EX-13 2 f10-ex13.txt ANNUAL REPORT TABLE OF CONTENTS 3 Message to Shareholders 5 Financial Highlights 6 Selected Financial Data 8 Management`s Discussion and Analysis of Financial Condition and Results of Operations 26 Consolidated Balance Sheets 27 Consolidated Statements of Income 28 Consolidated Statements of Changes in Shareholders` Equity 29 Consolidated Statements of Cash Flows 30 Notes to Consolidated Financial Statements December 31, 2008, 2007 and 2006 51 Report of Independent Registered Public Accounting Firm 52 Report of Management on the Coorporation`s Internal Control Over Financial Reporting 53 Comparison of Five-Year Cumulative Total Return of National Bancshares Corporation, S&P 500 Stock Index, and S&P 500 Bank Index 54 Price Range of Common Stock 54 Shareholder Information 55 Officers 56 Directors 56 First National Bank Offices MESSAGE TO SHAREHOLDERS Dear Shareholders: We continued to make progress in 2009 even though earnings declined 27% from $1.00 per share to $0.73 per share. Any earnings decline is a disappointment, but 2009 was a very unusual year. Actually, we could characterize 2009 as the `exclamation point` on the `bubble decade.` Some have referred to the last ten years as the lost decade. Whatever we choose to call it, all of us know we are living in a very challenging economic environment. When our clients suffer financially, we suffer. In our business, `we feel your pain` is not a cliche. People without jobs can not make loan payments. Retail merchants who suffer a decline in business can not make rent or mortgage payments. Businesses who suffer a decline in sales can not make loan payments. Millions of people have lost jobs and in some parts of the United States real estate values have been cut in half. In 2009, we witnessed a record number of personal bankruptcies and business failures. As a result we made the prudent decision to increase the provision for loan losses by over $1 million from $482 thousand in 2008 to $1.8 million in 2009. This increased provision also directly reduced net income. An end to the current economic malaise is not in sight and we intend to continue making an increased provision to the allowance for loan losses in 2010. In 2009, we witnessed `too big to fail` brokerage firms, insurance companies and banks being bailed out by the Federal Government. Community banks, on the other hand, were not treated in similar fashion. Community banks were allowed to fail and many of them did. The cost of those failures caused the FDIC to increase the cost for deposit insurance. In 2009, our FDIC insurance premium increased from $35 thousand in 2008 to $605 thousand, an increase of $570 thousand. This increase in the cost for FDIC insurance directly reduces net income. Please take some time to review the financial statements and footnotes contained in this Annual Report for more details about our 2009 financial results. Now let`s discuss some good news. In 2009, net interest income increased nearly $1 million. The volume of new loans in 2009 set a record. New commercial loans totaled $52 million and commercial loan fee income increased from $72 thousand in 2008 to $291 thousand in 2009. Our new Fairlawn office originated $27 million in new commercial loans, many of them in Wayne and Stark counties, in just seven months. Income from originating mortgage loans increased from $19 thousand in 2007 and $126 thousand in 2008 to $353 thousand in 2009. In an effort to underscore the fact that we are ready and willing to make loans, it is now possible for anyone to apply for a loan and talk with a loan consultant 24/7. In 2009, we significantly increased the sale of business cash management and remote deposit services which make it possible for local businesses to deposit checks electronically from their offices and eliminate the need to make a trip to the bank. In the past four months local businesses made remote electronic deposits totaling $58 million. Hundreds of our business customers are now using the many new services we have introduced in the last two years. In 2009, we introduced Bonus Checking, a service for customers who use our debit card, make deposits electronically, use our bill pay service and receive their statement electronically. Bonus Checking earns an annual percentage yield of 4.02% on the entire balance up to $25 thousand. We also introduced a Health Savings Account with a Debit Card which makes it much easier for clients to use the account for medical expenses. Our new Seville office opened in February, our Fairlawn office opened in May and the downtown Massillon, West High in Orrville, Smithville and Dalton offices were remodeled to incorporate all of the design elements of our office rebranding project. In many ways, 2009 was a dreadful year but the positives far outweigh the negatives. This is a tough economic environment, but the difficulties we face are less severe than what we witness each day in other parts of our country and the world. We are surely blessed because our Bank is strong. We have an outstanding and dedicated Board of Directors, and the best staff and management team any community bank could possibly assemble. Most importantly, we have the support of you, our shareholders. Thank you for your interest in National Bancshares Corporation and First National Bank. All of the Directors, Officers and staff appreciate your support. David C. Vernon President and CEO Last year at the annual meeting, Donna Dale Davis, one of our long time shareholders and 2005 Orrville Citizen of the Year, suggested we let everyone know about our charitable giving. In 2009, the Charitable Giving Committee of the Board of Directors approved gifts to the following organizations. Thank you for the great suggestion, Donna Dale. Boy Scouts of America Central Christian High School Building Every Woman`s House First National Bank Scholarship (Wayne County Community Foundation) Heartland Education Community, Inc. ICAN Housing Solutions Kidron Community Historical Society Kidron United Fund Main Street Wooster, Inc. Massillon Boys and Girls Club Massillon Chamber of Commerce Newspapers in Education Orrville Area Boys and Girls Club Orrville Chamber of Commerce Orrville Community Chorus Orrville-Dalton YMCA Orrville Public Library Orrville School Multi-Purpose Facility Orrville United Way, Inc. Paint Township Area Fireworks Smithville Community Historical Society STEPS (FKA Wayne County Alcoholism Services) United Way of Wayne and Holmes Counties United Way of Western Stark County Village Network (FKA Boy`s Village) Wayne College Capital Campaign Wayne Development Council Wayne/Holmes Soap Box Derby Wooster Chamber of Commerce Wooster Jazz Arts Festival Wooster/Orrville NAACP Young Life of Wayne County Special thanks to the following local companies who have helped us with the rebranding and remodeling of our offices. Kidron Electric Marshall Construction RBS Construction Northstar Asphalt Orrville Plumbing and Heating Benchmark Craftsmen Adams Signs FINANCIAL HIGHLIGHTS These financial highlights are excerpts of and are not a substitute for National Bancshares Corporation`s consolidated financial statements, including notes, and other detailed financial information we provide elsewhere in this document. You should read the entire document, including the Financial Review and the consolidated financial statements and notes to the consolidated financial statements.
Financial Position (Dollar amounts in thousands, except per share data) Percentage At December 31, 2009 2008 Change Total assets $370,228 $338,002 9.5 % Deposits 291,373 263,642 10.5 % Loans, net 194,071 179,831 7.9 % Securities 130,241 127,248 2.4 % Shareholders` equity 38,903 36,881 5.5 % Book value per share 17.64 16.75 5.3 % Year ended December 31, Net interest income $ 12,228 $ 11,286 8.3 % Income before income taxes 2,007 2,964 (32.3)% Net income 1,609 2,194 (26.7)% Cash dividends declared 705 1,404 (49.8)% Net income per share 0.73 1.00 (27.0)% Cash dividends per share 0.32 0.64 (50.0)%
National Bancshares Corporation is the holding company for First National Bank, a federally chartered national bank formed in Ohio in 1881. First National Bank has fourteen offices in Orrville, Massillon, Wooster, Apple Creek, Dalton, Fairlawn, Kidron, Lodi, Mt. Eaton, Seville and Smithville. Additional information is available at www.discoverfirstnational.com. SELECTED FINANCIAL DATA (Dollar amounts in thousands, except per share data)
As of or for the years ended December 31, 2009 2008 2007 2006 2005 Income statement data: Interest income $16,465 $17,071 $17,832 $17,157 $16,075 Interest expense 4,237 5,785 6,968 5,995 4,128 Net interest income 12,228 11,286 10,864 11,162 11,947 Provision for loan losses 1,829 482 147 160 159 Net interest income after provision for loan losses 10,399 10,804 10,717 11,002 11,788 Noninterest income 2,972 2,333 1,990 1,653 1,801 Noninterest expense 11,364 10,173 10,500 11,354 10,986 Income before income taxes 2,007 2,964 2,207 1,301 2,603 Income taxes 398 770 496 137 503 Net income 1,609 2,194 1,711 1,164 2,100 Balance sheet data: Cash and due from banks $ 8,124 $11,001 $11,842 $ 8,955 $11,985 Federal funds sold - - 443 9,820 8,780 Securities 130,241 127,248 84,514 86,000 77,009 Loans, net 194,071 179,831 191,488 184,481 191,538 Deposits 291,373 263,642 242,523 247,681 249,488 Borrowings 36,720 34,285 26,374 22,744 19,952 Shareholders` equity 38,903 36,881 34,991 34,680 34,653 Total assets 370,228 338,002 306,651 308,358 306,881 Share and per share data: Net income $ 0.73 $ 1.00 $ 0.77 $ 0.52 $ 0.94 Cash dividends 0.32 0.64 0.64 0.64 0.64 Book value at period end 17.64 16.75 15.85 15.52 15.51 Weighted average number of shares outstanding 2,202,457 2,203,218 2,231,369 2,234,488 2,234,488 Performance ratios: Return on average equity 4.21% 6.20% 4.94% 3.29% 5.90% Return on average assets 0.46% 0.70% 0.56% 0.38% 0.70% Dividend payout percentage 43.82% 64.00% 83.58% 122.87% 68.10% Efficiency ratio (1) 74.76% 74.70% 81.69% 88.60% 79.91% Full-time equivalent staff 101 108 105 132 135 Average total assets to full-time equivalent staff $3,491 $2,916 $2,903 $2,296 $2,234 Asset quality ratios: Allowance for loan losses to ending total loans 1.48% 0.95% 1.05% 1.07% 0.98% Net loan charge-offs to average loans 0.35% 0.41% 0.06% 0.03% 0.01% Capital ratios: Average equity to average assets 10.84% 11.24% 11.35% 11.66% 11.81% Leverage ratio (2) 7.40% 7.78% 8.26% 8.57% 9.76% Total risk-based capital ratio (2) 12.64% 12.60% 12.78% 13.26% 14.45% (1) The efficiency ratio is calculated by dividing noninterest expenses by the sum of net interest income and noninterest income. (2) Computed in accordance with Comptroller of the Currency and FDIC guidelines.
SELECTED FINANCIAL DATA The following table shows quarterly results of operations for 2009 and 2008.
Basic and Interest Net interest Provision for Income before diluted earnings income income loan losses income taxes Net income per share (Dollar amounts in thousands) 2009 First quarter $4,208 $2,993 $123 $780 $573 $0.26 Second quarter 4,149 3,013 228 596 454 0.21 Third quarter 4,026 3,072 576 285 267 0.12 Fourth quarter 4,082 3,150 902 346 315 0.14 2008 First quarter $4,270 $2,744 $187 $660 $491 $0.22 Second quarter 4,196 2,763 71 685 514 0.23 Third quarter 4,294 2,843 126 778 574 0.26 Fourth quarter 4,311 2,936 98 841 615 0.28
MANAGEMENT`S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section of the annual report is intended to assist the reader in evaluating the performance of National Bancshares Corporation for the years ended December 31, 2009, 2008 and 2007. This information should be read in conjunction with the consolidated financial statements and accompanying notes to the financial statements. Forward Looking Statement The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. Forward-looking statements can be identified by terminology such as `believes,` `expects,` `anticipates,` `estimates,` `intends,` `should,` `will,` `plans,` `potential` and similar words. Forward-looking statements are also statements that are not statements of historical fact. Forward-looking statements necessarily involve risks and uncertainties. They are merely predictive or statements of probabilities, involving known and unknown risks, uncertainties and other factors. If one or more of these risks or uncertainties occurs or if the underlying assumptions prove incorrect, actual results in 2010 and beyond could differ materially from those expressed in or implied by the forward-looking statements. Forward-looking statements are based upon a variety of estimates and assumptions. The estimates and assumptions involve judgments about a number of things, including future economic, competitive, and financial market conditions and future business decisions. These matters are inherently subject to significant business, economic, and competitive uncertainties, all of which are difficult to predict and many of which are beyond National Bancshares Corporation`s control. Although we believe the estimates and assumptions are reasonable, actual results could vary materially from those shown. Inclusion of forward-looking information does not constitute a representation by National Bancshares Corporation or any other person that the indicated results will be achieved. You are cautioned not to place undue reliance on forward-looking information. Management Strategy The Corporation is a community-oriented financial institution offering a variety of financial services to meet the needs of the communities it serves. The Corporation attracts deposits from the general public and uses such deposits, together with borrowings and other funds, primarily to originate commercial and commercial real estate loans, single-family and multi-family residential mortgage loans, home equity loans and lines of credit and consumer loans. During 2009, the Corporation continued to execute a plan, which was implemented in December 2006. The plan focuses on four critical areas. These areas are first; enhancing services for depositor clients, second; strengthening regulatory compliance, third; enhancing the Corporation`s ability to originate loan assets and fourth; reducing costs and increasing noninterest income. In the first half of 2008, the Corporation introduced `Platinum Checking`, a high-interest checking account for clients with balances above $10 thousand. The Platinum Checking account product accounted for $45.0 million or 15.4% of total deposits at December 31, 2009. In November 2008, the Corporation introduced `Bonus Checking`, an account that pays bonus interest to clients that use our Visa debit card, bill pay services, receive their account statement online, and make at least one electronic direct deposit. The Bonus Checking account product accounted for $2.1 million of deposits at December 31, 2009. In 2009, the Corporation introduced `Mobile Banking`, a program which allows customers to receive text message alerts regarding account balances and allows clients to access online banking accounts through the use of a cell phone internet browser. Loans, net of allowance for loan losses increased $14.3 million from year-end 2008 to year-end 2009. The loan demand in the Bank`s primary market remains soft. However, the Bank has been able to achieve loan growth by taking advantage of the opportunity to lend to businesses in search of a bank that will be responsive to their credit needs as other banks have tightened lending requirements. The Bank opened a full-service office in Fairlawn, Ohio in May, 2009. The office is staffed by four business bankers and one corporate services specialist, who are focused on the sale of business financial services in Summit and Cuyahoga counties. The Fairlawn office has generated over $27 million in loans and over $2.2 million in deposits since opening. The Corporation initiated an office rebranding project in the second half of 2008. The Seville Office was moved from a leased location to a new Bank-owned facility in February 2009 as part of the project. The Corporation has completed the remodeling of the Burbank Road (Wooster), Smithville, West High (Orrville), Downtown Massillon and Dalton offices as of December 31, 2009. Office of the Comptroller of the Currency (`OCC`) regulations require banks to maintain certain minimum levels of regulatory capital. Additionally, the regulations establish a framework for the classification of banks into five categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Generally, an institution is considered well-capitalized if it has a core (Tier 1) capital ratio of at least 5.0% (based on adjusted total assets); a core (Tier 1) risk-based capital ratio of a least 6.0%; and a total risk-based capital ratio of at least 10.0%. The Bank had capital ratios above the well-capitalized levels at December 31, 2009 and December 31, 2008. The Corporation is not aware of any market or institutional trends, events or uncertainties that are expected to have a material effect on liquidity, capital resources or operations. The Corporation is not aware of any current recommendations by its regulators which would have a material effect if implemented. The Corporation has not engaged in sub-prime lending activities and does not plan to engage in those activities in the future. Financial Condition Total assets increased 9.5% to $370.2 million as of December 31, 2009, from $338.0 million at December 31, 2008. Securities available for sale totaled $130.2 million as of December 31, 2009, compared to $127.2 million at December 31, 2008. Loans, net of allowance for loan losses increased $14.3 million to $194.1 million as of December 31, 2009, compared to $179.8 million at December 31, 2008. Deposits increased 10.5% to $291.4 million as of December 31, 2009, compared to $263.6 million at December 31, 2008. Shareholders` equity increased 5.4% to $38.9 million at the end of 2009, from $36.9 million at the end of 2008. Accumulated other comprehensive income increased to $2.5 million as of December 31, 2009, compared to $1.5 million as of December 31, 2008. The change in accumulated other comprehensive income was a result of an increase in unrealized gains on securities available for sale. Loans Total loans increased by $15.6 million or 8.6% from year-end 2009 to year-end 2008. The Bank continues to focus its efforts on attracting commercial loan business. Commercial and commercial real estate loans increased $18.3 million during 2009. The Bank`s loan portfolio consists of $154.5 million loans secured by real estate, which represents 78.2% of total loans as of December 31, 2009. First National Bank`s loan policy provides for a loan mix up to 60% of total loans for commercial loans, up to 40% of total loans for consumer loans, up to 60% of total loans for residential real estate loans and up to 200% of total capital for commercial real estate loans. The loan to deposit ratio will not exceed 90%. The Bank purchased $1.2 million of automobile loans from another Ohio bank during 2009. All of the purchased loans were underwritten individually using the same underwriting standards used for loans generated in our offices. Loan portfolio composition at December 31,
2009 2008 2007 2006 2005 $ % $ % $ % $ % $ % (Dollar amounts in thousands) Real estate: Commercial $65,139 33% $48,034 27% $51,463 27% $45,737 25% $47,638 25% Residential 50,390 26% 54,924 30% 80,113 41% 86,652 46% 91,592 47% Home equity 26,526 13% 24,442 13% 20,857 11% 19,383 10% 19,045 10% Construction(1) 12,395 6% 12,846 7% 8,367 4% 6,079 3% 6,440 3% 154,450 78% 140,246 77% 160,800 83% 157,851 84% 164,715 85% Consumer 12,343 6% 14,354 8% 11,988 6% 7,522 4% 6,205 3% Commercial 26,792 14% 25,583 14% 17,552 9% 18,519 10% 20,046 10% Credit cards - 0% - 0% 1,614 1% 1,521 1% 1,406 1% Other 3,830 2% 1,658 1% 1,987 1% 1,609 1% 1,566 1% Total Loans 197,415 100% 181,841 100% 193,941 100% 187,022 100% 193,938 100% Less: Unearned and deferred income (438) (292) (425) (548) (496) Allowance for loan losses (2,906) (1,718) (2,028) (1,993) (1,903) Net loans $194,071 $179,831 $191,488 $184,481 $191,539 Net loans as a percent of total assets 52.42% 53.20% 62.45% 59.83% 62.41% (1) ~ Includes land development.
Ranked by North American Industry Classification System ~ or NAICS ~ codes, the industries most represented by First National Bank`s commercial borrowers include lessors of residential buildings and dwellings and lessors of non-residential buildings, in that order, accounting for 10.5% and 9.5% of the total loans at year-end 2009, respectively. Approximately 53% of the conventional mortgage loans secured by 1-4 family real estate are long term fixed interest rate loans. The majority of loans added to First National Bank`s portfolio, by the 2002 acquisition of Peoples Federal, were fixed-rate residential mortgage loans, but the number of such loans has declined since the merger as the fixed-rate mortgages have been refinanced or paid off. Approximately 47% of the portfolio of conventional mortgage loans secured by 1-4 family and multifamily real estate at year-end 2009 consisted of adjustable rate loans. First National Bank`s fixed-rate conventional mortgage loans are originated with loan documentation that permits their sale in the secondary market. The Bank`s policy is to classify all fixed-rate mortgage loans as `Held for Sale` or `Held for Portfolio` at the time the loans are originated within various scenarios and classifications set by the Bank. The classification is based upon several factors such as the Bank`s interest rate risk position, the loan`s interest rate and term, the Bank`s liquidity position, the interest rate environment and general economic conditions. Allowance for Loan Losses As explained in Note 1 of the consolidated financial statements, the allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and recoveries, and decreased by charge-offs. The allowance for loan losses is the sum of components recognized and measured either: (1) according to Accounting Standards Codification (ASC) 450-10-05, `Accounting for Contingencies,` for pools of homogenous loans, or (2) according to ASC 310-10-35, `Accounting by Creditors for Impairment of a Loan,` for loans the Bank considers impaired based upon individual loan review. Management determines the necessary allowance balance using the Bank`s loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Loans Analyzed Individually Determining the loan loss allowance begins with the Bank`s assessment of credit risk for loans analyzed individually. Individual loans are assigned credit-risk grades based on the Bank`s assessment of conditions affecting a borrower`s ability to satisfy its contractual obligation under the loan agreement. The assessment process includes reviewing a borrower`s current financial information, historical payment experience, credit documentation, public information, and other information specific to each borrower. Loans reviewed individually are reviewed at least annually or more frequently if management becomes aware of information affecting a borrower`s ability to fulfill its obligation. All loans over $250 thousand or to customers whose aggregate total borrowing exceeds $250 thousand are reviewed individually, except for first mortgage loans on a borrower`s personal residence. Loans or customers with balances under $250 thousand may also be reviewed individually if considered necessary by the board and management. All commercial lending relationships over $100 thousand are ranked according to risk at least annually. Risk rankings also change at any point during the year if the creditworthiness of a borrower changes. In addition, risk ratings are reviewed annually by a qualified independent third party. The independent third party reviews all aggregate loan relationships of $250 thousand or greater along with a sampling of loan relationships between $100 thousand and $250 thousand. Loans analyzed individually are ranked as follows: Loans Graded 1, 2, 3 and 4 are loans that are considered satisfactory, with lower than average risk and low probability of serious financial deterioration on the borrower`s part. Loans Graded 5 (`Watch`) are performing according to the terms of the loan agreement but that nevertheless require enhanced management supervision because of factors such as an unusual payment history or a deterioration in the borrower`s financial condition. Loans Graded 6 (`Special Mention`) have more than average risk, with identified potential weaknesses that deserve management`s close attention. Left uncorrected, the potential weaknesses could result in deterioration of repayment prospects. In the case of a commercial borrower, for example, potential weaknesses could include adverse trends in the borrower`s operations or adverse economic or market conditions that could affect the borrower in the future. Loans Graded 7 (`Substandard`) are inadequately protected by the current financial condition and paying capacity of the borrower or by the collateral securing the loan. Substandard loans have a well-defined weakness or weaknesses jeopardizing collection of the debt in full, with a distinct possibility of loss if the weakness or weaknesses are not corrected. Loans may be classified substandard even if payments are not 90 days or more past due. Loans 90 days or more past due are classified as substandard or lower unless the loan is adequately collateralized and in the process of collection. Loans Graded 8 (`Doubtful`) have all the weaknesses inherent in those classified as substandard, with the added characteristic that existing facts, conditions and values make collection or liquidation in full highly questionable and improbable. The possibility of loss is extremely high, but because of factors that could work to the borrower`s advantage classification of the `doubtful` loan as `loss` is deferred. Loans Graded 9 (`Loss`) are those considered uncollectible or portions of loans that are considered uncollectable. Loans in this category are charged-off by management. If it is probable that the Bank will be unable to collect all principal and interest due on a commercial or non-homogenous loan then that loan is considered impaired. Management measures the amount of impairment using the loan`s expected future cash flows (discounted at the loan`s effective interest rate), or the fair value of the underlying collateral if loan repayment is expected to come from the sale or operation of the collateral. First National Bank considers commercial or non-homogenous loans graded doubtful or loss to be impaired. Some loans graded substandard are considered impaired. Special mention and watch loans are not considered to be impaired. Impairment is evaluated in total for smaller-balance loans of similar type and purpose ~ such as residential mortgage and consumer, ~ and on an individual loan basis for other loans (other loans consists of loans to non-profit organizations and loans collateralized with cash). If a loan is impaired, a portion of the loan loss allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan`s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Increases in the allowance for loan losses are made by expensing a provision for loan losses. No specific provision for loan losses expense would result if an individually reviewed loan is graded higher than `watch`, but such loans are included in the pools of loans analyzed under ASC 450-10-05. Loans classified `special mention` or `substandard`, and smaller-balance loans classified `doubtful` are assigned a provision based upon a historical migration analysis performed on classified loans. The migration analysis identifies the percentage of classified loans by category that has historically been ultimately charged-off. The migration percentages are reviewed and adjusted by management to reflect various factors such as the growth and change in mix of the loan portfolio and the regulator`s guidelines. Loans ranked `loss` are charged off in their entirety because at that point the unconfirmed loss that the loan loss allowance is intended to approximate is considered to be confirmed. As of December 31, 2009, 2008 and 2007 classified assets were as follows: Classified assets at December 31,
2009 2008 2007 Percent of Percent of Percent of Amount total loans Amount total loans Amount total loans (Dollar amounts in thousands) Classified Loans: Special mention $2,841 1.4% $3,294 1.8% $ 401 0.2% Substandard 11,783 6.0% 3,874 2.1% 4,839 2.5% Doubtful - 0.0% - 0.0% 79 0.0% Loss - 0.0% - 0.0% - 0.0% Total classified loans 14,624 7.4% 7,168 3.9% 5,319 2.7% Other classified assets 104 0.1% 354 0.2% 194 0.1% Total classified assets 14,728 7.5% 7,522 4.1% 5,513 2.8%
Pools of Loans Analyzed under ASC 450 The total loan loss allowance is derived both from analysis of individual impaired loans under ASC 310-10-35 and analysis of aggregated pools of loans under ASC 450. Smaller balance loans (such as automobile or home equity loans, for example), groups of loans (such as residential mortgage loans), and less severely classified loans reviewed individually may be analyzed on an aggregated or pooled basis under ASC 450. Under ASC 450, loans are segmented into groups of loans having similar risk characteristics based on purpose, loan type, and collateral, for example residential mortgage loans, home equity loans, and consumer loans. Losses inherent in pools of loans are estimated using average historical losses over a period of years for loans of those types, but with adjustments to account for changes in loan policies, changes in underwriting or loan recovery practices, changes in prevailing economic conditions, changes in the nature or volume of the loan portfolio, and changes in other internal and external factors. Loans secured by real estate ~ particularly residential mortgage loans ~ generally have less credit risk than other types of loans. Changes in the Allowance for Loan Losses and Classified Assets An effective loan review function is vital to the establishment of an appropriate loan loss allowance. Loan officers and the Bank`s credit analysts are responsible for the assignment of risk ratings for loans reviewed individually. Each quarter, a committee consisting of the Bank`s Chief Financial Officer and Senior Credit Officer evaluates the loan loss allowance and reports the results of its evaluation to senior management and the Bank`s board. The Bank adjusts its loan loss allowance methodologies retrospectively as well, making adjustments in its estimates and assumptions as necessary to account for variances of estimated loan losses from actual loan loss experience. The Bank`s determination about classification of its assets and the amount of its allowances is subject to review by the Office of the Comptroller of the Currency (OCC), which may order the establishment of additional loss allowances. First National Bank`s allowance for loan losses increased $1.2 million during the year to $2.9 million as of December 31, 2009. The allowance for loan losses to total loans was 1.48% at December 31, 2009. This is an increase of 53 basis points when compared to December 31, 2008. The percentage of the allowance for loan losses to total loans was 0.95% at December 31, 2008. Total nonperforming loans have increased from $2.0 million as of December 31, 2008 to $5.2 million at December 31, 2009. In 2009, total classified loans increased from $7.2 million to $14.6 million or 102.8%. A stagnant local economy and marginal deterioration of the financial position of some of the Bank`s commercial borrowers led to more loans being classified. Loan review and monitoring is integral to effective credit administration and risk management. In order to minimize the credit risk inherent in the lending process, management and the Board of Directors has adopted a more formal and systematic approach with credit administration and loan review. As part of this systematic approach, a qualified independent third party was engaged to perform loan reviews in both 2009 and 2008. Management intends to continue this practice on an annual basis. Loans deemed uncollectible are charged against the allowance for loan losses. After a loan is charged off, the Bank continues its efforts to recover the loss. Recoveries of previously charged-off amounts are credited to the allowance for loan losses. The Bank recorded a $400 thousand partial charge-off of a $1.6 million commercial real estate loan in 2009. The Bank recorded a $676 thousand partial charge-off of a $1.7 million commercial real estate loan in 2008. Transactions in the allowance for loan losses are summarized in following table: Year ended December 31,
2009 2008 2007 2006 2005 (Dollar amounts in thousands) Balance, beginning of period $1,718 $2,028 $1,993 $1,903 $1,763 Loans charged off: Collateralized by real estate: Commercial - 688 - 39 - Residential 38 16 12 42 - Home equity 25 9 - - - Construction and land development 400 - - - - Consumer 195 69 72 43 8 Commercial - 32 67 17 33 Credit cards 1 21 - 21 16 Other - 10 - - - Total loans charged off 659 845 151 162 57 Recoveries of loans previously charged off: Collateralized by real estate: Commercial - 5 - - - Residential - 14 1 14 - Home equity 2 2 - - - Construction and land development - - - 55 32 Consumer 15 11 37 16 5 Commercial 1 - - 1 1 Credit cards - 1 1 6 - Other - 20 - - - Total recoveries 18 53 39 92 38 Net loans charged off (641) (792) (112) (70) (19) Provision charged to operations 1,829 482 147 160 159 Balance, end of period $2,906 $1,718 $2,028 $1,993 $1,903 Loans outstanding: Average $184,965 $192,472 $187,888 $186,146 $197,064 End of period 196,977 181,549 193,941 187,022 193,937 Ratio of allowance for loan losses to total loans outstanding at end of period 1.48% 0.95% 1.05% 1.07% 0.98% Net charge offs to average loans 0.35% 0.41% 0.06% 0.04% 0.01%
The allowance for loan losses is allocated among loan categories as shown in the following table. Although the Bank considers inherent losses in individual loans and categories of similar loans when it establishes the loan loss allowance, the allowance is a general reserve available to absorb all credit losses in the portfolio. No part of the allowance is segregated for or dedicated to any particular asset or group of assets.
Allocation of the allowance for loan losses at December 31, 2009 2008 2007 2006 2005 Amount Percent(1) Amount Percent(1) Amount Percent(1) Amount Percent(1) Amount Percent(1) (Dollar amounts in thousands) Real estate: Commercial $ 810 33% $ 501 27% $ 779 27% $ 654 25% $ 720 25% Residential 97 26% 169 30% 321 41% 88 46% 186 47% Home equity 78 13% 121 13% 115 11% 9 10% 8 10% Construction(2) 446 6% 26 7% - 4% - 3% - 3% Consumer 261 6% 280 8% 116 6% 89 4% 40 3% Commercial 1,206 14% 579 14% 552 9% 1,064 10% 826 10% Credit cards - 0% - 0% 48 1% 31 1% 47 1% Other 5 2% 10 1% - 1% 58 1% 76 1% Unallocated 3 n/a 32 n/a 97 n/a - n/a - n/a Total $2,906 100% $1,718 100% $2,028 100% $1,993 100% $1,903 100% (1) ~ Percent of loans in each category to total loans. (2) ~ Includes land development.
Management reviews nonperforming assets on a regular basis and assesses the requirement for specific reserves on those assets. Any loan past due 90 days or more and any loan on non-accrual is considered to be a nonperforming asset. Any loan 90 days or more past due that is not both adequately collateralized and in a positive cash-flow position and any loan to a borrower experiencing serious financial deterioration may be placed on non-accrual by the Senior Credit Officer with the concurrence of senior management. Interest received on non-accrual loans ~ also referred to as nonperforming loans ~ is recorded as a reduction of principal. The table to follow summarizes nonperforming assets and other nonperforming assets by category. Problem assets at December 31, 2009 2008 2007 2006 2005
(Dollar amounts in thousands) Real estate: Commercial: Non-accrual $ 2,432 $ 1,306 $ 2,106 $ 454 $ - Past due 90 days or more - - - - - Residential: Non-accrual 503 60 209 223 599 Past due 90 days or more 362 173 142 217 198 Home equity: Non-accrual 386 386 - 8 5 Past due 90 days or more 86 34 9 - - Construction and land development: Non-accrual 1,200 - - 276 - Past due 90 days or more - - - - - Not collateralized by real estate: Consumer and other: Non-accrual - - - - 4 Past due 90 days or more 10 24 1 8 5 Commercial: Non-accrual 195 - 330 1,100 1 472 Past due 90 days or more - 30 - 22 36 Credit cards: Non-accrual - - - - - Past due 90 days or more - - 6 - 6 Total nonperforming loans 5,174 2,013 2,803 2,308 2,325 Other real estate owned 104 354 194 103 103 Total nonperforming assets $ 5,278 $ 2,367 $ 2,997 $ 2,411 $ 2,428 Loans outstanding, net $194,071 $179,831 $191,488 $184,481 $191,538 Nonperforming loans to total net loans 2.67% 1.12% 1.46% 1.25% 1.21% Nonperforming assets to total assets 1.43% 0.70% 0.98% 0.78% 0.79% Allowance for loan losses to total loans 1.48% 0.95% 1.05% 1.07% 0.98% Allowance for loan losses to nonperforming loans 56.17% 85.35% 72.35% 86.38% 81.86%
Securities Total securities increased $3.0 million or 2.4% at December 31, 2009 when compared to December 31, 2008. Securities are primarily comprised of mortgage-backed securities, municipal securities and securities issued by corporations. The Bank actively purchases bonds issued by local municipalities, school systems and other public entities when opportunities arise. Securities are classified either as held to maturity or as available for sale. The Bank does not hold any securities for trading purposes. If management has the intent and the Bank has the ability at the time of purchase to hold a security until maturity, the security is classified as held to maturity and it is reflected on the balance sheet at amortized cost. Securities to be held for indefinite periods and not intended to be held to maturity or on a long-term basis are classified as available for sale, and they are reflected on the balance sheet at their fair value. Management generally believes that all securities should be classified as available for sale but makes that determination at the time of purchase. In order to more effectively manage securities and to be in a better position to react to market conditions, at December 31, 2009, all securities were classified as available for sale. At year-end 2009 and 2008 there was no single issuer of securities where the total book value of such securities exceeded 10% of shareholders` equity except for U.S. government and agency obligations. The following table shows the amortized cost and estimated fair values of the corporation`s securities portfolio at the date indicated.
Gross Gross Amortized unrealized unrealized Fair cost gains losses value (Dollar amounts in thousands) December 31, 2009 Available for sale: U.S. Government and federal agency $ 819 $ - $ - $ 819 State and municipal 28,019 763 (99) 28,683 Corporate bonds and notes 7,640 137 - 7,777 Mortgage-backed: residential 89,972 3,058 (87) 92,943 Equity securities 23 - (4) 19 Total securities $126,473 $ 3,958 $ (190) $130,241 December 31, 2008 Available for sale: State and municipal $ 16,173 $ 234 $ (193) $ 16,214 Corporate bonds and notes 7,630 5 (453) 7,182 Mortgage-backed: residential 101,220 2,616 - 103,836 Equity securities 23 - (7) 16 Total securities $125,046 $ 2,855 $ (653) $127,248 December 31, 2007 Available for sale: U.S. Government and federal agency $ 10,107 $ 161 $ - $ 10,268 State and municipal 15,786 295 (13) 16,068 Corporate bonds and notes 17,864 26 (295) 17,595 Mortgage-backed: residential 40,310 294 (21) 40,583 Total securities $ 84,067 $ 776 $ (329) $ 84,514
The contractual maturity of securities available for sale at December 31, 2009 is shown below.
One year More than one More than five More than or less to five years to ten years ten years Total securities Carrying value Carrying value Carrying value Carrying value Carrying value Market Average yield Average yield Average yield Average yield Average yield value (Dollar amounts in thousands) U.S. Government and $ - $ - $ 819 $ - $ 819 $ 819 federal agency - - 4.40% - 4.40% State and municipal 784 1,873 13,727 12,299 28,683 28,683 4.09% 4.27% 3.93% 3.98% 3.97% Corporate bonds and notes 5,242 2,535 - - 7,777 7,777 4.94% 5.05% - - 4.98% Mortgage-backed: residential - 5,201 36,474 51,268 92,943 92,943 - 1.62% 4.68% 4.56% 4.44% Total $ 6,026 $ 9,609 $ 51,020 $ 63,567 $130,222 $130,222 4.83% 3.04% 4.47% 4.45% 4.37%
Restricted Equity Securities As of December 31, 2009, the Bank held 24,855 shares of $100 par value Federal Home Loan Bank of Cincinnati stock, which are restricted-equity securities. FHLB stock represents an equity interest in the FHLB, but it does not have a readily determinable fair value. The stock can be sold at its par value only, and only to the FHLB or to another member institution. Member institutions are required to maintain a minimum stock investment in the FHLB, based on total assets, total mortgages, and total mortgage-backed securities. Total Liabilities Total liabilities increased by $30.2 million or 10.0% from 2008 to 2009. This increase is primarily a result of a $19.6 million increase in interest-bearing deposits and an increase of $6.0 million in Federal Home Loan Bank advances. Deposits Deposits increased during 2009 by $27.7 million or 10.5%. The increase is primarily attributed to a growth in interest-bearing demand deposits of $25.3 million. This increase was partially offset by decreases in savings and time deposits. Savings accounts decreased by $3.3 million or 6.6% from the end of 2008 to the end of 2009. This was primarily due to customers moving to higher yielding demand accounts. Time deposits decreased by $2.5 million or 3.3%. This decrease is a result of the success of our premium money market and interest-bearing checking accounts, and management`s decision to maintain a reasonable time deposit rate structure. Interest-bearing demand deposits, which include negotiable order of withdrawal accounts and money market demand accounts, increased $25.3 million or 27.4% during 2009. Much of the increase in this category is attributed to the Bank`s success in marketing our `Platinum Checking` account. First National Bank has not solicited brokered deposits. Maturity of time deposits of $100,000 or more at December 31, 2009
(Dollar amounts in thousands) Time Remaining to Maturity Amount Percent of Total Three months or less $ 6,244 39.7% Over three through 12 months 5,400 34.4% Over one year through 3 years 3,386 21.6% Over 3 years 682 4.3% Total $15,712 100.0%
Liquidity and Capital Resources A Bank`s liquidity risk is the risk associated with having to satisfy current and future financial obligations in a timely manner. Both short- and long-term liquidity needs are addressed by maturities and sales of unpledged securities, loan repayments and maturities, sales of loans that are not pledged as security for FHLB borrowings, and transactions in cash and cash equivalents, such as federal funds purchased. The use of these resources, combined with access to credit, provide funds for satisfying depositor and borrower needs. Management considers the Bank to have satisfactory liquidity, with the ability to satisfy the demands of customers and the local economy. Liquidity may be adversely affected by unexpected deposit outflows, which can be caused by higher interest rates paid by competitors. Management continually monitors projected liquidity needs and establishes a desirable level based in part on the Bank`s commitment to make loans as well as management`s assessment of the Bank`s ability to generate funds. The most liquid assets are cash and cash equivalents, which at year-end 2009 consisted of $8.1 million in cash and due from banks. At year-end 2008 cash and cash equivalents consisted of $11.0 million in cash and due from banks. Federal funds sold are overnight investments with correspondent banks, an investment and liquidity tool used to maximize earning assets. Securities classified as available for sale that are not pledged are another source of liquidity. We consider the Bank`s loans-to-deposits ratio to assess liquidity, seeking to cap the ratio of loans to deposits at 90%. The ratio of total loans to deposits at year-end 2009 was 67.6%. At the end of 2009 the fair value of securities available for sale was approximately $130.2 million, while the total carrying value of securities pledged was approximately $45.9 million, representing securities pledged to secure public deposits and repurchase agreements. The Corporation`s operating activities, as described in the Consolidated Statements of Cash Flows in the attached consolidated financial statements, include net cash provided of $1.4 million in 2009, $2.3 million in 2008 and $1.8 million in 2007, generated principally from net income in those years. The Bank reported $16.8 million in originations and proceeds from sales of mortgage loans held for sale as operating activities in 2009. The Corporation`s investing activities, as described in the Consolidated Statements of Cash Flows in the attached consolidated financial statements, consist primarily of loan originations and repayments, along with securities purchases, sales and maturities. In 2009, net cash used in investing activities was $33.6 million. The increase in loans over the year and the purchase of loans utilized $16.3 million of cash. Net cash used to purchase time deposits with other financial institutions was $13.6 million in 2009. Purchases of property and equipment, primarily related to our office rebranding project, were $3.4 million. In 2008, net cash used in investing activities was $31.1 million. The increase in loans over the year and the purchase of loans utilized $11.3 million of cash. Net cash used from activity in securities available for sale totaled $20.3 million in 2008. Management continued the reallocation of the investment portfolio started in 2007 by primarily purchasing seasoned 15 and 20 year discount agency mortgage-backed securities in 2008. The Corporation`s financing activities, as described in the Consolidated Statements of Cash Flows in the attached consolidated financial statements, include the solicitation and repayment of customer deposits, borrowings and repayments, treasury stock activity, and the payment of dividends. In 2009, net cash provided by financing activities was $29.3 million. The increase in deposits and short-term borrowings over the year provided $24.2 million of cash. At December 31, 2009, the Bank had $27.0 million of borrowings outstanding with FHLB, maturing in the years 2010, 2011, 2012 and 2014. This amount represents a $6.0 million increase from the $21.0 million that was owed at the end of 2008. First National Bank has approximately $13.6 million available in short-term funding arrangements with its correspondent banks and the FHLB as of December 31, 2009. Additional information concerning FHLB borrowings and bank obligations under repurchase agreements is contained in Notes 8 and 9 of the consolidated financial statements of National Bancshares Corporation. The outstanding balances and related information about short-term borrowings, which consists almost entirely of securities sold under agreements to repurchase are summarized as follows:
Year ended December 31, 2009 2008 2007 (Dollar amounts in thousands) Balance at year-end $ 6,105 $10,469 $ 8,831 Average balance outstanding 7,442 10,134 8,642 Maximum month-end balance 8,965 11,136 10,956 Weighted-average rate at year-end 0.25% 0.50% 2.85% Weighted-average rate during the year 0.26% 1.42% 3.86%
The Bank is subject to federal regulations imposing minimum capital requirements. Total risk-based capital, tier I risk-based capital, and tier I leverage capital ratios are monitored to assure compliance with regulatory capital requirements. At December 31, 2009, the Bank exceeded minimum risk-based and leverage capital ratio requirements. The Bank`s ratio of total capital to risk-based assets was 12.46% on December 31, 2009. The minimum required ratio to be considered adequately capitalized is 8%. Additional information concerning capital ratios at year-end 2009 and 2008 is contained in Note 14 of the consolidated financial statements. Contractual Obligations As discussed in the notes to National Bancshares Corporation`s consolidated financial statements, obligations exist to make payments under contracts, including borrowings. At December 31, 2009, the aggregate contractual obligations are outlined below: Payment due by period
(Dollar amounts in thousands) One year More than one More than three More than Contractual Obligations Total or less to three years to five years five years Time deposits $ 72,850 $48,537 $18,141 $ 6,172 $ - Long-term obligations 27,000 12,000 10,000 5,000 - Information system contract obligations 5,230 1,086 2,162 1,776 206 Operating lease obligations 25 16 9 - - Total $105,105 $61,639 $30,312 $12,948 $ 206
Off-Balance Sheet and Contingent Liabilities Financial instruments, such as loan commitments, credit lines, and letters of credit are issued to satisfy customers` financing needs. Ordinarily having fixed expiration dates, these commitments are agreements to provide credit or to support the credit of others, as long as conditions established in the contracts are satisfied. Off-balance-sheet risk in the form of potential credit loss exists up to the face amount of these instruments, although we do not expect losses. Since these commitments are viewed as loans, the same credit policies used for loans are used to evaluate making the commitments. These funding commitments by expiration period were as follows at year-end 2009: Expiration of funding commitments
One year More than or less one year Total (Dollar amounts in thousands) Unused loan commitments $36,195 $24,372 $60,567 Commitment to make loans 2,531 - 2,531 Letters of credit 308 - 308 Total $39,034 $24,372 $63,406
Of the unused loan commitments, $9,974 are fixed-rate commitments and $50,593 are variable-rate commitments. Rates on unused fixed-rate loan commitments range from 6.25% to 21.9%. The funding commitments shown in the table above do not necessarily represent future cash requirements since experience demonstrates that a large percentage of funding commitments expire unused or partially used. The Bank is required by regulations of the Federal Reserve Board to maintain cash reserves on hand or on deposit with the Federal Reserve Bank. Reserve requirements vary according to the amount of a Bank`s transaction accounts, checking accounts principally. First National Bank was required to maintain cash reserve balances with the Federal Reserve Bank of $100 thousand at year-end 2009 and $100 thousand at year-end 2008. The Bank sells some of the loans it originates, particularly conventional fixed-rate residential mortgage loans. The loans are sold without recourse. The Bank has retained mortgage-servicing rights on approximately $29.3 million of residential mortgage loans sold. Shareholders` Equity The $2.0 million or 5.4% increase in shareholders` equity from year-end 2008 to year-end 2009 was caused by an increase in retained earnings of $884 thousand and an increase in accumulated other comprehensive income, which results from improvement in the fair value of securities available for sale and earnings greater than the dividend payout. Accumulated other comprehensive income represents the unrealized appreciation or depreciation (net of taxes) in the fair value of securities available for sale. Interest rate volatility, economic and interest rate conditions could cause material fluctuations in accumulated other comprehensive income. The dividend payout ratio for 2009 was 43.82% versus 64.00% in 2008. National Bancshares Corporation is dependent on the Bank for earnings and funds necessary to pay dividends, and the payment of dividends, by the Bank to National Bancshares Corporation, is subject to bank regulatory restrictions. According to the National Bank Act and Office of the Comptroller of the Currency (OCC) Rule 5.64, a national bank may never pay a cash dividend without advance OCC approval if the amount of the dividend exceeds retained net income for the year and for the two preceding years (after any required transfers to surplus). The Bank could, without prior approval, pay dividends to the holding company of approximately $437 as of December 31, 2009. Interest Rate Sensitivity Asset-liability management is the active management of a bank`s balance sheet to maintain a mix of loans and deposits consistent with its goals for long-term growth and risk management. Banks, in the normal course of business, assume financial risk by making loans at interest rates that differ from rates paid on deposits. Deposits often have shorter maturities than loans and adjust to current market rates faster than loans. The result is a balance sheet mismatch between assets (loans) and liabilities (deposits). The function of asset-liability management is to measure and control three levels of financial risk: interest rate risk (the pricing difference between loans and deposits), credit risk (the probability of default), and liquidity risk (occurring when loans and deposits have different maturities). A primary objective in asset-liability management is managing net interest margin, that is, the net difference between interest earning assets (loans) and interest paying liabilities (deposits) to produce consistent growth in the loan portfolio and shareholder earnings, regardless of short-term movement in interest rates. The dollar difference between assets (loans) maturing or repricing and liabilities (deposits) is known as the rate sensitivity gap (or maturity gap). Banks attempt to manage this asset-liability gap by pricing some of their loans at variable interest rates. A more precise measure of interest rate risk is duration, which measures the impact of changes in interest rates on the expected maturities of both assets and liabilities. In essence, duration takes the gap report data and converts that information into present-value worth of deposits and loans, which is more meaningful in estimating maturities and the probability that either assets or liabilities will reprice during the period under review. Interest rate risk is the result of such risks as repricing risk, option risk and basis risk. Repricing risk is caused by the differences in the maturity, or repricing, of assets and liabilities. Most residential mortgage and consumer loans give consumers the right to prepay with little or no prepayment penalty, and because of competitive pressures, it may not be advisable to enforce prepayment penalties on commercial loans. First National Bank`s fixed-rate conventional mortgage loans are originated with loan documentation that permits such loans to be sold in the secondary market. The Bank`s policy is to classify these loans as `Held for Sale` or `Held in Portfolio` at the time the loans are originated based on such factors as the Bank`s liquidity position, interest rate environment and general economic conditions. Option risk is the risk that a change in prevailing interest rates will lead to an adverse impact on earnings or capital caused by changes in the timing of cash flows from investments, loans and deposits. Cash flows may be received earlier than expected as a result of the exercise of the option to prepay or withdraw early embedded in the financial contracts. The option a borrower has to prepay a loan is similar to the option a depositor has to make an early withdrawal from a deposit account. This form of embedded option, which gives the customer the opportunity to benefit when interest rates change in their favor, ordinarily occurs at the Bank`s expense in the form of higher interest expense or lower interest income. Residential mortgage loans tend to have higher option risk because of the borrower`s option to prepay the loan, primarily through refinancing when rates decline, and higher interest rate risk because of the longer term associated with residential mortgage loans. Option risk in the form of prepayments also affects the value of mortgage-backed securities. Basis risk is the risk that changes in interest rates will cause interest-bearing deposit liabilities to reprice at a different rate than interest-bearing assets, creating an asset-liability mismatch. If for example, a bank lends at a rate which changes as the prime rate changes and finances the loan with deposits not tied to the prime rate as an index; it faces basis risk due to the possibility that the prime rate-deposit rate spread might change. Economic Value of Equity The economic value of equity (EVE) is the difference between the net present value of the assets and the net present value of liabilities. EVE can be thought of as the liquidation value of the Bank on the date the calculation is made. Calculating EVE involves using a discount rate to calculate the net present value of assets and liabilities after making assumptions about the duration of assets and liabilities. As interest rates change, the discount rate changes and the change in interest rates effects the duration of assets and liabilities. If interest rates fall, for example, the duration of loans shortens since borrowers tend to prepay by refinancing their loans. Conversely, the duration of loans increases if interest rates rise since borrowers are inclined to hold on to the favorable rate they were able to obtain in the lower interest rate environment. The Board of Directors has established limits on the fluctuation of EVE and EAR given changes in interest rates. These limits are that EVE shall not decline by more than 10%, 20% and 30% given a 100 basis point, 200 basis point and 300 basis point increase or decrease in interest rates respectively and that EAR shall not be greater than 8%, 16% or 24% given a 100 basis point, 200 basis point or 300 basis point increase or decrease in interest rates respectively. The following illustrates our equity at risk in the economic value of equity model: December 31, 2009
Basis Point Change in Rates +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp Increase (decrease) in EVE (13.4)% (7.4)% (2.3)% (4.4)% (10.9)% (19.9)%
The Bank is in compliance with the interest rate risk policy limits related to EVE as of December 31, 2009. Earnings at Risk Earnings at risk (EAR), is the amount by which net interest income will be affected given a change in interest rates. The interest income and interest expense for each category of earning assets and interest bearing liabilities is recalculated after making up and down assumptions about the change in interest rates. Changes in prepayment speeds and repricing speeds are also taken into account when computing earnings at risk, given a change in interest rates. The following illustrates the effect on earnings or EAR, given rate increases of 100 to 300 basis points and decreases in interest rates of 100 to 300 basis points. December 31, 2009
Basis Point Change in Rates +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp Increase (decrease) in Earnings (1.6)% (1.1)% (0.3)% (0.1)% (1.9)% (4.0)%
The Bank is in compliance with the interest rate risk policy limits related to EAR as of December 31, 2009. One way to minimize interest rate risk is to maintain a balanced or matched interest-rate sensitivity position. However, matched funding does not generally maximize profits. To increase net interest income, the Bank mismatches asset and liability repricing to take advantage of interest rate conditions. The magnitude of the mismatch depends on management`s assessment of the risks presented by the interest rate environment. Interest rate risk can significantly affect income and expense on interest sensitive assets and liabilities, and can also affect the underlying value of the Bank`s assets. The goal in managing interest rate sensitivity is to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize the impact of volatility in market interest rates. Management of maturity distributions of assets and liabilities between the most and least sensitive extremes is as important as the balances on hand. Management of maturity distributions involves matching interest rate maturities as well as principal maturities, which can influence net interest income significantly. In periods of rapidly changing interest rates, a negative or positive gap can cause major fluctuations in net interest income and earnings. Managing asset and liability sensitivities, and insulating net interest income from changes in market and interest rate conditions is one of the objectives of the Bank`s asset/liability management strategy. Management attempts to maintain consistent net interest income and net income while managing interest rate risk within Board approved policy limits. Evaluating the Bank`s exposure to changes in interest rates is the responsibility of Bank management which reports directly to the Board of Directors. Bank management assesses both the adequacy of the management process used to control interest rate risk and the quantitative level of exposure, monitoring and managing interest rate risk to control the effect of changing interest rates on net interest income and net income. Evaluating the quantitative level of interest rate risk exposure requires assessment of existing and potential effects of changes in interest rates on the Bank`s financial condition, including capital adequacy, earnings, liquidity and asset quality. Bank management also monitors the Bank`s liquidity levels. Interest rate risk .exposure is reviewed quarterly with the Board of Directors. Risk is mitigated by matching maturities or repricing opportunities. Results of Operations First National Bank derives substantially all of its income from banking and bank-related services, including interest earnings on residential real estate, commercial real estate, commercial and consumer loans and investment securities along with fee income from deposit services. National Bancshares Corporation`s business consists almost exclusively of acting as holding company for the Bank. First National Bank`s business is not complex: the Bank gathers deposits and it makes loans, principally in Wayne, Stark, Summit, Medina and Holmes counties, Ohio. Average Balances, Interest Rates and Yields The average balances of our interest-earning assets and interest-bearing liabilities, interest earned on assets and interest cost of liabilities for the periods indicated, and the average yields earned and rates paid are presented in the following table. Yields are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are daily averages. Year ended December 31,
(Dollars amounts in thousands) 2009 2008 2007 Average Yield/ Average Yield/ Average Yield/ Balance Interest Cost Balance Interest Cost Balance Interest Cost Assets Interest earning assets: Securities: Taxable $113,608 5,397 4.88% $ 79,522 4,095 5.14% $ 68,787 3,585 5.18% Nontaxable (1) 20,557 1,226 6.09% 16,491 991 6.07% 16,757 1,059 6.39% Federal funds sold 6,063 12 0.20% 3,353 63 1.88% 6,447 335 5.20% Interest bearing deposits 1,906 25 1.31% 1,019 18 1.77% 1,319 69 5.23% Net loans (including nonaccrual loans) 183,001 10,222 5.59% 192,472 12,241 6.36% 187,888 13,144 7.00% Total interest-earning assets 325,135 16,882 5.19% 292,857 17,408 5.94% 281,198 18,192 6.34% All other assets 27,502 22,059 23,645 Total assets $352,637 $314,916 $304,843 Liabilities and Shareholder`s Equity Interest-bearing liabilities: Interest-bearing checking $109,400 1,026 0.94% $ 73,243 1,342 1.83% $ 58,148 1,341 2.31% Savings 48,198 123 0.26% 51,963 291 0.56% 56,690 615 1.08% Time, $100,000 and over 13,901 340 2.45% 13,197 497 3.77% 14,087 641 4.55% Time, other 58,822 1,627 2.77% 65,248 2,527 3.87% 72,584 3,231 4.45% Other funds purchased 34,166 1,121 3.28% 31,138 1,128 3.62% 23,838 1,140 4.78% Total interest-bearing liabilities 264,487 4,237 1.60% 234,789 5,785 2.46% 225,347 6,968 3.09% Demand deposits 46,265 42,004 42,225 Other liabilities 3,662 2,741 2,666 Shareholders` equity 38,223 35,382 34,605 Total liabilities and shareholders` equity $352,637 $314,916 $304,843 Net interest income (1) $12,645 $11,623 $11,224 Interest rate spread (2) 3.59% 3.48% 3.25% Net yield on interest- earning assets (3) 3.89% 3.97% 3.99% Ratio of average interest- earning assets to average interest-bearing liabilities 122.93% 124.73% 124.78% (1) Tax-equivalent basis (2) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. (3) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.
Rate/Volume Analysis Changes in interest income and interest expense attributable to (1) changes in volume (changes in average volume multiplied by prior year rate), and (2) changes in rates (changes in rate multiplied by prior year average volume) are shown in the table to follow. Increases and decreases have been allocated proportionally to the change due to volume and the change due to rate.
2009 over 2008 2008 over 2007 (Dollar amounts in thousands) Volume Rate Net change Volume Rate Net change Interest Income Securities: Taxable $1,516 $ (214) $1,302 $ 557 $ (47) $ 510 Nontaxable 221 14 235 (27) (41) (68) (tax-equivalent basis) Federal funds sold 5 (56) (51) (58) (214) (272) Interest bearing deposits 12 (5) 7 (5) (46) (51) Loans (including nonaccrual loans) (529) (1,490) (2,019) 292 (1,195) (903) Total interest income (tax-equivalent basis) $1,225 $(1,751) $ (526) $ 759 $(1,543) $ (784) Interest Expense Deposits Interest bearing checking $ 339 $ (655) $ (316) $ 277 $ (276) $ 1 Savings (10) (158) (168) (26) (298) (324) Time, $100,000 and over 17 (174) (157) (34) (110) (144) Time, other (178) (722) (900) (284) (420) (704) Other funds purchased 99 (106) (7) 264 (276) (12) Total interest expense $ 267 $(1,815) $(1,548) $ 197 $(1,380) $(1,183) Change in net interest income (tax-equivalent basis)* $ 958 $ 64 $ 1,022 $ 562 $ (163) $ 399 *Tax equivalence based on highest statutory tax rates of 34%.
2009 versus 2008 During 2009, net income decreased $585 thousand or 26.7% to $1.6 million. Accordingly, basic and diluted earnings per share decreased from $1.00 per share in 2008 to $0.73 per share in 2009. Earnings for 2009 were negatively impacted by a $1.3 million increase in the provision for loan loss and a $570 increase in FDIC insurance expense, partially offset by an increase in net interest income of $942 thousand. Returns on average equity (ROE) and average assets (ROAA) for the year ending December 31, 2009, were 4.21% and 0.46%, respectively, compared to 6.20% and 0.70% for the year ending December 31, 2008. Total interest and dividend income decreased $606 thousand or 3.5% in 2009. Interest and fees on loans decreased $2.0 million or 16.5%, due to the decrease in interest rates during the year, and the mortgage loan securitization transaction with the Federal Home Loan Mortgage Corporation in December 2008 which decreased loans by $20.9 million. Securities interest and dividend income increased $1.5 million or 30.7% over 2008. Much of this increase is attributable to an increase in the average balance of securities related to the aforementioned mortgage loan securitization. Interest expense decreased by $1.5 million or 26.8% during 2009, as the Bank`s deposits and short-term borrowings were affected by the falling interest rate environment. Interest expense on deposits decreased $1.5 million or 33.1% in 2009. Deposit customers continued moving funds from lower-rate deposit accounts to higher-yielding accounts, such as premium money market accounts and high interest checking accounts during 2009. Interest expense for short-term borrowings decreased by $119 thousand or 72.6%, primarily due to the significant decrease in short-term market interest rates during 2009. Federal Home Loan Bank advances interest expense increased $112 thousand or 11.6% as the amount of advances increased from $21 million to $27 million during 2009. The provision for loan losses was $1.8 million in 2009, compared to $482 thousand in 2008. The allowance for loan losses and the related provision for loan losses is based on management`s judgment and evaluation of the loan portfolio. Net charge-offs were $641 thousand for 2009, compared to $792 thousand for 2008. The allowance as a percentage of loans increased from 0.95% at December 31, 2008 to 1.48% at December 31, 2009. Classified loans have increased from $7.2 million as of December 31, 2008 to $14.6 million as of December 31, 2009 as some of our borrowers have struggled with the challenging business environment created by the current economic recession. Total nonperforming loans have increased from $2.0 million as of December 31, 2008 to $5.2 million as of December 31, 2009. Management believes the current allowance for loan losses is adequate, however changing economic and other conditions may require future adjustments to the allowance for loan losses. Noninterest income increased $639 thousand or 27.4% during 2009. The increase is primarily related to net gains recorded on the sale of securities of $770 thousand. Income from mortgage banking activities increased from $126 thousand in 2008 to $310 thousand in 2009 as the Corporation originated $16.8 million in mortgage loans for sale on the secondary market. The 2009 originations represent an amount significantly higher than the $7.1 million originated in 2008. Noninterest expense was $11.4 million for the year ended December 31, 2009 compared to $10.2 million for 2008, an increase of 11.7%. The increase in noninterest expense was due primarily to an increase in the FDIC deposit insurance premium from $35 thousand in 2008 to $605 thousand in 2009. Salaries and employee benefits, occupancy and professional and consulting fees were slightly higher in 2009 compared to 2008 levels. Income tax expense was $398 thousand for the year ended December 31, 2009, representing a decrease of $372 thousand or 48.3% compared to 2008. The change is primarily related to a decrease in income before income taxes and an increase in interest income from nontaxable securities. 2008 versus 2007 During 2008, net income increased $483 thousand or 28.2% to $2.2 million. Accordingly, basic and diluted earnings per share increased from $0.77 per share in 2007 to $1.00 per share in 2008. The increase in net income is the result of a relatively stable net interest margin, an increase in noninterest income and a decrease in noninterest expenses. Returns on average equity (ROE) and average assets (ROAA) for the year ending December 31, 2008, were 6.20% and 0.70%, respectively, compared to 4.94% and 0.56% for the year ending December 31, 2007. Total interest and dividend income decreased $761 thousand or 4.3% in 2008. Interest and fees on loans decreased $903 thousand or 6.9%, due primarily to the decrease in interest rates during the year, partially offset by the $4.6 million increase in average loans. Management has focused on aggressively attracting commercial loan business and purchasing loan participations from other Ohio banks (commercial real estate and consumer loans). Securities interest and dividend income increased $465 thousand or 10.9% over 2007. Much of this increase is attributable to an increase in the average balance of securities. Interest expense decreased by $1.2 million or 17.0% during 2008, as the Bank`s deposits and short-term borrowings were affected by the falling interest rate environment. Interest expense on deposits decreased $1.2 million or 20.1% in 2008. Deposit customers continued moving funds from lower-rate deposit accounts to higher-yielding accounts, such as premium money market accounts and high interest checking accounts during 2008. Interest expense for short-term borrowings decreased by $196 thousand or 54.4%, primarily due to the significant decrease in short-term market interest rates during 2008. Federal Home Loan Bank advances interest expense increased $184 thousand or 23.6% as the amount of advances increased from $17 million to $21 million during 2008. The provision for loan losses was $482 thousand in 2008, compared to $147 thousand in 2007. The allowance for loan losses and the related provision for loan losses is based on management`s judgment and evaluation of the loan portfolio. Net charge-offs were $792 thousand for 2008, compared to $112 thousand for 2007. The increase in 2008 charge-offs were primarily related to a $676 thousand partial charge-off of a $1.7 million Summit County commercial real estate loan. The allowance as a percentage of loans declined from 1.05% at December 31, 2007 to 0.95% at December 31, 2008. Classified loans have increased from $5.3 million as of December 31, 2007 to $7.2 million as of December 31, 2008. Total nonperforming loans have decreased from $2.8 million as of December 31, 2007 to $2.0 million as of December 31, 2008, a decrease of 28.2%. Management believes the current allowance for loan losses is adequate, however changing economic and other conditions may require future adjustments to the allowance for loan losses. Noninterest income increased $343 thousand or 17.2% during 2008. The increase is related to the Bank`s enhancement of the deposit and service charge fee structure, improvements in mortgage banking operations and marketing activities and an increase in customer utilization of Visa check card transactions. The Bank sold its $1.5 million credit card portfolio in July 2008. The transaction generated a $435 thousand gain on sale. During 2008, the Corporation recorded an other than temporary impairment of $444 thousand for the FHLMC preferred stock owned by the holding company. Noninterest expense was $10.2 million for the year ended December 31, 2008 compared to $10.5 million for 2007, a decrease of 3.1%. The decrease is primarily due to lower data processing expenses, professional and consulting fees and maintenance and repairs expense. Data processing expense decreased $158 thousand during 2008 as a result of a new contract entered into in January of 2008 with the provider of the Bank`s core processing solution. The decrease in professional and consulting fees was the result of a higher level of services utilized in 2007. The Corporation engaged a consulting firm to review the key business processes and procedures of First National Bank in 2007. Income tax expense was $770 thousand for the year ended December 31, 2008, representing an increase of $274 thousand or 55.2% compared to 2007. Critical Accounting Policies National Bancshares Corporation`s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ~ GAAP ~ and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments based on information available as of the date of the consolidated financial statements, affecting the amounts reported in the financial statements and accompanying notes. Certain policies necessarily require greater reliance on the use of estimates, assumptions, and judgments. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the consolidated financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management, including the use of internal cash-flow modeling techniques. National Bancshares Corporation`s most significant accounting policies are presented in Note 1 of the consolidated financial statements. Management considers the allowance for loan losses, valuation of securities and goodwill and other intangible assets to be the most subjective and the most susceptible to change as circumstances and economic conditions change. Allowance for Loan Losses An allowance for loan losses recorded under generally accepted accounting principles is a valuation allowance for probable incurred credit losses, based on current information and events, increased by the provision for loan losses and decreased by charge-offs less recoveries. The amount of the allowance is a product of management`s judgment and it is inevitably imprecise. Estimating the allowance requires significant judgment and the use of estimates related to many factors, including the amount and timing of future cash flows on problem loans, estimated losses on pools of loans based on historical loss experience, and consideration of current economic trends and conditions, all of which are susceptible to significant change. Although management believes that the allowance for loan losses was adequate at December 31, 2009, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy and employment could result in increased levels of non-performing assets and charge-offs, increased loan loss provisions, and reductions in income. Additionally, as an integral part of the examination process, bank regulatory agencies periodically review a bank`s loan loss allowance. The Office of the Comptroller of the Currency (OCC) could require the recognition of additions to the loan loss allowance based on the OCC`s judgment of information available to it at the time of its examination of First National Bank. Valuation of Securities The portfolio of available for sale securities is reported at fair value. The fair value of a security is determined based on quoted market prices. If quoted market prices are not available, fair value is determined based on quoted prices of similar instruments. Available for sale and held to maturity securities are reviewed quarterly for possible other than temporary impairment. The review includes an analysis of the facts and circumstances of each individual investment, such as the length of time the fair value has been below cost, the expectation for that security`s performance, the credit worthiness of the issuer, and the bank`s ability to hold the security to maturity. A decline in value that is considered to be other than temporary and related to a deterioration of the credit worthiness of the issuer would be recorded as a loss within noninterest income in the consolidated statements of income. Goodwill and Other Intangible Assets Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized on a straight line or accelerated method over their estimated useful lives, which is 7 to 10 years. The Corporation performed a goodwill impairment analysis as of September 30, 2009. The fair value of the single reporting unit was determined to be greater than the carrying value. The fair value was determined by using estimated sales price multiples based on recent observable market transactions. New Accounting Pronouncements See Note 1 of the consolidated financial statements for details on new accounting pronouncements. CONSOLIDATED BALANCE SHEETS December 31, 2009 and 2008 (Dollar amounts in thousands, except per share data)
2009 2008 ASSETS Cash and due from banks $ 8,124 $ 11,001 Federal funds sold - - Total cash and cash equivalents 8,124 11,001 Time deposits with other financial institutions 13,580 - Securities available for sale 130,241 127,248 Restricted equity securities 3,218 3,217 Loans held for sale 316 - Loans, net of allowance for loan losses: 2009 ~ $2,906 2008 ~ $1,718 194,071 179,831 Premises and equipment, net 9,033 6,197 Goodwill 4,723 4,723 Identified intangible assets 197 422 Accrued interest receivable 1,334 1,230 Bank owned life insurance 2,771 2,677 Other assets 2,620 1,456 $370,228 $338,002 LIABILITIES AND SHAREHOLDERS` EQUITY Liabilities Deposits Non-interest bearing $ 54,290 $ 46,159 Interest bearing 237,083 217,483 Total deposits 291,373 263,642 Repurchase agreements 6,105 10,469 Federal funds purchased 3,300 1,830 Federal Reserve note account 315 986 Federal Home Loan Bank advances 27,000 21,000 Accrued interest payable 408 690 Accrued expenses and other liabilities 2,824 2,504 Total liabilities 331,325 301,121 Commitments and contingent liabilities Shareholders` equity Common stock, no par value; 6,000,000 shares authorized; 2,289,528 shares issued 11,447 11,447 Additional paid-in capital 4,752 4,718 Retained earnings 21,856 20,972 Treasury stock, at cost (83,555 and 87,160 shares) (1,639) (1,709) Accumulated other comprehensive income (loss) 2,487 1,453 Total shareholders` equity 38,903 36,881 $370,228 $338,002
CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data)
2009 2008 2007 Interest and dividend income Loans, including fees $ 10,222 $ 12,241 $ 13,144 Securities: Taxable 5,397 4,095 3,585 Nontaxable 809 654 699 Federal funds sold and other 37 81 404 Total interest and dividend income 16,465 17,071 17,832 Interest expense Deposits 3,116 4,657 5,828 Short-term borrowings 45 164 360 Federal Home Loan Bank advances 1,076 964 780 Total interest expense 4,237 5,785 6,968 Net interest income 12,228 11,286 10,864 Provision for loan losses 1,829 482 147 Net interest income after provision for loan losses 10,399 10,804 10,717 Noninterest income Checking account fees 1,070 1,218 1,191 Visa check card interchange fees 353 326 269 Deposit and miscellaneous service fees 135 171 176 Mortgage banking activities 310 126 19 Gain on sale of credit card portfolio - 435 - Loss on sales of other real estate owned (112) (15) (33) Securities gains (losses), net 770 (344) 14 Other 446 416 354 Total noninterest income 2,972 2,333 1,990 Noninterest expense Salaries and employee benefits 5,279 5,118 5,182 Data processing 909 947 1,105 Net occupancy 1,056 915 859 FDIC assessment 605 35 29 Professional and consulting fees 546 412 593 Franchise tax 327 326 336 Maintenance and repairs 187 212 327 Amortization of intangibles 225 232 237 Telephone 216 194 243 Marketing 233 144 127 Director fees and pension 224 312 212 Other 1,557 1,326 1,250 Total noninterest expense 11,364 10,173 10,500 Income before income taxes 2,007 2,964 2,207 Income tax expense 398 770 496 Net income $ 1,609 $ 2,194 $ 1,711 Weighted average common shares outstanding 2,202,457 2,203,218 2,231,369 Basic and diluted earnings per common share $ 0.73 $ 1.00 $ 0.77
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS` EQUITY Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data)
Accumulated Additional Other Total Common Paid-In Retained Treasury Comprehensive Shareholders` Stock Capital Earnings Stock Income (Loss) Equity Balance at January 1, 2007 $11,447 $4,690 $19,901 $(1,189) $ (169) $34,680 Comprehensive income: Net income 1,711 1,711 Other comprehensive income (loss) 464 464 Total comprehensive income 2,175 Cash dividends declared ($.64 per share) (1,430) (1,430) Purchase of 27,103 common stock (434) (434) Balance at December 31, 2007 11,447 4,690 20,182 (1,623) 295 34,991 Comprehensive income: Net income 2,194 2,194 Other comprehensive income (loss) 1,158 1,158 Total comprehensive income 3,352 2,175 Cash dividends declared ($.64 per share) (1,404) (1,404) Purchase of 5,017 common stock (86) (86) Compensation expense under stock-based compensation plans 28 28 Balance at December 31, 2008 11,447 4,718 20,972 (1,709) 1,453 36,881 Comprehensive income Net income 1,609 1,609 Other comprehensive income (loss) 1,034 1,034 Total comprehensive income 2,643 Cash dividends declared ($.32 per share) (705) (705) Stock awards issued from Treasury Shares (3,605 shares) (20) 70 50 Compensation expense under stock-based compensation plans 34 34 Balance at December 31, 2009 $11,447 $4,752 $21,856 $(1,639) $2,487 $38,903
CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands except per share data)
2009 2008 2007 Cash flows from operating activities Net income $1,609 $ 2,194 $ 1,711 Adjustments to reconcile net income to net cash from operating activities Provision for loan losses 1,829 482 147 Deferred income taxes (382) 40 (19) Depreciation, amortization and accretion 877 271 442 Earnings on Bank owned life insurance (94) (90) (88) Restricted equity securities dividends (1) (96) - Origination of mortgage loans held for sale (16,751) (7,080) (1,826) Proceeds from sales of mortgage loans held for sale 16,745 7,187 1,826 Gain on sale of loans (310) (114) (19) Net security (gains) losses (770) (100) (14) Securities impairment loss recognized in earnings - 444 - Gain on sale of credit card portfolio - (435) - (Gain) loss on sale/write-down of other real estate owned 112 24 33 Compensation expense under stock-based compensation plans 84 28 - Change in other assets and liabilities (1,503) (498) (353) Net cash from operating activities 1,445 2,257 1,840 Cash flows from investing activities Purchases of time deposits with other financial institutions (13,580) - - Securities available for sale Proceeds from maturities and repayments 36,757 28,426 15,753 Proceeds from sales 23,084 25,417 22,662 Purchases (60,353) (74,179) (36,083) Purchases of property and equipment (3,437) (1,462) (325) Proceeds from sale of credit card portfolio - 1,871 - Proceeds from sale of property and equipment - 13 211 Proceeds from sale of other real estate owned 191 179 - Purchase of loans (1,151) (6,130) (6,408) Net change in loans to customers (15,118) (5,210) (747) Net cash from investing activities (33,607) (31,075) (4,937) Cash flows from financing activities Net change in deposits 27,731 21,119 (5,158) Net change in short-term borrowings (3,565) 3,911 629 Proceeds from Federal Home Loan Bank advances 10,000 4,000 3,000 Repayments Federal Home Loan Bank advances (4,000) - - Dividends paid (881) (1,410) (1,430) Purchase of common stock - (86) (434) Net cash from financing activities 29,285 27,534 (3,393) Net change in cash and cash equivalents (2,877) (1,284) (6,490) Beginning cash and cash equivalents 11,001 12,285 18,775 Ending cash and cash equivalents $ 8,124 $11,001 $12,285 Supplemental cash flow information: Interest paid $ 4,519 $ 6,070 $ 7,022 Income taxes paid 400 970 662 Supplemental noncash disclosures: Transfer from loans to securities available for sale $ - $20,810 $ - Transfer from loans to other real estate owned 54 354 124
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Nature of Operations and Principles of Consolidation: The consolidated financial statements include National Bancshares Corporation and its wholly-owned subsidiary, First National Bank, Orrville, Ohio (Bank), together referred to as `the Corporation.` The Bank has a minority interest in First Kropf Title, LLC, which is immaterial to the consolidated financial statements. Intercompany transactions and balances are eliminated in consolidation. The Corporation provides financial services through its main and branch offices in Orrville, Ohio, and branch offices in surrounding communities in Wayne, Medina, Stark and Summit counties. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are commercial and residential mortgage, commercial and consumer installment loans. Most loans are secured by specific items of collateral including business assets, consumer assets and real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by both residential and commercial real estate. Other financial instruments, which potentially represent concentrations of credit risk, include investment securities, deposit accounts in other financial institutions and federal funds sold. There are no significant concentrations of loans to any one industry or customer. However, the customer`s ability to repay their loans is dependent on the real estate and general economic conditions of the Corporation`s market area. Segments: As noted above, the Corporation provides a broad range of financial services to individuals and companies in northern Ohio. While the Corporation`s chief decision makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Corporation-wide basis. Accordingly, all of the Corporation`s financial service operations are considered by management to be aggregated in one reportable operating segment. Use of Estimates: To prepare financial statements in conformity with U. S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, fair values of financial instruments and carrying value of intangible assets are particularly subject to change. Cash Flows: Cash and cash equivalents include cash, deposits with other banks with original maturities under 90 days, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits with other banks, repurchase agreements and other short-term borrowings. Time Deposits with Other Financial Institutions: Interest-bearing deposits in other financial institutions mature within eighteen months and are carried at cost. Securities: Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method. Management evaluates securities for other than temporary impairment (`OTTI`) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Loans Held for Sale: Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale may be sold with servicing rights retained or released. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right for loans sold with servicing retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands except per share data) NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned and deferred income and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is recorded as a reduction in principal, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Concentration of Credit Risk: Most of the Corporation`s business activity is with customers located within Wayne, Stark, Summit, Holmes and Medina Counties. Therefore, the Corporation`s exposure to credit risk is significantly affected by changes in the economy in the Wayne, Stark, Summit, Holmes and Medina County area. Purchased Loans: The Corporation purchases individual loans and groups of loans. Purchased loans that show evidence of credit deterioration at the time of purchase are recorded at the amount paid, such that there is no carryover of the seller`s allowance for loan losses. After acquisition, incurred losses are recognized by an increase in the allowance for loan losses. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management`s judgment, should be charged-off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non classified loans and is based on historical loss experience adjusted for current factors. A loan is impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan`s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Servicing Rights: Servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. The Corporation compares the valuation model inputs and results to published industry data in order to validate the model results and assumptions. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) At December 31, 2009 and 2008, the servicing assets of the Corporation totaled $115 and $173, respectively, and are included with other assets on the consolidated balance sheets. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Servicing assets are evaluated for impairment based upon the fair value of the assets compared to carrying amount. Any impairment is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping. Servicing fee income is recorded when earned for servicing loans based on a contractual percentage of the outstanding principal or a fixed amount per loan. The amortization of mortgage servicing rights is netted against loan servicing fee income. Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at the lower of cost or fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 7 to 39 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years. Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) Stock: The Bank is a member of the FHLB and FRB systems. FHLB members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. The stocks are carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. Bank Owned Life Insurance: The Corporation has purchased life insurance policies on its directors. Life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other amounts due that are probable at settlement. Goodwill and Other Intangible Assets: Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1, 2009 represents the future economic benefits arising from other assets acquired that are not individually identified and separately recognized. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Corporation has selected September 30 as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset on the Corporation`s balance sheet with an indefinite life. Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which range from 7 to 10 years. Long-term Assets: These assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance. Benefit Plans: Retirement plan expense is the amount of required matching contributions plus any discretionary contributions to the Corporation`s 401(k) plan as determined by Board decision. Director retirement plan expense allocates the benefits over the estimated years of service. Stock-Based Compensation: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Corporation`s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period, on an accelerated basis. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Income Taxes: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. The Corporation adopted guidance by the Financial Accounting Standards Board (FASB) with respect to accounting for uncertainty in income taxes as of January 1, 2007. A tax position is recognized as a benefit only if it is `more likely than not` that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the `more likely than not` test, no tax benefit is recorded. The adoption had no affect on the Corporation`s financial statements. The Corporation recognizes interest and/or penalties related to income tax matters in income tax expense. Transfers of Financial Assets: Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Corporation, 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 the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer-financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. Earnings Per Common Share: Earnings per common share is net income divided by the weighted average number of shares outstanding during the period. Diluted earnings per share includes the dilutive effect of additional potential common shares issuable under stock options. 53,000 and 58,000 stock options were not considered in computing diluted earnings per common share for 2009 and 2008 because they were antidilutive. No options were outstanding prior to 2008. Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, which is also recognized as a separate component of equity. Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements. Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank of $100 and $100 was required to meet regulatory reserve and clearing requirements at year-end 2009 and 2008. These balances do not earn interest. Dividend Restriction: Banking regulations require maintaining certain capital levels and limit the dividends paid by the Bank to the holding company or by the holding company to shareholders. Dividends paid by the Bank to the holding company are the primary source of funds for dividends by the holding company to its shareholders. Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Reclassifications: Certain items in the prior year financial statements were reclassified to conform to the current presentation. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Adoption of New Accounting Standards: In September 2006, the FASB issued guidance that defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This guidance also establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The guidance was effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued guidance that delayed the effective date of this fair value guidance for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. The effect of adopting this new guidance was not material. In December 2007, the FASB issued guidance that establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. The guidance is effective for fiscal years beginning on or after December 15, 2008. The effect of adopting this new guidance was not material. In December 2007, the FASB issued guidance that changes the accounting and reporting for minority interests, which is recharacterized as noncontrolling interests and classified as a component of equity within the consolidated balance sheets. The guidance was effective as of the beginning of the first fiscal year beginning on or after December 15, 2008. The effect of adopting this new guidance was not material. In March 2008, the FASB issued guidance that amends and expands the disclosure requirements for derivative instruments and hedging activities. The guidance requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. The guidance was effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. The Corporation has expanded its disclosures related to derivative instruments and hedging activities. In June 2009, the FASB replaced The Hierarchy of Generally Accepted Accounting Principles, with the FASB Accounting Standards Codification TM (The Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification was effective for financial statements issued for periods ending after September 15, 2009. In April 2009, the FASB amended existing guidance for determining whether impairment is other than temporary for debt securities. The guidance requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) other than temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income and 2) OTTI related to credit loss, which must be recognized in the income statement. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. Additionally, disclosures about other than temporary impairments for debt and equity securities were expanded. This guidance was effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The effect of adopting this new guidance was not material. In April 2009, the FASB issued guidance that emphasizes the objective of a fair value measurement does not change even when market activity for the asset or liability has decreased significantly. Fair value is the price that would be received for an asset sold or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. When observable transactions or quoted prices are not considered orderly, then little, if any, weight should be assigned to the indication of the asset or liability`s fair value. Adjustments to those transactions or prices should be applied to determine the appropriate fair value. The guidance, which was applied prospectively, was effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The effect of adopting this new guidance was not material. In August 2009, the FASB amended existing guidance for the fair value measurement of liabilities by clarifying that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using a valuation technique that uses the quoted price of the identical liability when traded as an asset, quoted prices for similar liabilities or similar liabilities when traded as assets, or that is consistent with existing fair value guidance. The amendments in this guidance also clarify that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. The guidance was effective for the first reporting period beginning after issuance. The effect of adopting this new guidance was not material. Newly Issued Not Yet Effective Standards: In June 2009, the FASB amended previous guidance relating to transfers of financial assets and eliminates the concept of a qualifying special purpose entity. This guidance must be applied as of the beginning of each reporting entity`s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. This guidance must be applied to transfers occurring on or after the effective date. Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities should be evaluated for consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance. The disclosure provisions were also amended and apply to transfers that occurred both before and after the effective date of this guidance. Management is in the process of assessing the impact of adopting this new guidance and the effect on the Corporation`s results of operations or financial position. In June 2009, the FASB amended guidance for consolidation of variable interest entity guidance by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity`s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Additional disclosures about an enterprise`s involvement in variable interest entities are also required. This guidance is effective as of the beginning of each reporting entity`s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Early adoption is prohibited. Management is in the process of assessing the impact of adopting this new guidance and the effect on the Corporation`s results of operations or financial position. NOTE 2 ~ SECURITIES The amortized cost, fair value and the related gross unrealized gains and losses of available for sale securities recognized in accumulated other comprehensive income (loss) were as follows:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value 2009 U.S. Treasury and federal agency $ 819 $ - $ - $ 819 State and municipal 28,019 763 (99) 28,683 Corporate bond and notes 7,640 137 - 7,777 Mortgage backed: residential 89,972 3,058 (87) 92,943 Equity securities 23 - (4) 19 Total debt securities 126,473 $ 3,958 $ (190) $130,241
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 2 ~ SECURITIES (Continued)
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value 2008 State and municipal $ 16,173 $ 234 $ (193) $ 16,214 Corporate bond and notes 7,630 5 (453) 7,182 Mortgage-backed: residential 101,220 2,616 - 103,836 Equity securities 23 - (7) 16 Total debt securities $125,046 $2,855 $ (653) $127,248
Sales of available for sale securities were as follows:
2009 2008 2007 Proceeds $23,084 $25,471 $22,662 Gross gains 949 330 132 Gross losses (179) (230) (121) Gross gains from calls - - 3 Other than temporary impairment loss - (444) -
The tax provision (benefit) related to these net realized gains and losses was $262, $(34), and $5, respectively. The amortized cost and fair value of securities at year-end 2009 by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage backed securities and equity securities, are shown separately.
Amortized Cost Fair Value Due in one year or less $ 5,964 $ 6,026 Due from one to five years 4,245 4,408 Due from five to ten years 14,135 14,546 Due after ten years 12,134 12,299 Mortgage-backed: residential 89,972 92,943 Equity securities 23 19 Total $126,473 $130,241
Securities pledged at year-end 2009 and 2008 had a carrying amount of $45,882 and $30,679 and were pledged to secure public deposits and repurchase agreements. At year-end 2009 and 2008, there were no holdings of securities of any one issuer, other than the U.S. Government, and its agencies and corporations, in an amount greater than 10% of shareholders` equity. All mortgage-backed securities are issued by the United States government or any agency or corporation thereof, except for $1,535 of private label mortgage-backed securities as of December 31, 2009. Securities with unrealized losses at year-end 2009 and 2008, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:
Less Than 12 Months 12 Months or More Total Fair Unrealized Fair Unrealized Fair Unrealized 2009 Value Loss Value Loss Value Loss State and municipal $ 4,375 $ (60) $455 $ (39) $ 4,830 $ (99) Mortgage-backed: residential 11,761 (87) - - 11,761 (87) Equity securities 19 (4) - - 19 (4) Total temporarily impaired $16,155 $(151) $455 $ (39) $16,610 $(190)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2008, 2007 and 2006 (Dollar amounts in thousands, except per share data) NOTE 2 ~ SECURITIES (Continued)
Less Than 12 Months 12 Months or More Total Fair Unrealized Fair Unrealized Fair Unrealized Value Loss Value Loss Value Loss 2008 State and municipal $3,406 $(193) $ - $ - $3,406 $(193) Corporate bonds and notes 5,166 (453) - - 5,166 (453) Equity securities 16 (7) - - 16 (7) Total temporarily impaired $8,588 $(653) $ - $ - $8,588 $(653)
Unrealized losses have not been recognized into income because the securities are of high credit quality, management has the intent and ability to hold for the foreseeable future, and the decline in fair value is largely due to changes in market interest rates or normally expected market pricing fluctuations. The fair value of debt securities is expected to recover as the securities approach their maturity date. National Bancshares Corporation purchased $467 of FHLMC preferred stock in the first quarter of 2008. During 2008, management determined this preferred stock was other than temporarily impaired. Management recorded $84 and $360 of other than temporary impairment write-downs in the second and third quarter of 2008 related to this investment security. The loss has been recorded in Securities gains (losses), net in the Consolidated Statements of Income. The fair value of these securities at December 31, 2009 and 2008 was $19 and $16 compared to an adjusted cost basis of $23. NOTE 3 ~ LOANS Loans at year-end were as follows:
2008 2007 Collateralized by real estate: Commercial $ 65,139 $ 48,034 Residential 50,390 54,924 Home equity 26,526 24,442 Construction and land development 12,395 12,846 154,450 140,246 Other: Consumer 12,343 14,354 Commercial 26,792 25,583 Other 3,830 1,658 197,415 181,841 Unearned and deferred income (438) (292) Allowance for loan losses (2,906) (1,718) Total $194,071 $179,831
Activity in the allowance for loan losses was as follows:
2009 2008 2007 Beginning balance $1,718 $2,028 $1,993 Provision for loan losses 1,829 482 147 Loans charged-off (659) (845) (151) Recoveries 18 53 39 Ending balance $2,906 $1,718 $2,028
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 3 ~ LOANS (Continued) Individually impaired loans were as follows:
2009 2008 Year-end loans with no allocated allowance for loan losses $2,069 $ 396 Year-end loans with allocated allowance for loan losses 3,692 940 Amount of the allowance for loan losses allocated 916 75
2009 2008 2007 Average of individually impaired loans during year $2,897 $1,846 $2,500
The impact on interest income of impaired loans was not significant to the consolidated statements of income. Nonaccrual loans and loans past due 90 days still on accrual were as follows:
2009 2008 Loans past due over 90 days still on accrual $ 458 $ 261 Nonaccrual loans 4,716 1,752
Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. The Bank sold its $1,486 credit card portfolio to Elan Financial Services (Elan), a subsidiary of U.S. Bank National Association ND in July, 2008. Under the agreement, Elan purchased the Bank`s existing credit card portfolio, and subsequently will issue credit cards for the Bank utilizing the First National Bank name and logo. First National Bank will continue to earn certain fees from ongoing portfolio activity and new accounts. The transaction generated a $435 gain recorded in the third quarter of 2008. The Bank securitized $20,897 single-family residential mortgage loans formerly held in its mortgage loan portfolio, with Freddie Mac in December, 2008 as a guaranteed mortgage securitization and retained the resulting securities as available for sale. The Bank has recorded the securities as available for sale and continues to service the loans. The securitization increased the Bank`s liquidity as the securities are readily marketable, eliminated credit risk on the loans and increased the Bank`s risk-based capital ratio. As a result of the securitization, single-family residential mortgage loan balances net of unamortized loan origination fees declined $20,810, the loan servicing asset increased $132 and securities available for sale increased $21,532. The unrealized gain on the securities at December 31, 2008 was $840 which increased the Bank`s accumulated other comprehensive income and capital by $554. During 2009, the Corporation sold a portion of the securities created by the securitization resulting in proceeds of $3.3 million and a gross gain on sale of $152. The Corporation continues to service all of the underlying loans of the guaranteed mortgage securitization, including the portion of the securitization sold during 2009. NOTE 4 ~ LOAN SERVICING Mortgage loans serviced for others are not reported as assets. The principal balances of these loans at year-end are as follows:
2009 2008 Mortgage loan portfolios serviced for: FHLMC $29,255 $38,011
There were no custodial escrow balances maintained in connection with serviced loans at year-end 2009 and 2008. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 4 ~ LOAN SERVICING (Continued) Activity for mortgage servicing rights and the related valuation allowance follows:
2009 2008 2007 Servicing rights: Beginning balance $ 173 $ 67 $ 86 Additions 2 139 19 Amortized to expense (60) (33) (38) Ending balance $ 115 $ 173 $ 67
NOTE 5 ~ PREMISES AND EQUIPMENT Year-end premises and equipment were as follows:
2009 2008 Land $ 1,571 $ 1,528 Buildings 8,518 6,380 Furniture, fixtures and equipment 4,997 4,764 Construction in progress 183 275 15,269 12,947 Less: Accumulated depreciation (6,236) (6,750) $ 9,033 $ 6,197
Depreciation expense was $588, $442 and $457 in 2009, 2008 and 2007. Rent expense under operating leases included in occupancy was $39, $39 and $38 for the years ended December 31, 2009, 2008 and 2007. Future lease payments are not material. NOTE 6 ~ INTANGIBLE ASSETS During 2002, the Corporation acquired Peoples Financial Corporation and merged the Corporation`s banking operations into the Bank. Identified intangible assets totaling $1,791 were recognized and have useful lives of 7 to 10 years. Goodwill of $4,723 was realized from this transaction. Identified intangible assets at year-end were as follows:
2009 2008 Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization Amortized intangible assets: Core deposit intangibles $1,063 $ 866 $1,063 $ 772 Branch acquisition intangible 760 760 760 733 Customer relationship intangibles 728 728 728 624 Total $2,551 $2,354 $2,551 $2,129
Aggregate amortization expense was $225, $232 and $237 for 2009, 2008 and 2007. Estimated amortization expense for the next three years:
2010 $ 89 2011 86 2012 22
Goodwill impairment exists when a reporting unit`s carrying value of goodwill exceeds its fair value, which is determined through a two-step impairment test. Step 1 includes the determination of the carrying value of our single reporting unit, including the existing goodwill and intangible assets, and estimating the fair value of the reporting unit. We determined the fair value of our reporting unit and compared it to its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, we are required to perform a second step to the impairment test. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 6 ~ INTANGIBLE ASSETS (Continued) Our annual impairment analysis as of September 30, 2009, indicated that the Step 2 analysis was not necessary. Step 2 of the goodwill impairment test is performed to measure the impairment loss. Step 2 requires that the implied fair value of the reporting unit goodwill be compared to the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess. NOTE 7 ~ DEPOSITS 2009 2008 Demand, noninterest-bearing $ 54,290 $ 46,159 Demand, interest-bearing 117,862 92,515 Savings 46,371 49,642 Time, $100,000 and over 15,712 12,937 Time, other 57,138 62,389 $291,373 $263,642
A summary of time deposits at year-end 2009 by maturity follows:
2010 $48,537 2011 16,211 2012 1,930 2013 5,576 2014 596 $72,850
NOTE 8 ~ FEDERAL HOME LOAN BANK ADVANCES At year-end, advances from the Federal Home Loan Bank were as follows:
2009 2008 Maturity in 2010, fixed rate at 6.26%, $ 1,000 $ 1,000 onvertible to variable rate if 3-month LIBOR is at or above predetermined conversion rate level Maturities in 2010 and 2011, fixed rate at 4.93% 13,000 13,000 to 5.79% at December 31, 2009 and 2008, convertible to variable if 1-month LIBOR is at or above fixed rate Maturities in 2009, fixed rate at 3.95% to 4.10% - 3,000 Maturities in 2010, fixed rate at 3.19% 1,000 1,000 Maturities in 2011, fixed rate at 2.31% to 2.88% 4,000 3,000 Maturities in 2012, fixed rate at 2.00% 3,000 - Maturities in 2014, fixed rate at 2.86% to 2.88% 5,000 - Total $27,000 $21,000
Each advance is payable at its maturity date; advances may be paid prior to maturity subject to a prepayment penalty. As collateral for the advances, the Bank has approximately $45,626 and $49,769 of first mortgage loans available under a blanket lien arrangement at year-end 2009 and 2008. Required payments over the next four years are:
2010 3.19 to 6.26% $12,000 2011 2.31 to 5.12% 7,000 2012 2.00% 3,000 2014 2.86 to 2.88% 5,000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 9 ~ REPURCHASE AGREEMENTS Repurchase agreements generally mature within 30 days from the transaction date. Information concerning repurchase agreements is summarized as follows:
2009 2008 2007 Average balance during the year $ 7,442 $10,134 $ 8,642 Average interest rate during the year 0.26% 1.42% 3.86% Maximum month-end balance during the year $ 8,965 $11,136 $10,956 Weighted average rate at year-end 0.25% 0.50% 2.85%
NOTE 10 ~ BENEFIT PLANS The Corporation has a 401(k) retirement plan that covers substantially all employees. The plan allows employees to contribute up to a predetermined amount, subject to certain limitations. Matching contributions may be made in amounts and at times determined by the Corporation. Total matching and discretionary contributions made by the Corporation during 2009, 2008 and 2007 amounted to $73, $81 and $83. The Corporation has an Employee Stock Purchase Incentive Plan for full-time and most part-time employees. Under the Plan, each employee is entitled to receive a cash payment equal to 20% of the purchase price of Corporation common stock acquired by the employee on the open market, up to a maximum of 100 shares per calendar year. Expenses recognized in 2009, 2008 and 2007 amounted to $2, $1, and $2. The Corporation has a director retirement and death benefit plan for the benefit of all members of the Board of Directors. The plan is designed to provide an annual retirement benefit to be paid to each director upon retirement from the Board and attaining age 70. The retirement benefit provided to each director is an annual benefit equal to $1 for each year of service on the Board from and after August 24, 1994 until August 2007, when the Board voted to cease further benefits. In addition, each director has the option of deferring any portion of directors` fees to a maximum of $5 per month until retirement. Interest credited to participant accounts associated with the deferrals was $9, $12 and $29 in 2009, 2008 and 2007. The deferred directors` fee liability was $224 at December 31, 2009 and $374 at December 31, 2008. Expense recognized in 2009, 2008 and 2007 for the director retirement and death benefit plan was $25, $117 and $59. The liability related to the plan was $670 at December 31, 2009 and $680 at December 31, 2008. NOTE 11 ~ INCOME TAXES The components of deferred taxes were as follows:
2009 2008 Deferred tax assets: Bad debts $ 828 $ 424 Deferred compensation 321 382 Deferred loan fees 223 192 FHLMC preferred stock impairment loss 151 151 Deferred income 43 - Real estate owned write-down 26 - Non-accrual loan interest income 17 45 Stock-based compensation 19 10 Core deposit intangibles - 7 Other 1 5 Total $1,629 $1,216 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 11 ~ INCOME TAXES (Continued) 2009 2008 Deferred tax liabilities: Unrealized security gains, net $1,281 $ 749 Federal Home Loan Bank stock dividends 542 542 Depreciation 432 321 Purchase accounting adjustments 137 206 Mortgage servicing rights 50 59 Prepaid expenses 25 44 Securities accretion 47 31 Partnership income 2 1 Total 2,516 1,953 Net deferred tax asset (liability) $ (887) $ (737)
Federal income tax laws provided that the 2002 acquired entity could claim additional bad debt deductions through 1987, totaling $1.9 million. Accounting standards do not require a deferred tax liability to be recorded on this amount, which liability otherwise would total $646 at December 31, 2009. If the Bank were liquidated or otherwise ceases to be a bank or if tax laws were to change, this amount would be expensed. The components of income tax expense are as follows:
2009 2008 2007 Currently payable $ 780 $ 730 $ 515 Deferred (382) 40 (19) Total $ 398 $ 770 $ 496
The following is a reconciliation of income tax at the federal statutory rate to the effective rate of tax on the financial statements:
2009 2008 2007 Rate Amount Rate Amount Rate Amount Tax at federal statutory rate 34% $ 682 34% $1,008 34% $ 750 Tax-exempt income (13) (270) (7) (214) (10) (228) Other (1) (14) (1) (24) (2) (26) Income tax expense 20% $ 398 26% $ 770 22% $ 496
As of December 31, 2008 and December 31, 2009, the Corporation had no unrecognized tax benefits or accrued interest and penalties recorded. The Corporation does not expect the amount of unrecognized tax benefits to significantly increase within the next twelve months. The Corporation will record interest and penalties as a component of income tax expense. The Corporation and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state of Ohio for National Bancshares. The Bank is subject to tax in Ohio based upon its net worth. The Company is no longer subject to examination by state taxing authorities for years prior to 2006. NOTE 12 ~ RELATED-PARTY TRANSACTIONS Loans to principal officers, directors, and their affiliates during 2009 were as follows:
Beginning balance $3,776 Effect of changes in composition of related parties 99 New loans 3,002 Repayments (516) Ending balance $6,361
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 12 ~ RELATED-PARTY TRANSACTIONS (Continued) Unused commitments to these related parties totaled $3,762 and $969 at year-end 2009 and 2008. Related party deposits totaled $4,749 and $2,050 at year-end 2009 and 2008. The Corporation has minority ownership in a title agency affiliated with a Director resulting in fee income to the Corporation of $32, $11 and $16 for 2009, 2008 and 2007, respectively. NOTE 13 ~ STOCK-BASED COMPENSATION The Corporation`s 2008 Equity Incentive Plan (`the Plan`), which is shareholder-approved, permits the grant of stock options or restricted stock awards, to its officers, employees, consultants and non-employee directors for up to 223,448 shares of common stock. Stock Option Awards Option awards are granted with an exercise price equal to the market price of the Corporation`s common stock at the date of grant; those option awards have vesting periods determined by the Corporation`s compensation committee and have terms that shall not exceed 10 years. On May 20, 2008, the Corporation granted options to purchase 58,000 shares of stock to directors and certain key officers, all of which remained outstanding at December 31, 2008. The exercise price of the options is $18.03 per share. The options vest in five equal installments over a five-year period and have a term of 10 years. 5,000 options were forfeited during 2009 leaving 53,000 outstanding at December 31, 2009. All options are expected to vest. The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical volatilities of the Corporation`s common stock. The Corporation has estimated the option exercise and post-vesting termination behavior and expected term of options granted due to the lack of historical data. The expected term of options granted represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferrable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The fair value of options granted of $1.83 per option was determined using the following weighted-average assumptions as of grant date.
Risk-free interest rate 3.19% Expected term (years) 6.5 Expected stock price volatility 13.76% Dividend yield 3.60%
The total compensation cost that has been charged against income for the plan was $34 and $28 for 2009 and 2008. The total income tax benefit was $12 and $10 for 2009 and 2008. There was $38 and $78 of total unrecognized compensation cost related to nonvested stock options granted under the Plan as of December 31, 2009 and 2008. The cost is expected to be recognized over a weighted-average period of 3.4 years. At December 31, 2009, 10,600 options are vested and the outstanding options have no intrinsic value. The weighted average remaining contractual term is 8.4 years. Restricted Stock Awards On December 23, 2009, the Company issued restricted stock awards for 3,605 shares of the Corporation`s common stock to certain officers. The awards vested immediately and the compensation expense related to the awards of $50 was recorded in 2009. The fair value of the stock was determined using closing market price of the Corporation`s common stock on the date of the grant. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 14 ~ REGULATORY CAPITAL MATTERS Banks are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. Management believes as of December 31, 2009, the Bank meets all capital adequacy requirements to which it is subject. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2009 and 2008, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution`s category. Actual and required capital amounts and ratios for the Bank are presented below at year-end.
To Be Well Required Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Regulations Amount Ratio Amount Ratio Amount Ratio 2009 Total capital to risk weighted assets $29,842 12.46% $19,161 8.00% $23,952 10.00% Tier 1 capital to risk weighted assets 26,936 11.25% 9,581 4.00% 14,371 6.00% Tier 1 capital to average assets 26,936 7.40% 14,562 4.00% 18,202 5.00% 2008 Total capital to risk weighted assets $26,730 12.60% $16,971 8.00% $21,213 10.00% Tier 1 capital to risk weighted assets 25,012 11.79% 8,485 4.00% 12,728 6.00% Tier 1 capital to average assets 25,012 7.78% 12,853 4.00% 16,066 5.00%
Dividend Restrictions ~ The Corporation`s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year`s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. The Bank could, without prior approval, pay dividends to the holding Corporation of approximately $437 as of December 31, 2009. NOTE 15 ~ LOAN COMMITMENTS AND OTHER RELATED ACTIVITIES Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met, and usually have expiration dates. Commitments may expire without being used. Off balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 15 ~ LOAN COMMITMENTS AND OTHER RELATED ACTIVITIES (Continued) The contractual amounts of financial instruments with off balance sheet risk at year-end were as follows:
2009 2008 Commitments to make loans $ 2,531 $ 2,382 Unused lines of credit 60,567 49,389 Letters of credit 308 109
Of the above unused instruments at December 31, 2009, approximately $9,974 pertains to fixed-rate commitments and variable-rate commitments account for approximately $53,432. At year-end 2008, approximately $10,065 of total commitments were fixed-rate and approximately $41,815 were variable rate. Rates on fixed-rate unused lines of credit ranged from 6.25% to 21.90% at December 31, 2009 and 6.25% to 19.80% at December 31, 2008. NOTE 16 - FAIR VALUE Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date. Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Level 3: Significant unobservable inputs that reflect a reporting entity`s own assumptions about the assumptions that market participants would use in pricing an asset or liability. The fair value of securities available for sale is determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities relationship to other benchmark quoted securities (Level 2 inputs). The fair value of servicing rights is based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. The Corporation is able to compare the valuation model inputs and results to widely available published industry data for reasonableness (Level 2 inputs). The fair value of derivatives is based on valuation models using observable market data as of the measurement date (Level 2 inputs). The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less cost to sell. Fair Values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized. Loans held for sale are carried at the lower of cost or fair value, as determined by outstanding commitments, from third party investors. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 16 ~ FAIR VALUE (Continued) Assets and Liabilities Measured on a Recurring Basis Assets and liabilities measured at fair value on a recurring basis are summarized below:
Fair Value Measurements At December 31, 2009 Using Quoted Prices in Significant Active Markets Other Significant for Identical Observable Unobservable Assets Inputs Inputs (Level 1) (Level 2) (Level 3) Assets: Available for sale securities U.S. Government and federal agency $ - $ 819 $ - State and municipal - 28,683 - Corporate bonds and notes - 7,777 - Mortgage-backed securities: residential - 92,943 - Equity securities 19 - - Interest rate swaps - 4 -
Fair Value Measurements At December 31, 2009 Using Quoted Prices in Significant Active Markets Other Significant for Identical Observable Unobservable Assets Inputs Inputs (Level 1) (Level 2) (Level 3) Liabilities: Interest rate swaps $ - $ 4 $ -
Fair Value Measurements At December 31, 2008 Using Quoted Prices in Significant Active Markets Other Significant for Identical Observable Unobservable Assets Inputs Inputs (Level 1) (Level 2) (Level 3) Assets: Available for sale securities $ 16 $127,232 $ -
Assets and Liabilities Measured on a Non-Recurring Basis Assets and liabilities measured at fair value on a non-recurring basis are summarized below:
Fair Value Measurements At December 31, 2009 Using Quoted Prices in Significant Active Markets Other Significant for Identical Observable Unobservable Assets Inputs Inputs (Level 1) (Level 2) (Level 3) Assets: Impaired loans $ - $ - $ 3,626 Other real estate owned - - 58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 16 - FAIR VALUE (Continued)
Fair Value Measurements At December 31, 2008 Using Quoted Prices in Significant Active Markets Other Significant for Identical Observable Unobservable Assets Inputs Inputs (Level 1) (Level 2) (Level 3) Assets: Impaired loans $ - $ - $ 865
Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal amount of $4,542, with a valuation allowance of $916, resulting in an additional provision for loan loss of $1,091. Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $58, which is made up of the outstanding balance of $133, net of a valuation allowance of $75 at December 31, 2009, resulting in a write-down of $75 for the year ending December 31, 2009. Carrying amount and estimated fair values of financial instruments at year-end were as follows:
2009 2008 Carrying Fair Carrying Fair Amount Value Amount Value Financial assets Cash and cash equivalents $ 8,124 $ 8,124 $ 11,001 $ 11,001 Time deposits with other financial institutions 13,580 13,580 - - Securities available for sale 130,241 130,241 127,248 127,248 Restricted equity securities 3,218 na 3,217 na Loans, net 194,071 194,103 179,831 179,586 Accrued interest receivable 1,334 1,334 1,230 1,230 Interest rate swaps 4 4 - - Financial liabilities Deposits 291,373 292,045 263,642 264,731 Short-term borrowings 9,720 9,720 13,285 13,285 Federal Home Loan Bank advances 27,000 27,779 21,000 21,239 Accrued interest payable 408 408 690 690 Interest rate swaps 4 4 - -
The methods and assumptions used to estimate fair value are described as follows: Carrying amount is the estimated fair value for cash and cash equivalents, time deposits with other financial institutions, interest bearing deposits, accrued interest receivable and payable, demand deposits, short term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of restricted equity securities due to restrictions placed on its transferability. The fair value of off balance sheet items is not considered material. NOTE 17 ~ DERIVATIVES The Corporation utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position. The notional amount of the interest rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements. The Corporation implemented a program whereby it lends to its borrowers at a fixed rate with the loan agreement containing a two-way yield maintenance provision in the first quarter of 2009. If the borrower prepays the loan, the yield maintenance provision will result in a prepayment penalty or benefit depending on the interest rate environment at the time of the prepayment. This provision represents an embedded derivative which is required to be bifurcated from the host loan contract. As a result of bifurcating the embedded derivative, the Corporation records the transaction with the borrower as a floating rate loan and a pay floating~receive fixed interest-rate swap. To offset the risk of the interest-rate swap with the borrower, the Corporation enters interest-rate swaps with outside counterparties that mirror the terms of the interest-rate swap between the Corporation and the borrower. Both interest-rate swaps are carried as freestanding derivatives with their changes in fair value reported in current earnings. The change in the fair value of the interest-rate swap with borrowers was a decrease of $4 for the year ended December 31, 2009, which was offset by an equal increase in value during the year ended December 31, 2009 on the interest-rate swaps with outside parties, with the result that there was no impact on income as of December 31, 2009. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 17 ~ DERIVATIVES (Continued) Summary information about the interest-rate swap between the Corporation and its borrower as of year-end is as follows:
Notional amount $ 1,544 Weighted average receive rate 5.33% Weighted average pay rate 3.88% Weighted average maturity (years) 4.0 Fair value of interest-rate swap 4
Notional amount $ 1,544 Weighted average receive rate 5.33% Weighted average pay rate 3.88% Weighted average maturity (years) 4.0 Fair value of interest-rate swap (4)
NOTE 18 ~ OTHER COMPREHENSIVE INCOME (LOSS) Other comprehensive income (loss) components and related tax effects were as follows:
2009 2008 2007 Unrealized holding gains (loss) on available for sale securities $2,337 $ 571 $ 714 Reclassification adjustment for losses (gains) later recognized in income (770) 344 (14) Net unrealized gains 1,567 915 703 Initial unrealized gain on mortgage-backed securities received in securitization - 840 - Tax effect (533) (597) (239) Other comprehensive income $1,034 $1,158 $ 464
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 19 ~ PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION Condensed financial statements for National Bancshares Corporation (parent only) are as follows:
BALANCE SHEETS December 31, 2009 2008 ASSETS Cash and cash equivalents $ 4,438 $ 5,237 Investment in Bank subsidiary 34,389 31,675 Securities available for sale 19 16 Other assets 234 215 Total assets $39,080 $37,233 LIABILITIES AND SHAREHOLDERS` EQUITY Dividends payable $ 177 $ 352 Shareholders` equity 38,903 36,881 Total liabilities and shareholders` equity $39,080 $37,233
STATEMENTS OF INCOME Years ended December 31,
2009 2008 2007 INCOME Dividends from Bank subsidiary $ - $2,500 $3,000 Securities gains (losses), net - (444) 1 Dividend income - 16 - Total Income - 2,072 3,001 EXPENSES Miscellaneous expense (59) (72) (85) Income (loss) before income tax and undistributed subsidiary income (59) 2,000 2,916 Income tax benefit 20 170 29 Undistributed equity in (distributions in excess of) net income of Bank subsidiary 1,648 24 (1,234) Net income $1,609 $2,194 $1,711
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2009, 2008 and 2007 (Dollar amounts in thousands, except per share data) NOTE 19 ~ PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (Continued) STATEMENTS OF CASH FLOWS Years ended December 31,
2009 2008 2007 Cash flows from operating activities Net income $1,609 $2,194 $1,711 Adjustments to reconcile net income to net cash from operating activities: Distributions in excess of (equity in undistributed net income) of Bank subsidiary (1,648) (24) 1,234 Net security (gains) loss - 444 (1) Change in other assets and liabilities 31 (170) (14) Net cash from operating activities (8) 2,444 2,930 Cash flows from investing activities Proceeds from sale of securities - - 1 Purchase of security available for sale - (467) - Net cash from investing activities - (467) 1 Cash flows from financing activities Dividends paid (881) (1,410) (1,430) Purchase of common stock - (86) (434) Net cash from financing activities (881) (1,496) (1,864) Net change in cash (889) 481 1,067 Beginning cash and cash equivalents 5,327 4,846 3,779 Ending cash and cash equivalents $4,438 $5,327 $4,846
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors and Shareholders National Bancshares Corporation Orrville, Ohio We have audited the accompanying consolidated balance sheets of National Bancshares Corporation as of December 31, 2009 and 2008, and the related consolidated statements of income, changes in shareholders` equity and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Corporation`s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Corporation Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation`s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the 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 National Bancshares Corporation as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2009 in conformity with U.S. generally accepted accounting principles. Crowe Horwath LLP Cleveland, Ohio March 19, 2010 REPORT OF MANAGEMENT ON THE COMPANY`S INTERNAL CONTROL OVER FINANCIAL REPORTING March 1, 2010 Management of National Bancshares Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are made only in accordance with authorizations of management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. Management of National Bancshares Corporation, including the Chief Executive Officer and the Chief Financial Officer, has assessed the Corporation`s internal control over financial reporting as of December 31, 2009, based on criteria for effective internal control over financial reporting described in `Internal Control ~ Integrated Framework` issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Corporation`s internal control over financial reporting was effective as of December 31, 2009, based on the specified criteria. This annual report does not include an audit report of the Corporation`s registered public accounting firm regarding internal control over financial reporting. Management`s report was not subject to audit by the Corporation`s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Corporation to provide only management`s report in this annual report. David C. Vernon Chief Executive Officer James R. VanSickle Chief Financial Officer COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN OF NATIONAL BANCSHARES CORPORATION, S&P 500 STOCK INDEX, AND S&P 500 BANK INDEX
2004 2005 2005 2007 2008 2009 National Bancshares Corp $100.00 85.42 90.24 64.67 52.85 61.11 S&P 500 Stock Index~ $100.00 104.91 121.48 128.16 80.74 102.11 S&P 500 Banks Index~ $100.00 98.54 114.41 80.33 42.18 39.40
~ National Bancshares Corporation is not included in the S&P 500 Bank Index or S&P 500 Stock Index. PRICE RANGE OF COMMON STOCK National Bancshares Corporation common stock is traded on the OTC Bulletin Board under the symbol `NBOH.` The OTC Bulletin Board is a regulated quotation service that displays real-time quotes, last-sale prices, and volume information in over-the-counter equity securities. A summary of the high and low prices of and cash dividends paid on National Bancshares Corporation common stock in 2009 and 2008 follows. This information does not reflect retail mark-up, markdown or commissions, and does not necessarily represent actual transactions.
High Low Dividends per share 2008 First Quarter $14.65 $11.96 $.08 Second Quarter 14.64 13.02 .08 Third Quarter 14.08 12.90 .08 Fourth Quarter 17.90 13.52 .08 2007 First Quarter $18.10 $16.20 $.16 Second Quarter 18.50 14.50 .16 Third Quarter 16.69 14.30 .16 Fourth Quarter 16.00 11.60 .16
SHAREHOLDER INFORMATION Corporate Office National Bancshares Corporation 112 West Market Street, PO Box 57 Orrville, OH 44667 www.discoverfirstnational.com Stock Trading Information The shares of common stock of National Bancshares Corporation are traded on the OTC Bulletin Board. The ticker symbol for National Bancshares Corporation is `NBOH.` The Corporation had 876 shareholders of Record as of December 31, 2009. Form 10-K A copy of the Corporation`s 2009 Annual Report on Form 10-K as filed with the SEC will be furnished free of charge to shareholders upon written request to the Company. Shareholder Assistance National Bancshares Corporation Shareholder Services Department Ellen Gerber, Shareholder Relations 330-765-0609 egerber@discoverfirstnational.com Transfer Agent Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 1-800-368-5948 info@rtco.com www.rtco.com National Bancshares Corporation has a Dividend Reinvestment Plan and a Dividend Direct Deposit Plan available at no cost. Please contact Registrar and Transfer Company for enrollment. OFFICERS NATIONAL BANCSHARES CORPORATION David C. Vernon, President and Chief Executive Officer James R. VanSickle, Senior Vice President and Chief Financial Officer Paul G. Kubiak, Senior Vice President and Secretary FIRST NATIONAL BANK David C. Vernon, President and Chief Executive Officer Business Banking Thomas R. Poe, Senior Vice President, Senior Loan Officer John L. Falatok, Senior Vice President, Market Manager John R. Macks, Vice President Paul A. Manghillis, Vice President Robert C. McConnell, Vice President John D. Shultz, Jr., Vice President Darrell L. Smucker, Vice President Laura R. Yoder, Assistant Vice President Mortgage Banking Cynthia A. Wagner, Assistant Vice President Matthew M. Miller, Assistant Vice President, Mortgage Consultant Credit Administration Richard A. White, Vice President, Senior Credit Officer Kathryn J. Barnes, Assistant Vice President, Credit Officer Dallas W. Falb, Credit Officer Loan Operations, Consumer Lending and Managed Assets Steven L. Riddick, Vice President Lisa M. Bryant, Loan Operations Officer Mindy L. Henderson, Loan Operations Officer Patricia J. Massaro, Loan Officer Retail Banking Paul G. Kubiak, Senior Vice President, Retail Banking John P. Hall, Vice President, Wooster Market Manager Harold D. Berkey, Vice President, Relationship Manager Amberly M. Wolf, Assistant Vice President, Retail Banking Paul J. Bayus, Assistant Vice President, Relationship Manager Dean M. Karhan, Assistant Vice President, Relationship Manager Heather L. Kiner, Assistant Vice President, Relationship Manager Jill R. Wachtel, Assistant Vice President, Relationship Manager Corporate James R. VanSickle, Senior Vice President, Chief Financial Officer James T. Griffith, Vice President, Information Technology Pamela S. Null, Vice President, Compliance, BSA, CRA and Security Michael G. Oberhaus, Vice President, Financial Analyst, Risk Manager Maria A. Roush, Vice President, Auditor Angela L. Smith, Controller Jodi R. Blair, Deposit Operations Officer BOARD OF DIRECTORS FIRST NATIONAL BANK OFFICES NATIONAL BANCSHARES CORPORATION & FIRST NATIONAL BANK Sara Steinbrenner Balzarini Orrville Partner, 112 W. Market St. Paramount Tennis, LLC. 330-682-1010 John P. Cook, CPA, Ph.D 1320 W. High St. Shareholder, 330-682-2881 Long, Cook & Samsa, Inc. 1720 N. Main St. Bobbi E. Douglas CASH ATM ONLY Executive Director, STEPS at Liberty Center Apple Creek Every Woman`s House 7227 E. Lincoln Way 330-264-8070 John W. Kropf Chairman of the Board, Dalton National Bancshares Corporation 12 W. Main St. First National Bank 330-828-2227 Attorney, Kropf, Wagner, Lutz Fairlawn & VanSickle, L.L.P. 3085 West Market Street 330-475-1363 John L. Muhlbach, Jr. Vice President, Kidron A.A. Hammersmith, Inc. 4950 Kidron Rd. 330-857-3101 Victor B. Schantz President, Lodi Schantz Organ Company 106 Ainsworth St. 330-948-1414 Steve Schmid President, Massillon Dairy Enterprises, Inc. 211 Lincoln Way E. 330-832-7441 James R. Smail Chairman/Director 2312 Lincoln Way N.W. J.R. Smail, Inc. 330-833-1622 Poulson Drilling, Inc. Monitor Ranch, Inc. 51 Massillon Marketplace Dr. S.W. Monitor Bancorp, Inc. CASH ONLY ATM David C. Vernon Mt. Eaton President & CEO, 15974 E. Main St. National Bancshares Corporation 330-359-3105 or 330-857-4301 First National Bank Seville Howard J. Wenger 4885 Atlantic Dr. President, 330-769-3105 Wenger Excavating, Inc. Lake Region Oil, Inc. Smithville Northstar Asphalt, Inc. 153 E. Main St. Massillon Materials, Inc. 330-669-2611 Stark Materials, Inc. Wooster Albert W. Yeagley 4192 Burbank Rd. Vice President, Industry & Government Affairs 330-263-5303 The J. M. Smucker Company 1725 Cleveland Rd. 330-263-1725