabilities 141,089 Stockholders' equity 18,609 --------- Total liabilities and stockholders' equity $ 159,698 ========= Net interest earnings $ 5,973 ========= Net interest spread (1) 3.03% ========= Net interest margin (2) 3.96% ========= Taxable equivalent adjustment $ 341 ========= (1) Net interest spread is the difference between the average interest rate received on earning assets and the average interest rate paid for interest-bearing liabilities. (2) Net interest margin is calculated by dividing taxable equivalent net interest earnings by total average earning assets. 28 MANAGEMENT'S DISCUSSION AND ANALYSIS NET INTEREST INCOME Net interest income, the primary source of the Company's earnings, is the amount by which interest and fee income generated by earning assets exceeds the interest paid on interest-bearing liabilities. Earning assets are comprised of loans, securities, federal funds sold and interest-bearing deposits in other banks. Interest-bearing liabilities consist of deposits and federal funds purchased. The volume and the general level of interest rates among earning assets and interest-bearing liabilities effect net interest income. Table 1 shows the average balance sheets for each of the years ended December 31, 2002, 2001 and 2000. In addition, the amounts of interest earned on earning assets, with related yields, and the interest paid on interest-bearing liabilities, together with rates, are shown. Loans placed on a nonaccrual status are included in the balances and were included in the computation of yields, upon which they had an immaterial effect. Interest on earning assets is on a taxable equivalent basis, which is computed using the federal corporate income tax rate of 34% for all three years. Net interest income, on a taxable equivalent basis, was $6.7 million, an increase of 4.0% from the $6.4 million in 2001. The net interest margin was 3.85% for 2002, down 4 basis points from the 3.89% reported in 2001. The growth in net interest income was positively impacted by the increase in loan volume and federal funds sold. While the overall yield on earning assets declined 113 basis points, the effect of the 138 basis point drop in cost of funds served to offset the lower yield on earning assets and support the net interest margin. During 2002, federal funds sold and interest bearing deposits in other banks grew to an average of $13.9 million and $6.7 million, respectively. Total loans rose $2.5 million with commercial and industrial loans accounting for the major portion of the growth. Total average interest-bearing deposits increased $9.1 million for the year 2002 to $141.1 million, an increase of 6.9% over the prior year. Savings deposits increased 43.9%, averaging $29.1 million, and interest checking accounts grew 19.3%, averaging $12.5 million. Large denomination deposits remained essentially unchanged from 2001 levels, averaging $23.5 million for the year. TABLE 2. RATE/VOLUME VARIANCE ANALYSIS (THOUSANDS)

29 MANAGEMENT'S DISCUSSION AND ANALYSIS PROVISION FOR LOAN LOSSES The allowance for loan losses represents the amount available for credit losses inherent in the Company's loan portfolio. Loan losses and recoveries are charged or credited directly to the allowance. Management determines the provision for loan losses required to maintain an allowance adequate to provide for any potential losses. The factors considered in making this decision are the collectibility of past due loans, volume of new loans, composition of the loan portfolio, and general economic outlook. In 2002, the provision for loan losses was $375 thousand, a decrease of $67 thousand from the $442 thousand recorded in 2001. After reviewing the modest growth in the loan portfolio, favorable changes in the components of nonperforming loans, and general economic trends, management felt the current year decrease in the provision for loan losses was appropriate. Management believes the provision recorded in 2002 maintains the allowance at a level adequate to cover potential losses. The Company had recoveries, net of charge-offs, of $94 thousand during 2002, compared to net charge-offs of $276 thousand during 2001. Management does not anticipate any abnormal changes in the delinquency rates or charge-offs and recoveries in connection with its normal lending activities. Additional information regarding the Company's allowance for loan losses is contained in Tables 12, 13 and 14, and in the discussion concerning Nonperforming Assets. NONINTEREST INCOME Noninterest income consists of revenues generated from a number of different financial services and activities. Service charges on deposit accounts including charges for insufficient funds items and fees charged for nondeposit services make up the majority of noninterest income. Noninterest income also includes fees charged for services such as safe deposit box rentals, letters of credit, and gains realized on the sale of securities. Noninterest income totaled $806 thousand in 2002, an increase of 35.7% from the $594 thousand recorded in 2001. The single largest increase in noninterest income, $149 thousand, resulted from income generated by the Company's investment in bank owned life insurance. Noninterest income in 2000 totaled $500 thousand. The primary sources of noninterest income for the past three years are summarized in Table 3 below. TABLE 3. NONINTEREST INCOME

NONINTEREST EXPENSE Noninterest expense was $3.8 million for 2002, an increase of $228 thousand over the $3.5 million recorded in 2001. Higher salaries and benefits costs of $112 thousand accounted for most of the year-to-year increase. Merit increases and higher medical insurance costs were the primary cause of higher salary and benefits costs. Table 4 provides a further breakdown of noninterest expense for the past three years. 30 MANAGEMENT'S DISCUSSION AND ANALYSIS TABLE 4. NONINTEREST EXPENSE YEAR ENDED DECEMBER 31, (IN THOUSANDS) 2002 2001 2000 - -------------------------------------- ----------- ----------- ---------- Salaries and employee benefits $ 2,272 $ 2,160 $ 2,023 Occupancy and equipment 541 523 511 Legal and professional 189 91 113 Bank franchise tax 110 108 99 Other operating expense 644 646 561 ----------- ----------- ---------- Total noninterest expense $ 3,756 $ 3,528 $ 3,307 =========== =========== ========== INCOME TAXES Income tax expense is based on amounts reported in the statements of income, after adjustments for non-taxable income and non-deductible expenses, and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. The deferred tax assets and liabilities represent the future Federal income tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Income tax expense, substantially all Federal, was $729 thousand in 2002, $632 thousand in 2001 and $499 thousand in 2000 representing 23.4%, 23.2% and 21.4% of income before income taxes, respectively. Income tax expense increased $97 thousand or 15.3% from 2001 to 2002. Cardinal Bankshares' deferred income tax benefits and liabilities result primarily from temporary differences in provisions for credit losses, valuation reserves, depreciation, deferred compensation, deferred income, pension expense and investment security discount accretion. Net deferred income tax benefits of approximately $510 thousand and $375 thousand at December 31, 2002 and 2001, respectively, are included in other assets. 31 MANAGEMENT'S DISCUSSION AND ANALYSIS EARNING ASSETS In 2002, average earning assets increased $10.2 million from the 2001 average of $165.3 million. Total average earning assets represented 95.1% of total average assets in 2002, essentially unchanged with the 95.2% reported in 2001. Increases in average federal funds sold, deposits in other banks and loans, accounted for an overall increase in total average earning assets of 6.1%. Average federal funds sold represented 7.5% of total average assets compared to 4.4% in 2001. Average deposits in other banks accounted for 3.7% of total average assets. Average loans remained the largest component of earning assets, accounting for 59.0% of total average assets in 2002, although down slightly from the 61.3% level reported in 2001. A summary of average assets for the past three years is shown below in Table 5. TABLE 5. AVERAGE ASSET MIX

LOANS Average total loans were $108.9 million for 2002, an increase of $2.5 million or 2.4% over 2001. At December 31, 2002, the actual balance of loans secured by real estate represented a significant portion of the loan portfolio at 90.6%. Total loans secured by 1-4 family residential properties represented 25.9% of total loans at the end of 2002 while nonfarm/nonresidential properties made up 57.3% of total loans. 32 MANAGEMENT'S DISCUSSION AND ANALYSIS Bank of Floyd makes both consumer and commercial loans to all neighborhoods within its market area, including the low-income and moderate-income areas. The Company's market area is generally defined as the areas within the Virginia Counties of Floyd, Roanoke, Montgomery and Carroll, and the Cities of Roanoke and Christiansburg, Virginia. The Bank places emphasis on consumer based installment loans and commercial loans to small and medium sized businesses. Predatory pricing and competition from unregulated organizations have also been a factor when generating new loans. The amounts of loans outstanding by type at year-end 2002 and 2001, and the maturity distribution of variable and fixed rate loans as of year-end 2002 are presented below in Table 6 and Table 7, respectively. TABLE 6. LOAN PORTFOLIO SUMMARY (THOUSANDS)

Interest rates charged on loans vary with the degree of risk, maturity and amount of the loan. Competitive pressures, money market rates, availability of funds, and government regulation also influence interest rates. On average, loans yielded 7.96% in 2002, lower by 87 basis points when compared to an average yield of 8.83% in 2001. The lower yield earned on the loan portfolio was primarily the result of the continued lower interest rate environment. 33 MANAGEMENT'S DISCUSSION AND ANALYSIS TABLE 7. LOAN MATURITY SCHEDULE

INVESTMENT SECURITIES The investment securities portfolio is managed to optimize the yield on excess funds while providing liquidity for unexpected deposit decreases or increased loan generation and diversification in the overall asset management of the Company. At December 31, 2002, the Company had $28.0 million in securities available for sale, compared to $23.7 million at year-end 2001. The yield on taxable investment securities declined from 6.46% in 2001 to 5.54% in 2002 as a result of maturities and calls of higher yielding securities. Management of the investment portfolio has always been conservative with virtually all investments taking the form of purchases of U.S. Treasury, U.S. Government agencies, Mortgage Backed Securities and issuances of State and local bond issues. All securities are high quality and high grade. Management views the investment portfolio as a source of income, and generally purchases securities with the intent of retaining them until maturity. However, adjustments in the portfolio are necessary from time to time to provide a source of liquidity to meet funding requirements for loan demand, deposit fluctuations and to manage interest rate risk. Accordingly, to meet such objectives, management may sell certain securities prior to their scheduled maturity. Table 8 presents the investment portfolio at the end of 2002 by major types of investments and maturity ranges. Maturities may differ from scheduled maturities in mortgage-backed securities because the mortgages underlying the securities may be called or repaid prior to the scheduled maturity date. Maturities on all other securities are based on the earlier of the contractual maturity or the call date, if any. At December 31, 2002, the market value of the investment portfolio was $46.0 million, representing a $1.4 million unrealized appreciation above amortized cost. This compared to a market value of $43.2 million and a $590 thousand appreciation above amortized cost a year earlier. 34 MANAGEMENT'S DISCUSSION AND ANALYSIS TABLE 8. INVESTMENT SECURITIES

35 MANAGEMENT'S DISCUSSION AND ANALYSIS DEPOSITS Cardinal Bankshares relies on deposits generated in its market area to provide the majority of funds needed to support lending activities and for investments in liquid assets. More specifically, core deposits (total deposits less certificates of deposits in denominations of $100,000 or more) are the primary funding source. The Company's balance sheet growth is largely determined by the availability of deposits in the markets it serves, the cost of attracting the deposits, and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios. The sustained low interest rate environment and other market conditions have resulted in depositors shopping for deposit rates more than in the past. Increased customer awareness of interest rates has added to the importance of effective interest rate management. Accordingly, management must continuously monitor market pricing, competitor's rates, and internal interest rate spreads to continue the Company's growth and improve profitability. Cardinal Bankshares' interest rate management goals include structuring rates in a manner that can promote both deposit and asset growth while increasing overall profitability of the Company. Average total deposits for the year ended December 31, 2002 rose $10.3 million to $161.3 million, or 6.8% over 2001. The Company's average deposits that are interest-bearing were at 87.5% in 2002, in essence unchanged from 2001. Average demand deposits, which earn no interest, increased to $20.2 million in 2002 from $19.0 million in 2001. Average deposits for the past three years are summarized in Table 9 below. TABLE 9. DEPOSIT MIX

The average balance of certificates of deposit issued in denominations of $100,000 or more remained basically unchanged at $23.5 million compared to the average for 2001. The Company maintained its strategy of supporting asset growth with core deposits instead of aggressively soliciting more volatile, large denomination certificates of deposit. Table 10 provides maturity information relating to Certificate of Deposits of $100,000 or more at December 31, 2002. 36 MANAGEMENT'S DISCUSSION AND ANALYSIS TABLE 10. LARGE DENOMINATION DEPOSITS $100,000 AND OVER ANALYSIS OF TIME DEPOSITS OF $100,000 OR MORE AT DECEMBER 31, 2002: Time remaining to maturity: Less than three months $ 2,868 Three through one year 11,721 Over one year 8,616 ------------- Total time deposits of $100,000 or more $ 23,205 ============= CAPITAL ADEQUACY The Company's capital serves to support asset growth and provide protection against loss to depositors and creditors. Cardinal Bankshares strives to maintain an optimum level of capital, commensurate with its risk profile, on which an attractive return to stockholders can be realized over both the near and long term, while serving depositors', creditors' and regulatory needs. Common stock and capital surplus represents the stockholders' investment in the Company and is a key source of capital. The largest component of capital for the Company is earnings retained after payment of dividends to stockholders. Total stockholders' equity was $23.2 million at December 31, 2002, an increase of $1.8 million or 8.2% compared with $21.5 million for the same period in 2001. The FDIC has adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total capital to risk-weighted assets is 8.0% of which at least 4.0% must be Tier 1 capital, composed of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. Cardinal Bankshares had a ratio of total capital to risk-weighted assets of 19.80% at December 31, 2002 and a ratio of Tier 1 capital to risk-weighted assets of 18.54%. Both of these ratios well exceed the capital requirements adopted by the federal regulatory agencies, and continue to be equal to or above most of our peer group. In addition, a minimum leverage ratio of Tier I capital to average total assets for the previous quarter is required by federal bank regulators, ranging from 3% to 5%, subject to the regulator's evaluation of the Company's overall safety and soundness. As of December 31, 2002, Cardinal Bankshares had a ratio of year-end Tier I capital to average total assets, as defined, of 12.37%. Table 11 below, sets forth summary information with respect to the Company and the Bank's capital ratios at December 31, 2002. All capital ratio levels indicate that Cardinal Bankshares and Bank of Floyd are well capitalized. 37 MANAGEMENT'S DISCUSSION AND ANALYSIS TABLE 11. YEAR-END RISK-BASED CAPITAL

* Tier I capital divided by average total assets for the quarter ended December 31. NONPERFORMING AND PROBLEM ASSETS Certain credit risks are inherent in making loans, particularly commercial and consumer loans. Management prudently assesses these risks and strives to manage them effectively. The Bank seeks to use shorter-term loans and, although a portion of the loans may be made based upon the value of collateral, it relies primarily on the cash flow of the borrower as the source of repayment rather than the value of the collateral. The Bank also manages its repayment risks by adhering to internal credit policies and procedures. These policies and procedures include officer and customer limits, periodic loan documentation review and follow-up on exceptions to credit policies. Nonperforming assets at December 31, 2002 and 2001 are shown in Table 12 below. 38 MANAGEMENT'S DISCUSSION AND ANALYSIS TABLE 12. NONPERFORMING ASSETS DECEMBER 31, 2002 (IN THOUSANDS) 2002 2001 - -------------------------------- ------------ ------------ Non-accrual loans $ - $ 17 Loans past due 90 days or more 100 636 Foreclosed properties 655 52 ------------ ------------ Total nonperforming assets $ 755 $ 705 ============ ============ Total nonperforming assets, which consist of nonaccrual loans, loans 90 days or more past due, and other real estate owned were $755 thousand at December 31, 2002, an increase of $50 thousand from one year earlier. ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES The allowance for loan losses represents the amount available for credit losses inherent in the Company's loan portfolio. The Company performs periodic systematic reviews of its portfolio to identify these inherent losses, and to assess the overall probability of collection of the portfolio. These reviews result in the identification and quantification of loss factors, which are used in determining the amount of the allowance for loan losses. In addition, the Company also evaluates the prevailing economic and business conditions affecting individual borrowers, changes in the size and characteristics of the loan portfolio and other pertinent factors. The allowance is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance, and the size of the allowance in comparison to peer companies identified by regulatory agencies. The Company is committed to the early recognition of problem loans and to a conservative allowance. The Company believes the current allowance is adequate to cover inherent losses in the loan portfolio. However, the allowance may be increased or decreased in the future based upon management's assessment of the factors outlined above. The allowance for loan losses was $1.8 million at December 31, 2002 and $1.3 million at December 31, 2001. The allowance as a percentage of period end loans was 1.54% at year-end 2002 and 1.14% at year-end 2001. The provision for loan losses for the year ended December 31, 2002 was $375 thousand, a decrease of $67 thousand from the previous year. During 2002, the Company saw modest loan growth of $586 thousand, or .5%, while the allowance for loan losses increased 36%. After reviewing the growth in the loan portfolio, changes in the components of nonperforming loans, and general economic trends, management felt the current year decrease in the provision for loan losses was appropriate. The provision recorded maintained the allowance at a level considered adequate to cover potential losses. 39 MANAGEMENT'S DISCUSSION AND ANALYSIS The provision for loan losses, net charge-offs and the activity in the allowance for loan losses is detailed in Table 13. TABLE 13. LOAN LOSSES

40 MANAGEMENT'S DISCUSSION AND ANALYSIS The Company had recoveries, net of charge-offs, of $94 thousand during 2002, compared to net charge-offs of $276 thousand during 2001. Net loan charge-offs as a percentage of average loans were 0.3% in 2001, and 1.1% in 2000. Gross charge-offs during 2002 totaled $96 thousand compared to $484 thousand in 2001. Recoveries during 2002 and 2001 totaled $190 thousand and $208 thousand, respectively. The Company has allocated the allowance for loan losses based on estimates of the allowance needed for each component of the loan portfolio. The allocation of the allowance as shown in Table 14. below should not be interpreted as an indication that loan losses in future years will occur in the same proportions or that the allocation indicates future loan loss trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the total allowance is a general allowance applicable to the entire portfolio. TABLE 14. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

/(1)/ Represents the percentage of loans in each category to the total loans outstanding. LIQUIDITY AND INTEREST RATE SENSITIVITY The principal goals of the Bank's asset and liability management strategy are the maintenance of adequate liquidity and the management of interest rate risk. Liquidity is the ability to convert assets to cash to fund depositors' withdrawals or borrowers' loans without significant loss. Interest rate risk management balances the effects of interest rate changes on assets that earn interest or liabilities on which interest is paid, to protect the Bank from wide fluctuations in its net interest income which could result from interest rate changes. Management must insure that adequate funds are available at all times to meet the needs of its customers. On the asset side of the balance sheet, maturing investments, loan payments, maturing loans, federal funds sold, and unpledged investment securities are principal sources of liquidity. On the liability side of the balance sheet, liquidity sources include core deposits, the ability to increase large denomination certificates, federal funds lines from correspondent banks, borrowings from the Federal Reserve Bank and the Federal Home Loan Bank, as well as the ability to generate funds through the issuance of long-term debt and equity. The liquidity ratio, the level of liquid assets divided by total deposits plus short-term liabilities, is considered to be adequate by management. 41 MANAGEMENT'S DISCUSSION AND ANALYSIS TABLE 15. INTEREST RATE SENSITIVITY (THOUSANDS)

Interest rate risk is the effect that changes in interest rates would have on interest income and interest expense as interest-sensitive assets and interest-sensitive liabilities either reprice or mature. Management attempts to maintain the portfolios of earning assets and interest-bearing liabilities with maturities or repricing opportunities at levels that will afford protection from erosion of net interest margin, to the extent practical, from changes in interest rates. Table 15 above shows the sensitivity of the Company's balance sheet on December 31, 2002. This table reflects the sensitivity of the balance sheet as of that specific date and is not necessarily indicative of the position on other dates. At December 31, 2002, the Bank appeared to be liability-sensitive with interest-bearing liabilities exceeding earning assets, subject to changes in interest rates, for the first twelve months. Included in the interest-bearing liabilities subject to interest rate changes within three months are interest checking accounts and savings accounts which historically have not been as interest-sensitive as other types of interest-bearing deposits. The Bank appears to be asset-sensitive after the first twelve months. Matching sensitive positions alone does not ensure that the Bank has no interest rate risk. The repricing characteristics of assets are different from the repricing characteristics of funding sources. Thus, net interest income can be impacted by changes in interest rates even if the repricing opportunities of assets and liabilities are perfectly matched. 42 MANAGEMENT'S DISCUSSION AND ANALYSIS EARNINGS AND BALANCE SHEET ANALYSIS 2001 Compared to 2000 - On a tax-equivalent basis, net interest income for 2001 was $6.4 million, an increase of 7.7% from 2000. This growth resulted primarily from the higher levels of loans achieved in 2001. Lower overall yields on interest-earning assets during 2001, however, resulted in the Company's net interest margin declining 7 basis points from 3.96% for 2000 to 3.89% for 2001. Average interest-earning assets for 2001 increased $14.5 million, or 9.6%. This growth produced approximately $1.0 million in additional income. Average interest-bearing liabilities increased $10.0 million, or 8.2%, from 2000 and interest expense increased $.5 million, or 8.2%, over 2000. The overall rate paid on interest-bearing liabilities for the year 2001 remained unchanged from 2000; however, the increased volume of deposits taken as a whole generated a higher level of funding costs for the year. The Company's investment portfolio decreased by $6.5 million on average to $49.7 million for 2001, mainly due to securities being called or repaid prior to their scheduled maturity dates. In 2001, total loans grew $16.6 million, or 18.5%, to an average of $106.4 million. Nonfarm and nonresidential loans secured by real estate accounted for the majority of this increase. Total average deposits increased $11.3 million, or 8.1%, from 2000 to an average of $151.0 million for 2001. Large denomination, time and demand deposits grew $6.4 million, $4.0 million and $1.5 million, respectively. Noninterest income increased $94 thousand in 2001 compared to 2000. Although service charges on deposit accounts and other fees grew by $48 thousand and securities gains increased $44 thousand, lower levels of other income offset much of this growth. Noninterest expense was $3.5 million for 2001, an increase of 6.7% over the prior year. Salaries and benefits, the largest component of noninterest expense, grew principally due to normal merit increases. The allowance for loan losses at December 31, 2001 was $1.3 million compared to $1.1 million a year earlier. The allowance for loan losses as a percentage of period end loans was 1.13% compared to 1.21% at year-end 2000. Net charge-offs were $276 thousand in 2001, compared to $1.0 million in 2000. The higher volume of charge-offs in 2000 were related to leases. Nonperforming loans totaled $705 thousand at December 31, 2001, a decline of 16.4% from 2000. This reduction was primarily due to a decrease in nonaccrual loans and foreclosed properties of $441 thousand. A WARNING ABOUT FORWARD-LOOKING STATEMENTS This annual report contains forward-looking statements. The Company may also make written forward-looking statements in periodic reports to the Securities and Exchange Commission, proxy statements, offering circulars and prospectuses, press releases and other written materials and oral statements made by Cardinal Bankshares' officers, directors or employees to third parties. Statements that are not historical facts, including statements about the Company's beliefs and expectations, are forward-looking statements. These statements are based on beliefs and assumptions of the Company's management, and on information currently available to such management. Forward-looking statements include statements preceded by, followed by or that include the words "believes," "expects," "estimates," "anticipates," "plans," or similar expressions. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update publicly any of them in light of new information or future events. 43 MANAGEMENT'S DISCUSSION AND ANALYSIS Forward-looking statements involve inherent risks and uncertainties. Management cautions the readers that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors include, but are not limited to, the following: competitive pressures among depository and other financial institutions may increase significantly; changes in the interest rate environment may reduce margins; general economic or business conditions may lead to a deterioration in credit quality or a reduced demand for credit; legislative or regulatory changes, including changes in accounting standards, may adversely affect the business in which Cardinal Bankshares is engaged; changes may occur in the securities markets; and competitors of the Company may have greater financial resources and develop products that enable such competitors to compete more successfully than Cardinal Bankshares. Other factors that may cause actual results to differ from the forward-looking statements include the following: the timely development of competitive new products and services by the Company and the acceptance of such products and services by customers; changes in consumer spending and savings habits; the effects of competitors' pricing policies; the Company's success in managing the costs associated with the expansion of existing distribution channels and developing new ones, and in realizing increased revenues from such distribution channels, including cross-selling initiatives; and mergers and acquisitions and their integration into the Company and management's ability to manage these other risks. Management of Cardinal Bankshares believes these forward-looking statements are reasonable; however undue reliance should not be placed on such forward-looking statements, which are based on current expectations. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. The future results and stockholder values of Cardinal Bankshares may differ materially from those expressed in forward-looking statements contained in this report. Many of the factors that will determine these results and values are beyond the Company's ability to control or predict. 44 STAFF MAIN OFFICE ----------- Sheena Akers Ralph Edwards Andrea Mollick Tara Akers Amanda Farmer Betty Moran Shelley Bond Sandra Gallimore Teresa Pendleton Jessica Bower Regena Gibson Gail Phillips Patricia Bower Bud Gilliam Janet Roberson Regina Compton Gail Goad Jan Rorrer Beulah Correll Gay Grim Robin Sutphin Leslie Cox Lucy Harris Lisa Thomas Shelia Dehart Teresa Keith Patsy Wallace Roger Dickerson Michael McConnell Gina West Vicky Diamond Yara Middleton Jeanne Woods CAVE SPRING CHRISTIANSBURG HILLSVILLE ---------------- -------------- -------------- Heather Earley Karen Bowman Rebecca Adams Jessica Flinchum Kay King Louise Goad Kevin Harvey Sharon Zeman Karen Pearman Jennifer Pastrana Frances Sharpe WILLIS ------ Karen Sutphin 45 BOARD OF DIRECTORS OF CARDINAL BANKSHARES AND BANK OF FLOYD K. Venson Bolt William R. Gardner, Jr. Leon Moore Joseph Howard Conduff C. W. Harman Dorsey H. Thompson Kevin D. Mitchell

46 STOCKHOLDER INFORMATION ANNUAL MEETING The annual meeting of shareholders will be held Wednesday, April 23, 2003, at 2:00 p.m. in the Bank of Floyd's conference room, 101 Jacksonville Circle, Floyd, Virginia. REQUESTS FOR INFORMATION Requests for information should be directed to Mrs. Annette Battle, Recording Secretary, at Bank of Floyd, Post Office Box 215, Floyd, Virginia, 24091; telephone (540) 745-4191. A copy of the Company's Form 10-KSB for 2002 can be obtained from the Securities and Exchange Commission's website at www.sec.gov after March 31, 2003 or upon request from the Company. INDEPENDENT AUDITORS STOCK TRANSFER AGENT Larrowe & Company, PLC Bank of Floyd Certified Public Accountants Post Office Box 215 Post Office Box 760 Floyd, Virginia 24091 Galax, Virginia 24333 FEDERAL DEPOSIT INSURANCE CORPORATION The Bank is a member of the FDIC. This statement has not been reviewed, or confirmed for accuracy or relevance by the Federal Deposit Insurance Corporation. Member of Federal Reserve Bank of Richmond. ---------- Member of Federal Home Loan Bank of Atlanta. ---------- BANKING OFFICES --------------- FLOYD OFFICE CAVE SPRING OFFICE 101 Jacksonville Circle 4094 Postal Drive Floyd, Virginia 24091 Roanoke, Virginia 24018 (540) 745-4191 (540) 774-1111 ATM location ATM location CHRISTIANSBURG OFFICE Post Office Box 6113 Christiansburg, Virginia 24068 (540) 381-8121 WILLIS OFFICE HILLSVILLE OFFICE Floyd Highway South 185 South Main Street Willis, Virginia 24380 (276) 728-2341 (540) 745-4191 ATM location 47 -----END PRIVACY-ENHANCED MESSAGE-----