10-Q

U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO

SECTION 13 or 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarter ended September 30, 2006

Commission File No. 0-28780

CARDINAL BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

Virginia	54-1804471
(State of Incorporation)	(I.R.S. Employer Identification No.)

101 Jacksonville Circle, P. O. Box 215, Floyd, Virginia 24091

(Address of principal executive offices)

(540) 745-4191

(Registrant’s telephone number)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. (Check one):

Large Accelerated Filer  ¨     Accelerated Filer  ¨     Non-accelerated Filer  x.

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

The number of shares outstanding of the issuer’s Common Stock, $10 par value as of November 9, 2006 was 1,535,733.

CARDINAL BANKSHARES CORPORATION

FORM 10-Q

September 30, 2006

INDEX

		Page
Part I.	Financial Information
Item 1.	Consolidated Balance Sheets as of September 30, 2006 (Unaudited) and December 31, 2005 (Audited)	3
	Consolidated Statements of Income for the three months and nine months ended September 30, 2006 and 2005 (Unaudited)	4
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2006 and 2005 (Unaudited)	5
	Notes to Consolidated Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	7
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	11
Item 4.	Controls and Procedures	11
Part II.	Other Information
Item 1.	Legal Proceedings	12
Item 1A.	Risk Factors	13
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	13
Item 3.	Defaults Upon Senior Securities	13
Item 4.	Submission of Matters to a Vote of Security Holders	13
Item 5.	Other Information	13
Item 6.	Exhibits	13

Cardinal Bankshares Corporation and Subsidiary

Consolidated Balance Sheets

	(Unaudited)			(Audited)
(In thousands, except share data)	September 30, 2006			December 31, 2005
Assets
Cash and due from banks	$	3,896		$	4,292
Interest-bearing deposits		9,655			9,042
Federal funds sold		7,775			5,125
Investment securities available for sale, at fair value		19,047			19,308
Investment securities held to maturity (fair value September 30, 2006 - $17,418; December 31, 2005 - $17,743)		17,238			17,470
Restricted equity securities		554			546
Total loans		123,242			129,981
Allowance for loan losses		(1,592	)		(1,427	)
Net loans		121,650			128,554
Bank premises and equipment, net		3,880			3,997
Accrued interest receivable		936			998
Foreclosed properties		212			418
Bank owned life insurance		4,749			4,631
Other assets		1,839			1,854
Total assets	$	191,431		$	196,235
Liabilities and Stockholders’ Equity
Noninterest-bearing deposits	$	27,044		$	26,747
Interest-bearing deposits		134,477			141,101
Total deposits		161,521			167,848
Securities sold under agreements to repurchase		—			134
Accrued interest payable		172			134
Other liabilities		1,217			1,061
Total liabilities		162,910			169,177
Commitments and contingent liabilities		—			—
Stockholders’ Equity
Common stock, $10 par value, 5,000,000 shares authorized, 1,535,733 shares issued and outstanding		15,357			15,357
Additional paid-in capital		2,925			2,925
Retained earnings		10,298			8,833
Accumulated other comprehensive income, net		(59	)		(57	)
Total stockholders’ equity		28,521			27,058
Total liabilities and stockholders’ equity	$	191,431		$	196,235

See Notes to Consolidated Financial Statements.

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Cardinal Bankshares Corporation and Subsidiary

Consolidated Statements of Income (Unaudited)

	Three months ended September 30,					Nine months ended September 30,
(In thousands, except share data)	2006		2005			2006			2005
Interest income
Loans and fees on loans	$	2,493	$	2,211		$	7,076		$	6,378
Federal funds sold and securities purchased under agreements to resell		68		52			142			110
Investment securities:
Taxable		203		178			602			596
Exempt from federal income tax		210		227			641			695
Deposits with banks		111		55			307			89
Total interest income		3,085		2,723			8,768			7,868
Interest expense
Deposits		1,047		925			3,003			2,544
Borrowings		—		3			—			25
Total interest expense		1,047		928			3,003			2,569
Net interest income		2,038		1,795			5,765			5,299
Provision for loan losses		135		12			165			48
Net interest income after provision for loan losses		1,903		1,783			5,600			5,251
Noninterest income
Service charges on deposit accounts		73		68			205			197
Other service charges and fees		24		27			73			76
Net realized gains on sales of securities		—		—			3			9
Other operating income		90		82			312			244
Total noninterest income		187		177			593			526
Noninterest expense
Salaries and employee benefits		733		781			2,221			2,166
Occupancy and equipment		165		170			505			535
Foreclosed assets, net		—		(17	)		(9	)		(17	)
Other operating expense		396		398			1,017			1,058
Total noninterest expense		1,294		1,332			3,734			3,742
Income before income taxes		796		628			2,459			2,035
Income tax expense		186		126			579			430
Net Income	$	610	$	502		$	1,880		$	1,605
Basic earnings per share	$	0.40	$	0.33		$	1.23		$	1.05
Diluted earnings per share	$	0.40	$	0.33		$	1.23		$	1.05
Weighted average basic shares outstanding		1,535,733		1,535,733			1,535,733			1,535,733
Weighted average diluted shares outstanding		1,535,733		1,535,733			1,535,733			1,535,733

See Notes to Consolidated Financial Statements.

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Cardinal Bankshares Corporation and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)

(In thousands) Nine Months Ended September 30,	2006			2005
Cash flows from operating activities
Net income	$	1,880		$	1,605
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		257			261
Net amortization (accretion) of bond premiums/discounts		20			(1	)
Provision for loan losses		165			48
Net realized (gains) losses on investment securities		(3	)		(9	)
Net realized (gains) losses on sale of foreclosed assets		(9	)		—
Deferred compensation and pension expense		129			153
Changes in operating assets and liabilities:
(Increase) decrease in accrued interest receivable		62			(16	)
Increase (decrease) in accrued interest payable		38			21
Net change in other operating assets and liabilities		(76	)		(314	)
Net cash provided by operating activities		2,463			1,748
Cash flows from investing activities
Net (increase) decrease in interest-bearing deposits in banks		(613	)		(5,008	)
Net (increase) decrease in federal funds sold		(2,650	)		5,450
Purchase of investment securities		(6,036	)		(3,127	)
Proceeds from sale of available for sale securities		—			750
Purchase of restricted equity securities		(8	)		—
Proceeds from redemption of equity securities		—			57
Proceeds from maturity and redemption of investment securities		6,510			7,935
Net (increase) decrease in loans		6,739			(8,580	)
Net purchases of bank premises and equipment		(140	)		(100	)
Proceeds from sale of foreclosed assets		215			—
Net cash (used) provided by investing activities		4,017			(2,623	)
Financing Activities
Net increase (decrease) in noninterest-bearing deposits		297			6
Net (decrease) in interest-bearing deposits		(6,624	)		3,548
Net increase (decrease) in securities sold		(134	)		(2,372	)
Dividends paid		(415	)		(384	)
Net cash (used) provided by financing activities		(6,876	)		798
Net (decrease) increase in cash and cash equivalents		(396	)		(77	)
Cash and cash equivalents at beginning of year		4,292			4,162
Cash and cash equivalents at end of year	$	3,896		$	4,085
Supplemental disclosures of cash flow information
Interest paid	$	2,965		$	2,548
Income taxes paid	$	556		$	471
Supplemental disclosures of noncash activities
Other real estate acquired in settlement of loans	$	—		$	418

See Notes to Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all of the disclosures and notes required by generally accepted accounting principles. In the opinion of management, all material adjustments (which are of a normal recurring nature) considered necessary for a fair presentation have been made. The results for the interim period are not necessarily indicative of the results to be expected for the entire year or any other interim period. The information reported herein should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Certain previously reported amounts have been reclassified to conform to current presentations.

Note 2. Allowance for Loan Losses

Changes in the allowance for loan losses are as follows:

Nine months ended September 30, (In thousands)	2006			2005
Balance, at January 1	$	1,427		$	1,631
Provision charged to expense		165			48
Recoveries of amounts previously charged off		26			87
Loans charged off		(26	)		(329	)
Balance, at September 30,	$	1,592		$	1,437

Note 3. Commitments and Contingencies

The Company’s exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and stand-by 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 the Company’s commitments at September 30 for the years indicated follows:

(In thousands)	2006		2005
Commitments to extend credit	$	22,537	$	20,576
Standby letters of credit		471		648
Total	$	23,008	$	21,224

Note 4. 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 components of the net periodic benefit cost.

Three months ended September 30, (In thousands)	2006			2005
Service cost	$	58,318		$	44,275
Interest cost		49,051			43,907
Expected return on plan assets		(49,062	)		(42,622	)
Amortization of net obligation at transition		(1,007	)		(1,007	)
Amortization of prior service cost		1,495			1,495
Amortization of net (gain) or loss		5,636			4,834
Total net periodic benefit cost	$	64,431		$	50,882

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Nine months ended September 30, (In thousands)	2006			2005
Service cost	$	174,954		$	132,825
Interest cost		147,153			131,721
Expected return on plan assets		(147,186	)		(127,866	)
Amortization of net obligation at transition		(3,021	)		(3,021	)
Amortization of prior service cost		4,485			4,485
Amortization of net (gain) or loss		16,908			14,502
Total net periodic benefit cost	$	193,293		$	152,646

The Company previously disclosed in its financial statements for the year ended December 31, 2005, that it expected to contribute $258 thousand to it pension plan in 2006. As of September 30, 2006, no contributions have been made.

Note 5. Recent Changes in Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 158 – Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (FAS 158), an amendment of FASB Statements No. 87, 88, 106, and 132 (R). For fiscal years ending after December 15, 2006, FAS 158 requires an employer to recognize the funded status of a benefit plan on its balance sheet and to recognize the gains or losses and prior service costs, not already recognized, as a component of other comprehensive income, net of taxes. FAS 158 also requires that the defined benefit plan assets and obligations be measured as of the date of the employer’s fiscal year-end balance sheet effective for fiscal years ending after December 15, 2008. The Company does not expect the adoption of FAS 158 to have a material effect on the consolidated financial statements.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cardinal Bankshares Corporation (the “Company” and “Cardinal Bankshares”), a Virginia corporation, is a bank holding company headquartered in Floyd, Virginia. The Company serves the marketplace primarily through its wholly owned banking subsidiary, Bank of Floyd (the “Bank”), a Virginia chartered, Federal Reserve member commercial bank. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) to the extent provided by law. Bank of Floyd is supervised and examined by the Federal Reserve and the Bureau of Financial Institutions of the State Corporation Commission of the Commonwealth of Virginia (the “SCC”). At September 30, 2006, the Bank operated seven branch facilities in the counties of Floyd, Montgomery, Roanoke and Carroll. The main office is in Floyd with a limited service office located in Willis. The Roanoke offices are in the Cave Spring and Tanglewood Mall areas of Roanoke County. The Salem office is located on West Main Street in Salem, Virginia. The Hillsville office is located in Carroll County. The Christiansburg office serves Montgomery County. In early 2007 the bank plans to open its eighth branch in Pulaski County, Virginia serving the Fairlawn community.

Through Bank of Floyd’s network of banking facilities, Cardinal Bankshares provides a wide range of commercial banking services to individuals, small to medium-sized businesses, institutions and governments located in Virginia. The Company conducts substantially all of the business operations of a typical independent commercial bank, including the acceptance of checking and savings deposits, and the making of commercial, real estate, personal, home improvement, automobile and other installment loans. The Company also offers other related services, such as traveler’s checks, safe deposit boxes, depositor transfer, customer note payment, collection, notary public, escrow, drive-in and ATM facilities, and other customary banking services. Cardinal Bankshares does not offer trust services.

The following discussion provides information about the major components of the financial condition, results of operations, asset quality, liquidity, and capital resources of Cardinal Bankshares. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements.

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FINANCIAL CONDITION

Total assets as of September 30, 2006 were $191.4 million, a decrease of $4.8 million from year-end 2005. Total loans declined 5.2% or $6.7 million during the first nine months of this year to $123.2 million. This decline is attributed to the slowing of the economy in several sectors and due to payoffs of loans due to refinancing for competitive rates. The bank is putting forth more effort to secure new loans and is considering economic factors for market strategies to attract and retain loan customers. Management is also anticipating loan growth in 2007 with the addition of the branch in Pulaski County.

The investment securities portfolio reflected a net decrease of $493.0 thousand. This decrease was a result of the call of municipal securities of $339 thousand, maturities of $4.3 million and usual pay downs in the amount of $1.9 million in mortgage-backed securities offset by purchases of investment securities totaling approximately $5.5 million. Federal funds sold increased $2.7 million during the first nine months of 2006.

As of September 30, 2006, total deposits were $161.5 million, down approximately $6.3 million compared to year-end 2005. Non-interest-bearing core deposits rose $297 thousand to $27.0 million as compared to $26.7 million at year-end 2005. Interest-bearing deposits declined 4.7% or $6.6 million to $134.4 million. Due to the soft loan demand in the current economic environment, the Company has strategically remained less competitive on rate sensitive deposits as reflected in the $7.4 million decline in large denomination deposits, those deposit accounts with balances greater than $100 thousand. Deposits greater than $100 thousand amounted to $39.6 million at September 30, 2006 as compared to $47.0 million at year-end 2005.

Stockholders’ equity was $28.5 million as of September 30, 2006 compared to $27.1 million as of December 31, 2005. Year-to-date net income of $1.9 million accounted for the major portion of the change in stockholders’ equity occurring over the first nine months of the year. Other factors affecting the change in stockholders’ equity were the payment on June 30, 2006 of the Company’s regular semi-annual cash dividend totaling $415 thousand, and the decline in accumulated other comprehensive income of $2 thousand caused by a decline in the market value of the available for sale portion of the Company’s investment portfolio. Management believes this decline in market value is a temporary decline.

RESULTS OF OPERATIONS

Net income for the three months ended September 30, 2006 was $610 thousand, up 21.5% compared to $502 thousand for the three months ended September 30, 2005. Diluted earnings per share increased 21.2% to $.40 for the three months ended September 30, 2006. Diluted earnings per share for the same period a year earlier was $.33.

Total interest income for the three months ended September 30, 2006 rose $362 thousand to $3.1 million compared to $2.7 million the same prior year quarter. Noninterest income remained level compared to the same prior year quarter at $187 thousand. Total interest expense increased $119 thousand to $1.0 million, reflecting the effect of certificate of deposit promotions during the quarter and interest rates paid thereon. Noninterest expense remained level at $1.3 million for the third quarter of 2006 as compared to the third quarter of 2005.

The bank’s interest income continues to rise even with the loss of loans. As loans payoff, prepaid fees are taken into revenue, thus adding to the increase in loan interest income. As securities are called and mature, the bank is able to reinvest those funds in higher yielding investments.

Net income for the nine months ended September 30, 2006 was $1.9 million, up 17.1% compared to $1.6 million for the nine months ended September 30, 2005. Diluted earnings per share increased 17.1% to $1.23 for the nine months ended September 30, 2006. Diluted earnings per share for the same period a year earlier was $1.05.

Interest income for the nine months ended September 30, 2006 was $8.8 million, up 11.4% from the $7.9 million reported a year earlier. This increase reflects the slight increase in overall portfolio yield when compared to the same period a year earlier. Total interest expense rose $434 thousand compared to the nine-month period ended September 30, 2005. Net interest income after the provision for loan losses for the nine months ended September 30, 2006 improved $349 thousand to $5.6 million.

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Total noninterest income for the nine months ended September 30, 2006 showed a slight increase of $67 thousand due primarily to an increase in other operating income. Total noninterest expense for the comparable nine-month periods ended September 30 remained level at $3.7 million.

ASSET QUALITY

The allowance for loan losses represents management’s estimate of an amount adequate to absorb potential future losses inherent in the loan portfolio. In assessing the adequacy of the allowance, management relies predominately on its ongoing review of the lending process and the risk characteristics of the portfolio in the aggregate. Among other factors, management considers the Company’s loan loss experience, the amount of past-due loans, current and anticipated economic conditions, and the estimated current values of collateral securing loans in assessing the level of the allowance for loan losses. In the first nine months of 2006, the provision for loan losses was $165 thousand as compared to $48 thousand provision for the same period in 2005. Based upon management’s periodic reviews of the loan portfolio using the above mentioned factors, the current year increase in the provision for loan losses was felt appropriate. Management believes the provision recorded in 2006 maintains the allowance at a level adequate to cover potential losses.

The allowance for loan losses totaled $1.6 million at September 30, 2006. The allowance for loan losses to period end loans was 1.29% at September 30, 2006 compared to 1.10% and 1.08% at December 31, 2005 and September 30, 2005, respectively. The Company had recoveries on loans in the amount of $26 thousand and charge offs of loans in the amount of $26 thousand during the first nine months of 2006. This compares with net charge offs for the nine months ended September 30, 2005 of $242 thousand. The net charge offs in 2005 was primarily related to the charge off of a participated note, offset by recoveries of previously charged off amounts.

The allowance for loan losses represents management’s estimate of an amount adequate to provide for potential losses inherent in the loan portfolio. The adequacy of the loan loss reserve and the related provision are based upon management’s evaluation of the risk characteristics of the loan portfolio under current economic conditions with consideration to such factors as financial condition of the borrowers, collateral values, growth and composition of the loan portfolio, the relationship of the allowance to outstanding loans and delinquency trends.

While management uses all available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

Nonperforming assets, which consist of nonaccrual loans, loans 90 days or more past due, and other real estate owned, were $872 thousand as of September 30, 2006 compared to $467 thousand as of December 31, 2005. Management does not expect to incur any material losses related to nonperforming assets.

LIQUIDITY

In determining the Company’s liquidity requirements, both sides of the balance sheet are managed to ensure that adequate funding sources are available to support loan growth, deposit withdrawals or any unanticipated need for funds.

Securities available for sale that mature within one year, or securities that have a weighted average life of one year or less are sources of liquidity. Anticipated mortgage-backed securities pay downs and maturing loans also generate cashflows to meet liquidity requirements. Wholesale funding sources are also used to supply liquidity such as federal funds purchased and large denomination certificates of deposit. The Company considers its sources of liquidity to be adequate to meet its anticipated needs.

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CAPITAL RESOURCES

Cardinal Bankshares’ capital position provides the necessary assurance required to support anticipated asset growth and to absorb potential losses.

The Company’s Tier I capital position was $28.6 million at September 30, 2006, or 21.00% of risk-weighted assets. Total risk-based capital was $30.2 million or 22.17% of risk-weighted assets.

Tier I capital consists primarily of common stockholders’ equity, while total risk-based capital includes the allowance for loan losses. Risk weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities. To be well capitalized under current risk-based capital standards, all banks are required to have Tier I capital of at least 4% and total capital of 8%. Based on these standards, Cardinal Bankshares is categorized as well capitalized at September 30, 2006.

In addition to the risk-based capital guidelines, banking regulatory agencies have adopted leverage capital ratio requirements. The leverage ratio – or core capital to assets ratio – works in tandem with the risk-capital guidelines. The minimum leverage ratios range from three to five percent. At September 30, 2006, the Company’s leverage capital ratio was 14.76%.

A WARNING ABOUT FORWARD-LOOKING STATEMENTS

This Form 10-Q 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 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.

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.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The principal goals of the Company’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 seeks to balance the effects of interest rate changes on assets that earn interest or liabilities on which interest is paid, to protect the Company from wide fluctuations in its net interest income.

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.

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.

The Company uses a number of tools to manage its interest rate risk, including simulating net interest income under various scenarios, monitoring the present value change in equity under the same scenarios, and monitoring the difference or gap between rate sensitive assets and rate sensitive liabilities over various time periods.

The earnings simulation model forecasts annual net income under a variety of scenarios that incorporate changes in absolute level of interest rates, changes in the shape of the yield curve and changes in interest rate relationships. Management evaluates the effect on net interest income from gradual changes in the Prime Rate of up to 200 basis points up or down over a 12-month period. The current model indicates that an increase in rates of 200 basis points over the next twelve months would result in an increase in net interest income of $874 thousand, or 11.71%, while a similar decrease in rates would result in a decrease in net interest income of $755 thousand, or 10.12%. The model also incorporates management’s forecasts for balance sheet growth, noninterest income and noninterest expense. The interest rate scenarios are used for analytical purposes and do not represent management’s view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may apply to the earnings of the Company. Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous assumptions embedded in the simulation model. While the earnings sensitivity analysis incorporates management’s best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earning impact likely will differ from projected.

Additional qualitative information about interest rate risk is included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. There have not been any material changes since December 31, 2005.

Item 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this report, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, including internal controls and procedures for financial reporting. Our chief executive officer and principal financial officer supervised this evaluation

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and have concluded that our disclosure controls and procedures are effective. Subsequent to this evaluation, (i) there have been no significant changes in our internal controls or in other factors that could significantly affect our disclosure controls and procedures and (ii) we have not taken any corrective actions with regard to our disclosure controls and procedures to correct any significant deficiencies and weaknesses.

The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goal under every potential condition, regardless of how remote. In addition, the operation of any system of controls and procedures is dependent upon the employees responsible for executing it. While we have evaluated the operation of our disclosure controls and procedures and found them effective, there can be no assurance that they will succeed in every instance to achieve their objective.

Part II. OTHER INFORMATION

Item: 1 Legal proceedings

The Company was named as a defendant in a complaint filed by a former employee with the United States Department of Labor under Section 806 of the Sarbanes-Oxley Act. The plaintiff alleged in his complaint that his termination in October, 2002 violated the Act. He is seeking reinstatement, back pay and damages. The Company maintains that the independent members of its Board of Directors terminated the plaintiff lawfully because he refused to comply with the directives of the Audit Committee in their attempt to look into certain matters raised by the plaintiff. The Audit Committee, after full investigation, later concluded that the matters raised by the plaintiff had no merit. The Board’s decision was initially upheld by the Department of Labor. The plaintiff appealed that decision. The Department of Labor Administrative Law Judge reversed the earlier decision in the Company’s favor and entered a decision in favor of the plaintiff in January 2004. The Company appealed that decision. The Administrative Review Board of the Department of Labor agreed to review the decision of the Administrative Law Judge in February 2004. Their decision to review suspended the decision of the Administrative Law Judge prior to any determination of damages by the Administrative Law Judge. In May 2004, the Administrative Review Board within the Department of Labor determined that it had accepted the Company’s petition for review prematurely.

Because of the uncertainty regarding the procedural handling of this case within the DOL, to preserve its ultimate ability to appeal to the Federal Courts, in June 2004, the Company filed with the United States Court of Appeals for the Fourth Circuit a Petition for Review of the decisions of the United States Department of Labor. The appeal was determined to be premature. The parties submitted evidence to the Administrative Law Judge of damages without a further hearing in December 2004 and January 2005. The Administrative Law Judge rendered a Supplemental Recommended Decision and Order in February 2005, which awarded damages to the plaintiff of $65 thousand, plus attorney’s fees of $108 thousand, and ordered the plaintiff’s reinstatement. The Company filed a petition for review to the Administrative Review Board of the Department of Labor. The case was accepted for review by the Administrative Review Board in March 2005. The Company’s management believes it has substantial grounds for a successful appeal of the decision in the plaintiff’s favor and will pursue appeals vigorously. Both sides have submitted briefs to the Administrative Review Board and are awaiting the Administrative Review Board’s decision. The Company’s position in the case has been supported by the American Bankers Association, the Virginia Bankers Association, the Virginia Association of Community Banks, and the American Association of Bank Directors who have filed so-called “Friends of the Court” briefs with the Administrative Review Board urging the dismissal of Mr. Welch’s complaint.

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On August 30, 2005, the plaintiff filed a complaint in the United States District Court for the Western District of Virginia seeking to enforce what he claimed was a preliminary order of reinstatement issued by the Administrative Law Judge. The Court granted the Company’s motion to dismiss January 14, 2006, on the grounds that there is no preliminary order of reinstatement to enforce. The plaintiff made a motion to alter or amend the judgment of dismissal, and that motion was denied January 26, 2006. The plaintiff has not appealed the decisions of the District Court.

The plaintiff also moved the Administrative Law Judge for expedited clarification of his earlier order. Relief was denied on the grounds of lack of jurisdiction. Then, on February 8, 2006, the plaintiff made a motion to the Administrative Review board for expedited declaration of preliminary order of reinstatement. The Administrative Review Board determined, contrary to the United States District Court, that the Administrative Law Judge had entered a preliminary order of reinstatement but permitted the Company to move to stay the preliminary order. The Company made that motion to stay preliminary reinstatement on April 17, 2006, and the motion for a stay was denied June 9, 2006.

Welch then filed a new action in the United States District Court on July 6, 2006, seeking once again to enforce the purported preliminary order of reinstatement. In this proceeding the Department of Labor intervened to support the enforcement of the purported preliminary order sought by Welch. The individual directors of the Company took the unusual step of retaining their own counsel and intervening as individual parties defendant in the proceeding to emphasize their opposition to Welch’s reinstatement. The American Association of Bank Directors also intervened as a “Friend of the Court” urging that Welch not be reinstated. A hearing was held on September 25, 2006 by the United States District Court on Welch’s case and on October 5, 2006 the District Court dismissed Welch’s petition to enforce the Department of Labor’s purported preliminary order of reinstatement.

1A. Risk factors

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

2 Unregistered sales of equity securities and use of proceeds - None

3 Defaults upon senior securities - None

4 Submission of matters to a vote of security holders – None

5 Other information - None

6 Exhibits

31.1 –	Certification of Chief Executive Officer Pursuant To Rule 13a-14(a)
31.2 –	Certification of Principal Financial Officer Pursuant To Rule 13a-14(a)
32.1 –	Certification of Chief Executive Officer and Principal Financial Officer Pursuant To 18 U.S.C. Section 1350

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized.

CARDINAL BANKSHARES CORPORATION

/s/Ronald Leon Moore

Ronald Leon Moore

Chairman of the Board, President and Chief Executive Officer

/s/Stephanie K. Sigman

Stephanie K. Sigman

Senior Vice President, Controller and Principal Financial Officer

Date: November 10, 2006

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EX-31.1

EXHIBIT 31.1

CERTIFICATION

I, Ronald Leon Moore, certify that:

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

2. Based on my knowledge, this quarterly 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 quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) and internal control over financial reporting (as defined in Exchange Rules 13a-15(f) and 15(d)-15(f) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

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

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which could adversely affect the registrant’s ability to record, process, summarize and report financial information 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 control over financial reporting.

Date: November 10, 2006

/s/ Ronald Leon Moore

Ronald Leon Moore

Chairman, President & Chief Executive Officer

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EX-31.2

EXHIBIT 31.2

CERTIFICATION

I, Stephanie K. Sigman, certify that:

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

2. Based on my knowledge, this quarterly 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 quarterly report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e) and internal control over financial reporting (as defined in Exchange Rules 13a-15(f) and 15(d)-15(f) for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;

b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.

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

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which could adversely affect the registrant’s ability to record, process, summarize and report financial information 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 control over financial reporting.

Date: November 10, 2006

/s/ Stephanie K. Sigman

Stephanie K. Sigman

Senior Vice President, Controller & Principal Financial Officer

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EX-32.1

EXHIBIT 32.1

CERTIFICATION

(Pursuant to 18 U.S.C. Section 1350)

The undersigned hereby certifies that (i) the foregoing Quarterly Report on Form 10-Q filed for the quarter ended September 30, 2006, 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: November 10, 2006	/s/ Ronald Leon Moore
	Ronald Leon Moore
	Chairman, President & Chief Executive Officer
Date: November 10, 2006	/s/ Stephanie K. Sigman
	Stephanie K. Sigman
	Senior Vice President, Controller
	& Principal Financial Officer

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