-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Oll17eolSfCVx709uVrmF8SeBT7dQZvtSdEc0/UGRIq8ALXXdz8drNU9ZpBU8j3x iiST3e/n1j9VC6/CkdYX1Q== 0000796534-98-000009.txt : 19980331 0000796534-98-000009.hdr.sgml : 19980331 ACCESSION NUMBER: 0000796534-98-000009 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980330 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL BANKSHARES INC CENTRAL INDEX KEY: 0000796534 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 541375874 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-15204 FILM NUMBER: 98577984 BUSINESS ADDRESS: STREET 1: 100 SOUTH MAIN ST CITY: BLACKSBURG STATE: VA ZIP: 24062-9002 BUSINESS PHONE: 7035522011 MAIL ADDRESS: STREET 1: 100 SOUTH MAIN STREET STREET 2: PO BOX 90002 CITY: BLACKSBURG STATE: VA ZIP: 24062-9002 10-K 1 10-K FORM 1997 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended Commission file number December 31, 1997 O-15204 NATIONAL BANKSHARES, INCORPORATED - -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Virginia 54-1375874 - ------------------------------- --------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 100 South Main Street Blacksburg, Virginia 24060 - ---------------------------------------- -------------------- (Address of principal executive offices) Zip Code Registrant's telephone number, including area code (540) 552-2011 -------------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $2.50 per Share - -------------------------------------------------------------------------------- (Title of Class) Indicate by a check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X ------- The aggregate market value of voting stock held by nonaffiliates of the Registrant as of March 18, 1998 was $96,689,655. The aggregate market value was computed based on a price determined from transactions known to management of the Registrant since its stock is not extensively traded, listed on any exchange, or quoted by NASDAQ. (In determining this amount, the registrant assumes that all of its Directors and principal Officers are affiliates. Such assumption shall not be deemed conclusive for any other purposes.) Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date. Class Outstanding at March 18, 1998 - ------------------------------ ------------------------------- COMMON STOCK, $2.50 PAR VALUE 3,792,833 DOCUMENTS INCORPORATED BY REFERENCE Selected information from the Registrants' Annual Report to Stockholders for the year ended December 31, 1997, is incorporated by reference into Parts I and II of this report. Selected information from the Registrant's Proxy Statement for the Annual Meeting to be held April 14, 1998 and filed with the Securities and Exchange Commission pursuant to Regulation 14A, is incorporated by reference into Part III of this report. (This report contains 40 pages.) -- (The Index of Exhibits are on pages 39-40.) NATIONAL BANKSHARES, INCORPORATED ANNUAL REPORT FOR 1997 ON FORM 10-K TABLE OF CONTENTS PAGE ---- PART I Item 1. Business 3-29 Item 2. Properties 29 Item 3. Legal Proceedings 29 Item 4. Submission of Matters to a Vote of Security Holders 29 Executive Officers of the Registrant 30 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 31 Item 6. Selected Financial Data 31 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 31 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 31-33 Item 8. Financial Statements and Supplementary Data 34 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 34 PART III Item 10. Directors and Executive Officers of the Registrant 34 Item 11. Executive Compensation 34 Item 12. Security Ownership of Certain Beneficial Owners and Management 34 Item 13. Certain Relationships and Related Transactions 35 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 35-37 -3- PART I ------ Item 1. Business. - ----------------- History and Business National Bankshares, Inc. (Bankshares) is a bank holding company organized under the laws of Virginia in 1986 and registered under the Bank Holding Company Act (BHCA). Bankshares conducts its operations through its two wholly-owned subsidiaries, The National Bank of Blacksburg (NBB) and Bank of Tazewell County (BTC), collectively referred to as "the Company". On June 1, 1996, Bankshares issued 1,888,209 shares of its common stock in a one-for-one exchange for all the outstanding common stock of Bank of Tazewell County, Tazewell, Virginia. This business combination has been accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements for the periods prior to the combination have been restated to include the accounts and results of operations of Bank of Tazewell County. There were no adjustments of a material amount resulting from Bank of Tazewell County's adoption of Bankshares' accounting policies. In May 1996, Bankshares declared a stock split of .11129 per share effected in the form of a stock dividend to the holders of Bankshares common stock just prior to the merger effective date to facilitate the one-for-one common stock exchange ratio. All stockholders' equity accounts, share and per share data have been adjusted retroactively to reflect the stock split. The National Bank of Blacksburg The National Bank of Blacksburg was originally chartered as the Bank of Blacksburg in 1891. Its state charter was converted to a national charter in 1922 and it became The National Bank of Blacksburg. NBB operates a full-service banking business from its headquarters in Blacksburg, Virginia, and its eight area branch offices. NBB offers general retail and commercial banking services to individuals, businesses, local government units and institutional customers. These products and services include accepting deposits in the form of checking accounts, money market deposit accounts, interest-bearing demand deposit accounts, savings accounts and time deposits; making real estate, commercial, revolving, consumer and agricultural loans; offering letters of credit; providing other consumer financial services, such as automatic funds transfer, collections, night depository, safe deposit, travelers checks, savings bond sales and utility payment services; and providing other miscellaneous services normally offered by commercial banks. NBB also conducts a general trust business in Blacksburg near its headquarters location. Through its trust operation, NBB offers a variety of personal and corporate trust services. NBB makes loans in all major loan categories, including commercial, commercial and residential real estate, construction and consumer loans. Bank of Tazewell County The antecedents of BTC are in a charter issued on September 28, 1889 for Clinch Valley Bank. On December 22, 1893, a second charter was issued in substantially the same form for Bank of Clinch Valley. In 1929, Bank of Clinch Valley merged with Farmers Bank under the charter of the former, and the name of the resulting institution became Farmers Bank of Clinch Valley. Bank of -4- Tazewell County resulted from the 1964 merger of Bank of Graham, Bluefield, Virginia with Farmers Bank of Clinch Valley. BTC provides general retail and commercial banking services to individuals, businesses and local government units. These services include commercial, real estate and consumer loans. Deposit accounts offered include demand deposit accounts, interest-bearing demand deposit accounts, money market deposit accounts, savings accounts and certificates of deposit. Other services include automatic funds transfer, collections, night depository, safe deposit, travelers checks, savings bond sales and utility payment services; and providing other miscellaneous service normally offered by commercial banks. BTC also conducts a general trust business. BTC makes commercial, residential real estate and consumer loans. Commercial Loans NBB and BTC make both secured and unsecured loans to businesses and to individuals for business purposes. Loan requests are granted based upon several factors including credit history, past and present relationships with the bank and marketability of collateral. Unsecured commercial loans must be supported by a satisfactory balance sheet and income statement. Business loans made on a secured basis may be secured by a security interest in marketable equipment, accounts receivable, business equipment and/or general intangibles of the business. In addition, or in the alternative, the loan may be secured by a deed of trust lien on business real estate. The risks associated with commercial loans are related to the strength of the individual business, the value of loan collateral and the general health of the economy. Residential Real Estate Loans Loans secured by residential real estate are originated by both bank subsidiaries. Loans originated by BTC are typically held in the bank's loan portfolio. NBB sells a substantial percentage of the residential real estate loans it originates in the secondary market on a servicing released basis. There are occasions when a borrower or the real estate do not qualify under secondary market criteria, but the loan request represents a reasonable credit risk. Also, an otherwise qualified borrower may choose not to have their mortgage loan sold. On these occasions, if the loan meets NBB's internal underwriting criteria, the loan will be closed and placed in NBB's portfolio. In its secondary market operation, NBB participates in insured loan programs sponsored by the Department of Housing and Urban Development, the Veterans Administration and the Virginia Housing Development Authority. Residential real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Construction Loans NBB makes loans for the purpose of financing the construction of business and residential structures to financially responsibly business entities and individuals. These loans are subject to the same credit criteria as commercial and residential real estate loans. Although BTC offers construction loans, its involvement in this area of lending is more limited than NBB's due to the nature of its market area. -5- In addition to the risks associated with all real estate loans, construction loans bear the risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may at any point in time be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be the bank's loan customer, is unable to finish the construction project as planned because of financial pressures unrelated to the project. Loans to customers that are made as permanent financing of construction loans may likewise under certain circumstances be affected by external financial pressures on those customers. Consumer Loans NBB and BTC routinely make consumer loans, both secured and unsecured. The credit history and character of individual borrowers is evaluated as a part of the credit decision. Loans used to purchase vehicles or other specific personal property and loans associated with real estate are usually secured with a lien on the subject vehicle or property. NBB also originates a small number of student loans that are sold to the Student Loan Marketing Association. Negative changes in a customer's financial circumstances due to a large number of factors, such as illness or loss of employment, can place the repayment of a consumer loan at risk. In addition, deterioration in collateral value can add risk to consumer loans. Sales and Purchases of Loans NBB and BTC will occasionally buy or sell all or a portion of a loan. These purchases and sales are in addition to the secondary market mortgage loans and student loans regularly sold by NBB. Because the demand for loans, particularly for commercial loans, is greater in NBB's market area than in BTC's market area, NBB regularly sells loans and participations in loans to BTC. BTC's loan to deposit ratio is at a level where additional loans are desirable, and NBB's loan to deposit ratio is at a level which its management considers to be optimal without the loans sold to BTC. Both banks will consider selling a loan or a participation in a loan, if: (i) the full amount of the loan will exceed the bank's legal lending limit to a single borrower; (ii) the full amount of the loan, when combined with a borrower's previously outstanding loans, will exceed the bank's legal lending limit to a single borrower; (iii) the Board of Directors or an internal Loan Committee believes that a particular borrower has a sufficient level of debt with the bank; (iv) the borrower requests the sale; (v) the loan to deposit ratio is at or above the optimal level as determined by bank management; and/or (vi) the loan may create too great a concentration of loans in one particular location or in one particular type of loan. The banks will consider purchasing a loan, or a participation in a loan, from another financial institution (including from another subsidiary of the Company) if the loan meets all applicable credit quality standards and (i) the bank's loan to deposit ratio is at a level where additional loans would be desirable; and/or (ii) a common customer requests the purchase. The following table sets forth, for the three fiscal years ended December 31, 1997, 1996 and 1995 the percentage of total operating revenue contributed by each class of similar services which contributed 15% or more of total operating revenues of the Company during such periods. -6- Percentage of Period Class of Service Total Revenues ------ ---------------- -------------- December 31, 1997 Interest and Fees on Loans 59.92% Interest on Investments 29.31% December 31, 1996 Interest and Fees on Loans 54.98% Interest on Investments 34.61% December 31, 1995 Interest and Fees on Loans 51.72% Interest on Investments 38.16% Market Area The National Bank of Blacksburg Market Area NBB's primary market area consists of the northern portion of Montgomery County and all of Giles County, Virginia. This area includes the towns of Blacksburg and Christiansburg in Montgomery County and the towns of Pearisburg, Pembroke and Rich Creek, in Giles County. The local economy is diverse and is oriented toward higher education, retail and service, light manufacturing and agriculture. For the years 1997, 1996 and 1995 the unemployment rate in Montgomery County was 2.6%, 3.3% and 3.0%, respectively, and the rate in Giles County during those years was 6.7% in 1997 and 8.4% in 1996 and 1995. Montgomery County's largest employer is Virginia Polytechnic Institute and State University (VPI & SU) located in Blacksburg. VPI & SU is the Commonwealth's land grant college and also its largest university. Employment at VPI & SU has remained stable over the past three years, and it is not expected to change materially in the next few years. A second state supported university, Radford University, is located in the western edge of NBB's service area. It too has provided stable employment opportunities in the region. Giles County's primary employer is the Celco plant, that manufactures the material from which cigarette filters are made. In 1995 and 1996 employment at that plant was stable, however, in late 1997 temporary employee furloughs were announced, and it is anticipated that some percentage of these temporary layoffs will become permanent. Several other small manufacturing concerns are located in Montgomery and Giles Counties. These concerns manufacture diverse products and are not dependent upon one sector of the economy. Since 1988, Montgomery County has developed into a regional retail center, with the construction of two large shopping areas. Two area hospitals, each of which are affiliated with different large health care systems, have in the past several years constructed additional facilities and have attracted additional health care providers to Montgomery County, making it a center for basic health care services. VPI & SU's Corporate Research Center has brought several small high tech companies to Blacksburg, and further expansion is planned. Montgomery County has experienced good growth, with the total fair market value of real estate, measured in constant dollars, increasing 49% in the years between 1980 and 1992. Growth is predicted to continue through the year 2000; however, the rate is likely to be slower, as the predicted rate of population growth in Montgomery County is expected to moderate. Neighboring Giles County is more rural and had only 22% of Montgomery County's total population in 1990. Giles County has experienced a slight decline in population since the 1990 -7- census. Total fair market value of real estate, measured in real dollars, increased in Giles County by 54% between 1980 and 1992, but declined by 9% over that twelve-year period, as measured in constant dollars. The continued slow decline of Giles County's population is predicted to continue through the year 2000. However, since the total population of the County reported in the 1990 census was only 16,366, and the population projected by the Virginia Employment Commission for Giles in the year 2000 is 16,121, the predicted decline of 245 individuals is not expected to materially impact NBB's business in Giles County. NBB's primary market area offers the advantages of a good quality of life, scenic beauty, moderate climate and the cultural attractions of two major universities. The region has marketed itself as a retirement destination, and it has had some recent success attracting retirees, particularly from the Northeast and urban Northern Virginia. These marketing efforts are expected to continue. Bank of Tazewell County Market Area Most of BTC's business originates from Tazewell County, Virginia and Mercer County, West Virginia. This includes the towns of Tazewell and Bluefield, Virginia and Bluefield, West Virginia. BTC's primary market area has largely depended on the coal mining industry and farming for its economic base. In recent years, coal companies have mechanized and this has reduced the number of individuals required for the production of coal. There are still a number of support industries for the coal mining business that continue to provide employment in the area. Additionally, several new businesses have been established in the area, and Bluefield, West Virginia has begun to emerge as a regional medical center. Unemployment has stabilized, and real estate values also remain stable and comparable to other areas in southwest Virginia. For 1997, 1996 and 1995 the unemployment rate for Tazewell County was 9.5%, 9.5% and 10.2%, respectively. In the same years, Mercer County, West Virginia's unemployment rate was 5.3%, 5.2% and 5.7%, respectively. Competition The banking and financial service business in Virginia generally, and in NBB's and BTC's market areas specifically, is highly competitive. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial service providers. The Company's bank subsidiaries compete for loans and deposits with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, money market funds, credit unions and other nonbank financial service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services than NBB and BTC. In order to compete with these other financial service providers, NBB and BTC rely upon service-based business philosophies, personal relationships with customers, specialized services tailored to meet customers' needs and the convenience of office locations. In addition, the banks are generally competitive with other financial institutions in their market areas with respect to interest rates paid on deposit accounts, interest rates charged on loans and other service charges on loans and deposit accounts. Registrant's Organization and Employment Bankshares, NBB and BTC are organized in a holding company/subsidiary bank structure. Bankshares has no employees, except for executive officers, and conducts substantially all of its operations through its subsidiaries. All -8- compensation paid to officers and employees is paid by NBB, except for fees paid by Bankshares to President and Chief Executive Officer James G. Rakes for his service as a director of the Company. At December 31, 1997, NBB employed 107 full time equivalent employees at its main office, operations center and branch offices. BTC at December 31, 1997 employed 69 in its various offices and operational areas. Certain Regulatory Considerations Bankshares, NBB and BTC are subject to various state and federal banking laws and regulations which impose specific requirements or restrictions on and provide for general regulatory oversight with respect to virtually all aspects of operations. As a result of the substantial regulatory burdens on banking, financial institutions, including Bankshares, NBB and BTC, are disadvantaged relative to other competitors who are not as highly regulated, and their costs of doing business are much higher. The following is a brief summary of the material provisions of certain statutes, rules and regulations which affect Bankshares, NBB and/or BTC. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations which are applicable to the businesses of Bankshares, NBB and/or BTC. Any change in applicable laws or regulations may have a material adverse effect on the business and prospects of Bankshares, NBB and/or BTC. National Bankshares, Inc. Bankshares is a bank holding company within the meaning of the BHCA and Chapter 13 of the Virginia Banking Act, as amended (the Virginia Banking Act). The activities of Bankshares also are governed by the Glass-Steagall Act of 1933 (the Glass-Steagall Act). The Bank Holding Company Act. The BHCA is administered by the Federal Reserve Board, and Bankshares is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board also is authorized to examine Bankshares and its subsidiaries. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before (i) it or any of its subsidiaries (other than a bank) acquires substantially all the assets of any bank; (ii) it acquires ownership or control of any voting shares of any bank if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank; or (iii) it merges or consolidates with any other bank holding company. The BHCA and the Change in Bank Control Act, together with regulations promulgated by the Federal Reserve Board, require that, depending on the particular circumstances, either Federal Reserve Board approval must be obtained or notice must be furnished to the Federal Reserve Board and not disapproved prior to any person or company acquiring "control" of a bank holding company, such as Bankshares, subject to certain exemptions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of Bankshares. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities of Bankshares. The regulations provide a procedure for challenging the rebuttable control presumption. Under the BHCA, a bank holding company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in nonbanking activities, unless the Federal Reserve -9- Board, by order or regulation, has found those activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve Board has determined by regulation to be proper incidents to the business of a bank holding company include making or servicing loans and certain types of leases, engaging in certain insurance and discount brokerage activities, performing certain data processing services, acting in certain circumstances as a fiduciary or investment or financial adviser, owning savings associations and making investments in certain corporations or projects designed primarily to promote community welfare. The Federal Reserve Board imposes certain capital requirements on Bankshares under the BHCA, including a minimum leverage ratio and a minimum ratio of "qualifying" capital to risk-weighted assets. Subject to its capital requirements and certain other restrictions, Bankshares can borrow money to make a capital contribution to NBB or BTC, and such loans may be repaid from dividends paid from NBB or BTC to Bankshares (although the ability of NBB or BTC to pay dividends are subject to regulatory restrictions). Bankshares can raise capital for contribution to NBB and BTC by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws. The Virginia Banking Act. All Virginia bank holding companies must register with the Virginia State Corporation Commission (the Commission) under the Virginia Banking Act. A registered bank holding company must provide the Commission with information with respect to the financial condition, operations, management and intercompany relationships of the holding company and its subsidiaries. The Commission also may require such other information as is necessary to keep itself informed about whether the provisions of Virginia law and the regulations and orders issued thereunder by the Commission have been complied with, and may make examinations of any bank holding company and its subsidiaries. In March 1994, the Virginia General Assembly adopted an amendment to Chapter 15 of the Virginia Banking Act to allow bank holding companies located in any state to acquire a Virginia bank or bank holding company if the Virginia bank or bank holding company could acquire a bank holding company in their state and the Virginia bank or bank holding company to be acquired has been in existence and continuously operated for more than two years. This amendment may permit bank holding companies from throughout the United States to enter the Virginia market, subject to federal and state approval. Glass-Steagall Act. Bankshares is also restricted in its activities by the provisions of the Glass-Steagall Act, which prohibit Bankshares from owning subsidiaries that are engaged principally in the issue, flotation, underwriting, public sale or distribution of securities. Bankshares does not presently engage in securities-related activities in any material respect. NBB and BTC General. NBB is a national banking association incorporated under the laws of the United States and is subject to examination by the Office of the Comptroller of the Currency (the OCC). Deposits in NBB are insured by the FDIC up to a maximum amount (generally $100,000 per depositor, subject to aggregation rules). The OCC and the FDIC regulate or monitor all areas of NBB's operations, including security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuances of securities, payment of dividends, interest rates payable on deposits, interest rates or fees chargeable on loans, establishment of branches, corporate -10- reorganizations and maintenance of books and records. The OCC requires NBB to maintain certain capital ratios. NBB is required by the OCC to prepare quarterly reports on NBB's financial condition and to conduct an annual audit of its financial affairs in compliance with minimum standards and procedures prescribed by the OCC. NBB also is required by the OCC to adopt internal control structures and procedures in order to safeguard assets and monitor and reduce risk exposure. While appropriate for safety and soundness of banks, these requirements impact banking overhead costs. BTC is organized as a Virginia-chartered banking corporation and is regulated and supervised by the Bureau of Financial Institutions (BFI) of the Virginia State Corporation Commission. In addition, as a federally insured bank, BTC is regulated and supervised by the Federal Reserve Board, which serves as its primary federal regulator and is subject to certain regulations promulgated by the FDIC. Under the provisions of federal law, federally insured banks are subject, with certain exceptions, to certain restrictions on extensions of credit to their affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, such banks are prohibited from engaging in certain tie- in-arrangements in connection with any extension of credit or the providing of any property of service. The Virginia State Corporation Commission and the Federal Reserve Board conduct regular examinations of BTC reviewing the adequacy of the loan loss reserves, quality of the loans and investments, propriety of management practices, compliance with laws and regulations and other aspects of the bank's operations. In addition to these regular examinations, Virginia chartered banks must furnish to the Federal Reserve Board quarterly reports containing detailed financial statements and schedules. Community Reinvestment Act. NBB and BTC are subject to the provisions of the Community Reinvestment Act of 1977 (the CRA), which requires the appropriate federal bank regulatory agency, in connection with its regular examination of a bank, to assess the bank's record in meeting the credit needs of the community served by the bank, including low and moderate-income neighborhoods. Under the implementing CRA regulations, banks have the option of being assessed for CRA compliance under one of several methods. Small banks are evaluated differently than larger banks and technically are not subject to some data collection requirements. The focus of the regulations is on the volume and distribution of a bank's loans, with particular emphasis on lending activity in low and moderate-income areas and to low and moderate-income persons. The regulations place substantial importance on a bank's product delivery system, particularly branch localities. The new regulations require banks, other than small banks, to comply with significant data collection requirements. The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required for any bank which has applied to, among other things, establish a new branch office that will accept deposits, relocate an existing office, or merge, consolidate with or acquire the assets or assume the liabilities of a federally regulated financial institution. It is likely that banks' compliance with the CRA, as well as other so-called fair lending laws, will face ongoing government scrutiny and that costs associated with compliance will continue to increase. NBB has received a CRA rating of "Outstanding" in its last examination by federal bank regulators. BTC was rated as "Satisfactory". -11- Branching. In 1986, the Virginia Banking Act was amended to remove the geographic restrictions governing the establishment of branch banking offices. Subject to the approval of the appropriate federal and state bank regulatory authorities, BTC as a state bank, may establish a branch office anywhere in Virginia. National banks, like NBB, are required by the National Bank Act to adhere to branch banking laws applicable to state banks in the states in which they are located. Under current Virginia law, NBB may open branch offices throughout Virginia with the prior approval of the OCC. In addition, with prior approval of one or more of the Federal Reserve Board, the Virginia Commission, the OCC and the FDIC, NBB will be able to acquire existing banking operations in Virginia. On September 29, 1994, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the Interstate Act) became law. The Interstate Act, which became effective September 29, 1995, allows bank holding companies to acquire banks in any state, without regard to state law, except that if the state has a minimum requirement for the amount of time a bank must be in existence, that law must be preserved. Under the Virginia Banking Act, a Virginia bank or all of the subsidiaries of Virginia holding companies sought to be acquired must have been in continuous operation for more than two years before the date of such proposed acquisition. The Interstate Act permits banks to acquire out-of-state branches through interstate mergers, beginning June 1, 1997. States could opt-in to interstate branching earlier, or opt-out before June 1, 1997. De novo branching, where an out-of-state bank holding company sets up a new branch in another state, requires a state's specific approval. An acquisition or merger is not permitted under the Interstate Act if the bank, including its insured depository affiliates, will control more than 10% of the total amount of deposits of insured depository institutions in the United States, or will control 30% or more of the total amount of deposits of insured depository institutions in any state. Virginia has, by statute, elected to opt-in fully to interstate branching under the Interstate Act, effective July 1, 1995. Under the Virginia statute, Virginia state banks may, with the approval of the Virginia State Corporation Commission, establish and maintain a de novo branch or acquire one or more branches in a state other than Virginia, either separately or as part of a merger. Procedures also are established to allow out-of-state domiciled banks to establish or acquire branches in Virginia, provided the "home" state of the bank permits Virginia banks to establish or acquire branches within its borders. The activities of such branches will be subject to the same laws as Virginia domiciled banks, unless such activities are prohibited by the law of the state where the bank is organized. The Virginia State Corporation Commission has the authority to examine and supervise out-of-state state banks to ensure that the branch is operating in a safe and sound manner and in compliance with the laws of Virginia. The Virginia statute authorizes the Bureau of Financial Institutions to enter into cooperative agreements with other state and federal regulators for the examination and supervision of out-of-state state banks with Virginia operations, or Virginia domiciled banks with operations in other states. Likewise, national banks, with the approval of the OCC, may branch into and out of the state of Virginia. Any Virginia branch of an out-of-state national bank is subject to Virginia law (enforced by the OCC) with respect to intrastate branching, consumer protection, fair lending and community reinvestment as if it were a branch of a Virginia bank, unless preempted by federal law. -12- The Interstate Act permits banks and bank holding companies from throughout the United States to enter Virginia markets through the acquisition of Virginia institutions and makes it easier for Virginia bank holding companies and Virginia state and national banks to acquire institutions and to establish branches in other states. Competition in market areas served by the Company may increase as a result of the Interstate Act and the Virginia interstate banking statutes. Deposit Insurance. The FDIC establishes rates for the payment of premiums by federally insured financial institutions. A Bank Insurance Fund (the BIF) is maintained for commercial banks, with insurance premiums from the industry used to offset losses from insurance payouts when banks fail. Beginning in 1993, insured depository institutions like NBB and BTC paid for deposit insurance under a risk-based premium system. Both NBB and BTC qualified for the minimum annual premium rate of $2,000 per year in 1996. Beginning in 1997, all banks, including NBB and BTC, were subject to a higher FDIC assessment which funds interest payments for bank issues to resolve problems associated with the savings and loan industry. This assessment will continue until 2018-2019. The assessment will vary over the period from 1.29 cents to 2.43 cents per $100 of deposits. Government Policies. The operations of NBB and BTC are affected not only by general economic conditions, but also by the policies of various regulatory authorities. In particular, the Federal Reserve Board regulates money and credit and interest rates in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of loans, investments and deposits and affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve Board monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Limits on Dividends and Other Payments. As a national bank, NBB, may not pay dividends from its capital; all dividends must be paid out of net profits then on hand, after deducting expenses, losses, bad debts, accrued dividends on preferred stock, if any, and taxes. In addition, a national bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one-tenth of the bank's net profits of (i) the preceding two consecutive half- year periods (in the case of an annual dividend) or (ii) the preceding half-year period (in the case of a quarterly or semi-annual dividend). The approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus or to fund the retirement of preferred stock. The OCC has promulgated regulations that became effective on December 13, 1990, which significantly affect the level of allowable dividend payments for national banks. The effect is to make the calculation of national banks' dividend-paying capacity consistent with generally accepted accounting principles. The allowance for loan and lease losses will not be considered an element of "undivided profits then on hand" and provisions to the allowance are treated as expenses and therefore not part of "net profits." Accordingly, a national bank with an allowance greater than its statutory bad debts may not include the excess in calculating undivided profits for dividend purposes. Further, a national bank may be able to use a portion of its earned capital surplus account as "undivided profits then on hand," depending on the composition of that account. -13- As a state member bank subject to the regulations of the Federal Reserve Board, BTC must obtain the approval of the Federal Reserve Board for any dividend if the total of all dividends declared in any calendar year would exceed the total of its net profits, as defined by the Federal Reserve Board, for that year, combined with its retained net profits for the preceding two years. In addition, a state member bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts. For this purpose, bad debts are generally defined to include the principal amount of loans which are in arrears with respect to interest by six months or more, unless such loans are fully secured and in the process of collection. Moreover, for purposes of this limitation, a state member bank is not permitted to add the balance in its allowance for loan losses account to its undivided profits then on hand; however, it may net the sum of its bad debts as so defined against the balance in its allowance for loan losses account and deduct from undivided profits only bad debts as so defined in excess of that account. In addition, the Federal Reserve Board is authorized to determine, under certain circumstances relating to the financial condition of a state member bank, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The payment of dividends that depletes a bank's capital base could be deemed to constitute such an unsafe or unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings. Virginia law also imposes restrictions on the ability of BTC to pay dividends. A Virginia state bank is permitted to declare a dividend out of its "net undivided profits", after providing for all expenses, losses, interest and taxes accrued or due by the bank. In addition, a deficit in capital originally paid in must be restored to its initial level, and no dividend can be paid which could impair the bank's paid in capital. The Bureau of Financial Institutions further has authority to limit the payment of dividends by a Virginia bank if it determines the limitation is in the public interest and is necessary to ensure the bank's financial soundness. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) provides that no insured depository institution may make any capital distribution (which would include a cash dividend) if, after making the distribution, the institution would not satisfy one or more of its minimum capital requirements. Capital Requirements. The Federal Reserve Board has adopted risk-based capital guidelines in final form which are applicable to Bankshares and BTC. The Federal Reserve Board guidelines redefine the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of risk-weighted assets. The minimum ratio of qualified total capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8.0%. At least half of the total capital must be comprised of Tier 1 capital for a minimum ratio of Tier 1 Capital to risk-weighted assets of 4.0%. The remainder may consist of a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The OCC has adopted similar regulations applicable to NBB. In addition, the Federal Reserve Board has established minimum leverage ratio (Tier 1 capital to total assets less intangibles) guidelines that are applicable to Bankshares and BTC. The OCC has adopted similar regulations applicable to NBB. These guidelines provide for a minimum ratio of 4.0% for banks that meet certain specified criteria, including that they have the highest regulatory -14- CAMEL rating and are not anticipating or experiencing significant growth and have well-diversified risk. All other banks will be required to maintain an additional cushion of at least 100 to 200 basis points, based upon their particular circumstances and risk profiles. The guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Bank regulators from time to time have indicated a desire to raise capital requirements applicable to banking organizations beyond current levels. In addition, the number of risks which may be included in risk-based capital restrictions, as well as the measurement of these risks, is likely to change, resulting in increased capital requirements for banks. Bankshares, NBB and BTC are unable to predict whether higher capital ratios would be imposed and, if so, at what levels and on what schedule. Legislative Developments The difficulties encountered nationwide by financial institutions during 1990 and 1991 prompted federal legislation designed to reform the banking industry and to promote the viability of the industry and of the deposit insurance system. FDICIA, which became effective on December 19, 1991, bolsters the deposit insurance fund, tightens bank regulation and trims the scope of federal deposit insurance as summarized below. FDIC Funding. The legislation bolsters the bank deposit insurance fund with $70 billion in borrowing authority and increases to $30 billion from $5 billion the amount the FDIC can borrow from the U.S. Treasury to cover the cost of bank failures. The loans, plus interest, would be repaid by premiums that banks pay on domestic deposits over the next fifteen years. Prompt Corrective Action. Among other things, FDICIA requires the federal banking agencies to take "prompt corrective action" in respect to banks that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." If a depository institution's principal federal regulator determines that an otherwise adequately capitalized institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, it may require the institution to submit a corrective action plan, restrict its asset growth and prohibit branching, new acquisitions and new lines of business. An institution's principal federal regulator may deem the institution to be engaging in an unsafe or unsound practice if it receives a less than satisfactory rating for asset quality, management, earnings or liquidity in its most recent examination. Among other possible sanctions, an undercapitalized depository institution may not pay dividends and is required to submit a capital restoration plan to its principal federal regulator. In addition, its holding company may be required to guarantee compliance with the capital restoration plan under certain circumstances. If an undercapitalized depository institution fails to submit or implement an acceptable capital restoration plan, it can be subject to more severe sanctions, including an order to sell sufficient voting stock to become adequately capitalized. More severe sanctions and remedial actions can be mandated by the regulators if an institution is considered significantly or critically undercapitalized. -15- In addition, FDICIA requires regulators to draft a new set of non-capital measures of bank safety, such as loan underwriting standards and minimum earnings levels. The legislation also requires regulators to perform annual on- site bank examinations, places limits on real estate lending by banks and tightens auditing requirements. In April 1995, the regulators adopted safety and soundness standards as required by FDICIA in the following areas: (i) operational and managerial; (ii) asset quality earnings and stock valuation; and (iii) employee compensation. Deposit Insurance. FDICIA reduces the scope of federal deposit insurance. The most significant change ended the "too big to fail" doctrine, under which the government protects all deposits in most banks, including those exceeding the $100,000 insurance limit. The FDIC's ability to reimburse uninsured deposits--those over $100,000 and foreign deposits--has been sharply limited. Since December 1993, the Federal Reserve Board's ability to finance undercapitalized banks with extended loans from its discount window has been restricted. In addition, only the best capitalized banks will be able to offer insured brokered deposits without FDIC permission or to insure accounts established under employee pension plans. As of September 29, 1996, "The Depository Insurance Fund Act of 1996" became law. This legislation provided for a one time assessment on banks that had previously acquired certain deposits from savings and loan institutions. Neither NBB or BTC were subject to that special assessment. Beginning in 1997, all banks were subject to increased assessments that are designed to finally resolve problems associated with the savings and loan industry. Other Legislative and Regulatory Concerns Other legislative and regulatory proposals regarding changes in banking and the regulation of banks, thrifts and other financial institutions are periodically considered by the executive branch of the federal government, Congress and various state governments, including Virginia. New proposals, could significantly change the regulation of banks and the financial services industry. It cannot be predicted what might be proposed or adopted on how these proposals would affect the Company. Other Business Concerns The banking industry is particularly sensitive to interest rate fluctuations, as the spread between the rates which must be paid on deposits and those which may be charged on loans is an important component of profit. In addition, the interest which can be earned on a bank's invested funds has a significant effect on profits. Rising interest rates typically reduce the demand for new loans, particularly the real estate loans which represent a significant portion of NBB's and BTC's loan demand, as well as certain NBB loans in which BTC participates. -16- STATISTICAL DISCLOSURE BY NATIONAL BANKSHARES, INC. AND SUBSIDIARIES (BANKSHARES) I. DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL --------------------------------------------------------------------- A. AVERAGE BALANCE SHEETS The following table presents, for the years indicated, condensed daily average balance sheet information. ($ in thousands) December 31, ------------------------- ASSETS 1997 1996 1995 ------ ---- ---- ---- Cash and due from banks $ 9,954 9,842 10,189 Interest bearing deposits 4,165 1,651 --- Federal funds sold 8,181 8,903 12,105 Securities available for sale: Taxable 54,213 65,992 41,695 Nontaxable 6,312 6,679 930 Securities held to maturity: Taxable 67,046 79,599 105,701 Nontaxable 29,608 25,133 35,668 Mortgage loans held for sale 413 850 723 Loans, net 204,540 177,419 159,920 Other assets 11,500 11,977 11,475 -------- ------- ------- Total assets $395,932 388,045 378,406 ======== ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Noninterest-bearing demand deposits $ 44,193 41,997 38,833 Interest-bearing demand deposits 75,519 76,017 77,545 Savings deposits 47,781 49,783 54,698 Time deposits 171,946 168,141 159,185 -------- ------- ------- Total deposits 339,439 335,938 330,261 Short-term borrowings 319 433 593 Other liabilities 2,462 2,215 1,826 -------- ------- ------- Total liabilities 342,220 338,586 332,680 Stockholders' equity 53,712 49,459 45,726 -------- ------- ------- Total liabilities and stockholders' equity $395,932 388,045 378,406 ======== ======= ======= -17- B. ANALYSIS OF NET INTEREST EARNINGS The following table shows the major categories of interest-earning assets and interest-bearing liabilities, the interest earned or paid, the average yield or rate on the daily average balance outstanding, net interest income and net yield on average interest-earning assets for the years indicated.
December 31, 1997 December 31, 1996 December 31, 1995 ------------------------- -------------------------- -------------------------- Average Average Average Average Yield/ Average Yield/ Average Yield/ ($ in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate ------- -------- ------- ------- -------- ------- ------- -------- ------- Interest-earning assets: Loans, net (1)(2)(3) $204,953 19,667 9.60% 178,269 17,339 9.73% 160,643 15,897 9.90% Taxable securities 121,259 7,776 6.41% 145,591 8,877 6.10% 147,396 9,723 6.60% Nontaxable securities (1) 35,920 2,708 7.54% 31,812 2,971 9.34% 36,598 2,856 7.80% Federal funds sold 8,181 470 5.75% 8,903 567 6.37% 12,105 704 5.82% Interest bearing deposits 4,165 230 5.52% 1,651 91 5.51% --- --- --- -------- ------ ---- ------- ------ ---- ------- ------ ---- Total interest- earning assets $374,478 30,851 8.24% 366,226 29,845 8.15% 356,742 29,180 8.18% ======== ====== ==== ======= ====== ==== ======= ====== ==== Interest-bearing liabilities: Interest-bearing demand deposits $ 75,519 3,073 4.07% 76,017 2,182 2.87% 77,545 2,353 3.03% Savings deposits 47,781 1,571 3.29% 49,783 1,646 3.31% 54,698 1,798 3.29% Time deposits 171,946 8,445 4.91% 168,141 9,181 5.46% 159,185 8,517 5.35% Short-term borrowings 319 17 5.33% 433 27 6.24% 593 35 5.90% Long-term debt --- --- --- --- --- --- --- --- --- -------- ------ ---- ------- ------ ---- ------- ------ ---- Total interest- bearing liabilities $295,565 13,106 4.43% 294,374 13,036 4.43% 292,021 12,703 4.35% ======== ====== ==== ======= ====== ==== ======= ====== ==== Net interest income and interest rate spread 17,745 3.81% 16,809 3.72% 16,477 3.83% ====== ==== ====== ==== ====== ==== Net yield on average interest-earning assets 4.74% 4.59% 4.62% ==== ==== ==== (1) Interest on nontaxable loans and securities is computed on a fully taxable equivalent basis using a Federal income tax rate of 34%. (2) Loan fees of $339 in 1997, $374 in 1996 and $305 in 1995 are included in total interest income. (3) Nonaccrual loans are included in average balances for yield computations.
-18- C. ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE The Company's primary source of revenue is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other funds. The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities and by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities. The following table sets forth, for the years indicated, a summary of the changes in interest income and interest expense resulting from changes in average asset and liability balances (volume) and changes in average interest rates (rate).
1997 Over 1996 1996 Over 1995 ------------------------------- ------------------------------- Changes Due To Changes Due To ------------------- ------------------- Net Dollar Net Dollar ($ in thousands) Rates(2) Volume(2) Change Rates(2) Volume(2) Change -------- --------- ---------- -------- --------- ---------- Interest income:(1) Loans $ (200) 2,528 2,328 (276) 1,718 1,442 Taxable securities 441 (1,542) (1,101) (728) (118) (846) Nontaxable securities (617) 354 (263) 518 (403) 115 Federal funds sold (53) (44) (97) 62 (199) (137) Interest bearing deposits --- 139 139 --- 91 91 ------ ------ ------ ----- ------ ------ Increase(decrease) in income on interest- earning assets $ (429) 1,435 1,006 (424) 1,089 665 ------ ------ ------ ----- ------ ------ Interest expense: Interest-bearing demand deposits $ 905 (14) 891 (125) (46) (171) Savings deposits (9) (66) (75) 10 (162) (152) Time deposits (940) 204 (736) 178 486 664 Short-term borrowings (4) (6) (10) 2 (10) (8) ------ ------ ------ ----- ------ ------ Increase(decrease) in expense of interest- bearing liabilities $ (48) 118 70 65 268 333 ------ ------ ------ ----- ------ ------ Increase (decrease) in net interest income $ (381) 1,317 936 (489) 821 332 ====== ====== ====== ===== ====== ====== (1) Taxable equivalent basis using a Federal income tax rate of 34%. (2) Variances caused by the change in rate times the change in volume have been allocated to rate and volume changes proportional to the relationship of the absolute dollar amounts of the change in each.
-19- II. INVESTMENT PORTFOLIO A. BOOK VALUE OF INVESTMENTS The amortized costs and fair values of securities available for sale as of December 31, 1997, 1996 and 1995 were as follows:
December 31, ---------------------------------------------------- 1997 1996 1995 ---------------- ---------------- ---------------- AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR ($ in thousands) COSTS VALUES COSTS VALUES COSTS VALUES --------- ------ --------- ------ --------- ------ Securities available for sale: U.S. Treasury $ 6,742 6,862 8,740 8,790 14,991 15,322 U.S. Government agencies and corporations 36,252 36,276 33,840 33,640 42,586 42,809 States and political subdivisions 9,540 9,639 8,688 8,619 7,613 7,567 Mortgage-backed securities (1) 4,172 4,119 4,568 4,452 4,748 4,645 Other securities 8,582 8,686 7,074 7,033 5,505 5,527 ------- ------ ------ ------ ------ ------ Total securities available for sale $65,288 65,582 62,910 62,534 75,443 75,870 ======= ====== ====== ====== ====== ====== The amortized costs of securities held to maturity as of December 31, 1997, 1996 and 1995 were as follows: December 31, ------------------------------ ($ in thousands) 1997 1996 1995 ---- ---- ---- Securities held to maturity: U.S. Treasury $ 7,527 11,547 19,330 U.S. Government agencies and corporations 36,853 54,804 49,938 States and political subdivisions 32,949 34,144 36,428 Mortgage-backed securities (1) 630 767 961 Other securities 6,433 7,448 5,108 ------- ------- ------- Total securities held to maturity $84,392 108,710 111,765 ======= ======= ======= (1) The majority of Mortgage-backed Securities and Collateralized Mortgage Obligations held at December 31, 1997 were backed by U.S. agencies. Certain holdings are required to be periodically subjected to the Financial Institution Examination Council's (FFIEC) high risk mortgage security test. These tests address possible fluctuations in the average life and price sensitivity which are the primary risks associated with this type of security. Such tests are usually subject to regulatory review. Except for U.S. Government securities, the Company has no securities with any issuer that exceeds 10% of stockholders' equity.
-20- B. MATURITIES AND ASSOCIATED YIELDS The following table presents the maturities for those securities available for sale and held to matrity as of December 31, 1997 and weighted average yield for each range of maturities.
Maturities and Yields December 31, 1997 --------------------------------------------------------- ($ in thousands except for % data) < 1 Year 1-5 Years 5-10 Years > 10 Years None Total -------- --------- ---------- ---------- ---- ----- Available for Sale ------------------ U.S. Treasury $ 995 3,867 2,000 --- --- $ 6,862 5.12% 7.10% 5.92% ---% ---% 6.47% U.S. Agencies 6,476 17,395 11,403 1,001 --- 36,275 5.60% 6.19% 7.16% 7.35% ---% 6.42% Mortgage-backed securities --- --- 622 3,501 --- 4,123 ---% ---% 5.82% 6.03% ---% 6.00% Taxable Securities --- 1,099 1,337 769 --- 3,205 ---% 6.64% 7.09% 7.63% ---% 7.07% Nontaxable Securities --- 2,263 3,696 473 --- 6,432 ---% 6.68% 7.06% 7.38% ---% 6.95% Corporate 1,204 1,521 3,041 2,057 --- 7,823 5.98% 6.72% 6.76% 7.07% ---% 6.71% Other securities --- --- --- --- 862 862 ---% ---% ---% ---% 13.51% 13.51% ------------------------------------------------------------ Total 8,675 26,145 22,099 7,801 862 65,582 5.60% 6.42% 6.93% 6.71% 13.51% 6.59% ============================================================ Held To Maturity ---------------- U.S. Treasury 3,000 6,035 --- --- --- 9,035 4.89% 6.04% ---% ---% ---% 5.66% U.S. Agencies 10,249 16,614 8,480 --- --- 35,343 5.24% 5.99% 6.80% ---% ---% 5.97% Mortgage-backed securities --- 42 192 395 --- 629 ---% 6.65% 7.67% 8.08% ---% 7.86% Taxable Securities 411 1,274 1,267 1,659 --- 4,611 6.72% 6.99% 7.50% 7.40% ---% 7.25% Nontaxable Securities 2,990 17,954 6,664 1,697 --- 29,305 8.59% 7.47% 8.24% 7.90% ---% 7.79% Corporate 1,500 3,005 471 493 --- 5,469 5.80% 6.98% 7.50% 8.00% ---% 6.79% Other securities --- --- --- --- --- --- ---% ---% ---% ---% ---% ---% ------------------------------------------------------------ Total 18,150 44,924 17,074 4,244 --- 84,392 5.81% 6.68% 7.44% 7.73% ---% 6.70% ============================================================ (1) Rates shown represent weighted average yield on a fully taxable basis.
-21- III. LOAN PORTFOLIO -------------- The Company concentrates its lending activities in commercial and industrial loans, real estate mortgage loans both residential and business, and loans to individuals. The following tables set forth (i) a comparison of the Company's loan portfolio by major category of loans as of the dates indicated and (ii) the maturities and interest rate sensitivity of the loan portfolio at December 31, 1997. A. TYPES OF LOANS December 31, ---------------------------------------- ($ in thousands) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Commercial and industrial loans $101,379 87,519 59,609 59,213 67,359 Real estate mortgage loans 42,969 43,917 45,589 44,447 40,236 Real estate construction loans 8,510 6,295 6,007 5,643 3,967 Loans to individuals 66,635 60,991 56,920 52,031 43,084 -------- ------- ------- ------- ------- Total loans 219,493 198,722 168,125 161,334 154,646 Less unearned income and deferred fees (2,503) (2,549) (2,307) (2,494) (1,907) -------- ------- ------- ------- ------- Total loans, net of unearned income 216,990 196,173 165,818 158,840 152,739 Less allowance for loans losses (2,438) (2,575) (2,625) (2,551) (2,583) -------- ------- ------- ------- ------- Total loans, net $214,552 193,598 163,193 156,289 150,156 ======== ======= ======= ======= ======= B. MATURITIES AND INTEREST RATE SENSITIVITIES December 31, 1997 -------------------------------------- After ($ in thousands) <1 Year 1-5 Years 5 Years Total ------- --------- ------- ----- Commercial and industrial $49,984 36,935 14,460 101,379 Real estate construction 8,510 --- --- 8,510 Less loans with predetermined interest rates (9,718) (13,447) (13,262) (36,427) ------- ------- ------- ------- Loans with adjustable rates $48,776 23,488 1,198 73,462 ======= ======= ======= ======= -22- C. RISK ELEMENTS 1. Nonaccrual, Past Due and Restructured Loans The following table presents aggregate amounts for nonaccrual loans, restructured loans, other real estate owned, net and accruing loans which are contractually past due ninety days or more as to interest or principal payments. December 31, ---------------------------------- ($ in thousands) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Nonaccrual loans: Commercial and industrial $ 55 121 270 --- 710 Real estate mortgage 32 495 418 390 1,123 Real estate construction --- --- --- --- --- Loans to individuals --- --- 30 30 31 ------ ----- ----- ----- ----- $ 87 616 718 420 1,864 Restructured loans: Commercial and industrial --- --- --- 229 598 ------ ----- ----- ----- ----- Total nonperforming loans $ 87 616 718 649 2,462 Other real estate owned, net 421 474 762 1,150 225 ------ ----- ----- ----- ----- Total nonperforming assets $ 508 1,090 1,480 1,799 2,687 ====== ===== ===== ===== ===== Accruing loans past due 90 days or more: Commercial and industrial $ 82 14 11 4 45 Real estate mortgage 358 252 250 219 198 Real estate construction --- --- --- 87 243 Loans to individuals 232 192 313 180 128 ------ ----- ----- ----- ----- $ 672 458 574 490 614 ====== ===== ===== ===== ===== The effect of nonaccrual and restructured loans on interest income is presented below: ($ in thousands) 1997 1996 1995 ---- ---- ---- Scheduled interest: Nonaccrual loans $ 8 68 59 Restructured loans --- --- --- ----- ----- ---- Total scheduled interest $ 8 68 59 ----- ----- ---- Recorded interest: Nonaccrual loans $ 1 24 5 Restructured loans --- --- --- ----- ----- ---- Total recorded interest $ 1 24 5 ===== ===== ==== Interest is recognized on the cash basis for all loans carried in nonaccrual status. Loans generally are placed in nonaccrual status when the collection of principal or interest is ninety days or more past due, unless the obligation is both well-secured and in the process of collection. -23- 2. Potential Problem Loans At December 31, 1997, the recorded investment in loans which have been identified as impaired loans totaled $177,000. Of this amount, $124,000 related to loans with no valuation allowance and $53,000 related to loans with a corresponding valuation allowance of $53,000. For the year-ended December 31, 1997, the average recorded investment in impaired loans was approximately $458,000 and the total interest income recognized on impaired loans was $23,000 of which $12,000 was recognized on a cash basis. At December 31, 1996, the recorded investment in loans which have been identified as impaired loans totaled $725,000. Of this amount, $354,000 related to loans with no valuation allowance and $371,000 related to loans with a corresponding valuation allowance of $290,000. For the year ended December 31, 1996, the average recorded investment in impaired loans was approximately $800,000, and the total interest income recognized on impaired loans was $33,000 of which $23,000 was recognized on a cash basis. 3. Foreign Outstandings At December 31, 1997, 1996 and 1995, there were no foreign outstandings. 4. Loan Concentrations The Company does a general banking business, serving the commercial, agricultural and personal banking needs of its customers. NBB's trade territory, commonly referred to as the New River Valley, consists of Montgomery and Giles Counties, Virginia and portions of adjacent counties. NBB's operating results are closely correlated with the economic trends within this area which are, in turn, influenced by the area's three largest employers, Virginia Polytechnic Institute and State University, Montgomery County Schools and Celco. Other industries include a wide variety of manufacturing, retail and service concerns. Most of BTC's business originates from the communities of Tazewell and Bluefield and other communities in Tazewell County, Virginia and in Mercer County, West Virginia. BTC's service area has largely depended on the coal mining industry and farming for its economic base. In recent years, coal companies have mechanized and reduced the number of persons engaged in the production of coal. There are still a number of support industries for the coal mining business that continue to provide employment in the area. Additionally, several new businesses have been established in the area and Bluefield, West Virginia has begun to emerge as a regional medical center. The ultimate collectibility of the loan portfolios and the recovery of the carrying amounts of repossessed property are susceptible to changes in the market conditions of these areas. At December 31, 1997 and 1996, approximately $80 million and $71 million, respectively, of the loan portfolio were concentrated in commercial real estate. This represents approximately 37% and 36% of the loan portfolio at December 31, 1997 and 1996, respectively. Included in commercial real estate at December 31, 1997 and 1996 was approximately $50 million and $49 million, respectively, in loans for college housing and professional office buildings. Loans secured by residential real estate were approximately $65 million and $60 million at December 31, 1997 and 1996, respectively. This -24- represents approximately 30% and 31% of the loan portfolio at December 31, 1997 and 1996, respectively. Loans secured by automobiles were approximately $34 million and $29 million at December 31, 1997 and 1996, respectively. This represents approximately 16% of the loan portfolio at December 31, 1997 and 15% at December 31, 1996. The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property and with loan amounts established based on certain percentage limitations of the property's total stated or appraised value. Credit approval is primarily a function of collateral and the evaluation of the creditworthiness of the individual borrower or project based on available financial information. -25- IV. SUMMARY OF LOAN LOSS EXPERIENCE ------------------------------- A. ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES The following tabulation shows average loan balances at the end of each period; changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category; and additions to the allowance which have been charged to operating expense:
December 31, ---------------------------------------------- ($ in thousands) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Average loans outstanding $204,540 177,419 159,920 152,976 149,027 ======== ======= ======= ======= ======= Balance at beginning of year 2,575 2,625 2,551 2,583 2,327 Charge-offs: Commercial and industrial loans 257 95 23 72 231 Real estate mortgage loans --- 11 9 192 285 Real estate construction loans --- --- --- 53 --- Loans to individuals 422 400 259 322 246 -------- ------- ------- ------- ------- Total loans charged off 679 506 291 639 762 -------- ------- ------- ------- ------- Recoveries: Commercial and industrial loans 70 4 10 7 10 Real estate mortgage loans --- 64 16 4 5 Real estate construction loans --- --- --- --- --- Loans to individuals 37 57 57 43 50 -------- ------- ------- ------- ------- Total recoveries 107 125 83 54 65 -------- ------- ------- ------- ------- Net loans charged off 572 381 208 585 697 -------- ------- ------- ------- ------- Additions charged to operations 435 331 282 553 953 -------- ------- ------- ------- ------- Balance at end of year $ 2,438 2,575 2,625 2,551 2,583 ======== ======= ======= ======= ======= Net charge-offs to average net loans outstanding 0.28% 0.21% 0.13% 0.38% 0.47% ======== ======= ======= ======= ======= Factors influencing management's judgment in determining the amount of the loan loss provision charged to operating expense include the quality of the loan portfolio as determined by management, the historical loan loss experience, diversification as to type of loans in the portfolio, the amount of secured as compared with unsecured loans and the value of underlying collateral, banking industry standards and averages, and general economic conditions.
-26- B. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES The allowance for loan losses has been allocated according to the amount deemed necessary to provide for anticipated losses within the categories of loans for the years indicated as follows:
December 31, ---------------------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 ------------------ ------------------ ------------------ ------------------ ------------------ Percent Percent Percent Percent Percent of of of of of Loans in Loans in Loans in Loans in Loans in Each Each Each Each Each Category Category Category Category Category ($ in Allowance to Total Allowance to Total Allowance to Total Allowance to Total Allowance to Total thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans --------- -------- --------- -------- --------- -------- --------- -------- --------- -------- Commercial and industrial loans $ 213 46.18% 403 44.04% 411 35.46% 679 36.70% 860 43.56% Real estate mortgage loans 67 19.58% 305 22.10% 363 27.12% 364 27.55% 373 26.02% Real estate construction loans --- 3.88% 51 3.17% 100 3.57% 37 3.50% 54 2.56% Loans to individuals 416 30.36% 504 30.69% 271 33.85% 569 32.25% 685 27.86% Unallocated 1,742 1,312 1,480 902 611 ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ $2,438 100.00% 2,575 100.00% 2,625 100.00% 2,551 100.00% 2,583 100.00% ====== ====== ====== ====== ====== ====== ====== ====== ====== ======
-27- V. DEPOSITS A. AVERAGE AMOUNTS OF DEPOSITS AND AVERAGE RATES PAID Average amounts and average rates paid on deposit categories in excess of 10% of average total deposits are presented below: December 31, -------------------------------------------------- 1997 1996 1995 ---------------- ---------------- --------------- Average Average Average Average Rates Average Rates Average Rates ($ in thousands) Amounts Paid Amounts Paid Amounts Paid ------- ------- ------- ------- ------- ------- Noninterest-bearing demand deposits $ 44,193 --- 41,997 --- 38,833 --- Interest-bearing demand deposits 75,519 4.07% 76,017 2.87% 77,545 3.03% Savings deposits 47,781 3.29% 49,783 3.31% 54,698 3.29% Time deposits 171,946 4.91% 168,141 5.46% 159,185 5.35% -------- ----- ------- ----- ------- ----- Average total deposits $339,439 4.43% 335,938 4.43% 330,261 4.35% ======== ===== ======= ===== ======= ===== B. TIME DEPOSITS OF $100,000 OR MORE The following table sets forth time certificates of deposit and other time deposits of $100,000 or more: DECEMBER 31, 1997 ----------------------------------------------- Over 3 Over 6 3 Months Months Months Through 6 Through 12 Over 12 ($ in thousands) or Less Months Months Months Total ------- --------- ---------- ------- ----- Certificates of deposit $13,098 7,055 12,685 6,399 39,237 Other time deposits 232 --- 172 2,906 3,310 ------- ------ ------ ------ ------ Total time deposits of $100,000 or more $13,330 7,055 12,857 9,305 42,547 ======= ====== ====== ====== ====== -28- VI. RETURN ON EQUITY AND ASSETS --------------------------- The ratio of net income to average stockholders' equity and to average total assets, and certain other ratios are presented below: December 31, ------------------------ 1997 1996 1995 ---- ---- ---- Return on average assets 1.66% 1.58% 1.46% Return on average equity(1) 12.21% 12.37% 12.08% Dividend payout ratio 39.31% 37.55% 37.32% Average equity to average assets(1) 13.57% 12.75% 12.08% (1) Includes amount related to common stock subject to ESOP put option excluded from stockholders' equity on the Consolidated Balance Sheets. Item 2. Properties - ------------------- Bankshares' headquarters, including the Main Office of NBB, are located at 100 South Main Street, Blacksburg, Virginia. In addition to the Main Office location, NBB owns seven branch offices: two in the Town of Blacksburg; one in the Town of Christiansburg; one in Montgomery County; and three in the County of Giles. NBB leases office space near the Main Office which is occupied by NBB's trust, marketing, audit, compliance and credit review departments. An additional property was acquired in 1996 to provide for additional office space. Construction of an office building on this site is expected to begin in 1998, reducing the future need for leased properties. Bank of Tazewell County owns the land and building of six of its seven offices. The bank leases the land and building for its seventh office. The Main Office is located at Main Street, Tazewell, Virginia. Three additional branches are located in Tazewell, one in North Tazewell and two are located in Bluefield, Virginia. Management believes that its existing facilities are adequate to meet present needs and any anticipated growth. NBB owns all its computer and data processing hardware and is a licensee of the software it utilizes. BTC at present owns all of its computer and data processing hardware and is a licensee of the software it utilizes. During 1997, the Company implemented a major hardware and software upgrade at NBB. It is management's plan in 1998 to consolidate BTC's data processing using NBB's recently upgraded system. Item 3. Legal Proceedings - -------------------------- Bankshares, NBB nor BTC are not currently involved in any material pending legal proceedings, other than routine litigation incidental to NBB's and BTC's banking business. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ There were no matters submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1997. -29- EXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------ Pursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered item in Part I of this report in lieu of being included in the Proxy Statement for the Annual Meeting of Stockholders to be held on April 14, 1998. The following is a list of names and ages of all executive officers of Bankshares; their terms of office as officers; the positions and offices within Bankshares held by each officer; and each person's principal occupation or employment during the past five years. YEAR ELECTED AN NAME AGE OFFICES AND POSITIONS HELD OFFICER/DIRECTOR ---- --- -------------------------- ---------------- James G. Rakes 53 President and Chief 1986 Executive Officer, National Bankshares, Inc.; and President and Chief Executive Officer of The National Bank of Blacksburg since 1983. J. Robert Buchanan 46 Treasurer, National 1998 Bankshares, Inc.; Senior Vice President/Chief Financial Officer of The National Bank of Blacksburg, since January 1, 1998; and Senior Vice President, Treasurer and Chief Financial Officer, Premier Bankshares Corporate since 1991. Marilyn B. Buhyoff 49 Secretary & Counsel, 1989 National Bankshares, Inc.; and Senior Vice President/ Administration since 1992, of The National Bank of Blacksburg. F. Brad Denardo 45 Corporate Officer, National 1989 Bankshares, Inc.; and Executive Vice President/ Loans since 1989 of The National Bank of Blacksburg. Joan C. Nelson 47 Corporate Officer, National 1993 Bankshares, Inc.; Treasurer, National Bankshares Inc., from 1993 to 1998; Cashier since 1993 and Senior Vice President/Operations since 1989 of The National Bank of Blacksburg. Except for J. Robert Buchanan and Joan C. Nelson, each of the executive officers listed above have served Bankshares and/or its subsidiaries in the aforementioned executive capacity for the past five years. -30- PART II ------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters - ---------------------------------------------------------- There is no established trading market for the stock of National Bankshares, Inc. As of March 18, 1998, the total number of holders of the Registrant's common stock was 1,151. Information concerning Market Price and Dividend Data is set forth under "Common Stock Information and Dividends" on page 14 of Bankshares' 1997 Annual Report to Stockholders and is incorporated herein by reference. Item 6. Selected Financial Data - -------------------------------- The table entitled "Selected Consolidated Financial Data" on page 5 of Bankshares' 1997 Annual Report to Stockholders is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - ----------------------------------------------------------------------------- The information contained under "Management's Discussion and Analysis" on pages 6 through 14 of Bankshares' 1997 Annual Report to Stockholders is incorporated herein by reference. Item 7A. Quantitative and Qualitative Disclosures About Market Risk - ------------------------------------------------------------------- See "Analysis of Interest Rate Sensitivity" set forth below. Additional information is set forth under the section "Interest Rate Senstitity" on page 6 and the section "Derivatives and Market Risk Exposure" on pages 11 and 12 of Bankshares' 1997 Annual Report to Stockholders and is incorporated herein by reference. ANALYSIS OF INTEREST RATE SENSITIVITY The table below sets forth, as of December 31, 1997, the distribution of repricing opportunities of the Company's interest-earning assets and interest-bearing liabilities, the interest rate sensitivity gap (i.e., interest rate sensitive assets less interest rate sensitive liabilities), the cumulative interest rate sensitivity gap ratio (i.e., interest rate sensitivity gap divided by total interest-earning assets) and the cumulative interest rate sensitivity gap ratio. The table sets forth the time periods during which interest-earning assets and interest-bearing liabilities will mature or may reprice in accordance with their contracted terms. -31- Certain shortcomings are inherent in the method of analysis presented in the following table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees and at different times to changes in market interest rates. Also, loan prepayments and early withdrawals of certificates of deposit could cause the interest sensitivities to vary from those which appear on the table. An interest rate sensitivity gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would generally tend to affect adversely net interest income while a positive gap would generally tend to result in an increase in net interest income. During a period of declining interest rates, a negative gap would generally tend to result in increased net interest income, while a positive gap would generally tend to affect adversely net interest income. The Company's future earnings may be adversely affected by a sharp upturn in interest rates as the Company is liability sensitive for a period extending beyond one year. In a falling rate environment, earnings might benefit to a certain degree from this position, because assets at higher rate levels would reprice downward at a slower rate than interest sensitive liabilities. Over the one to five year period, the Company's cumulative interest-sensitivity position reflects an asset sensitive position. This would mean the Company would benefit initially from falling rates but would be adversely affected by rising rates. This would depend, however, on the length of time rates were rising or falling and the length of time rates remained stable at the level ultimately reached. -32- An interest-sensitivity table showing all major interest sensitive asset and liability categories for the time intervals indicated and cumulative "gaps" for each interval is set forth on the following table.
INTEREST RATE December 31, 1997 ------------------------------------------------------ SENSITIVITY TABLE (1) Interest-sensitive (days) -------------------------- 1-5 >5 ($ in thousands) 1-90 91-180 181-365 Years Years Total ---- ------ ------- ----- ----- ----- Interest-earning assets: Commercial and industrial loans $ 27,324 5,399 17,207 36,936 14,460 101,326 Real estate mortgage loans 1,514 4,100 10,045 14,843 12,239 42,741 Real estate construction loans 5,773 1,833 885 --- --- 8,491 Loans to individuals 22,545 2,949 5,967 29,983 2,901 64,345 -------- ------- ------- ------ ------ ------- Total loans, net of unearned income (2) $ 57,156 14,281 34,104 81,762 29,600 216,903 Federal funds sold 4,300 --- --- --- --- 4,300 Interest bearing deposits 9,728 --- --- --- --- 9,728 Securities available for sale 10,168 3,661 10,097 29,164 12,492 65,582 Securities held to maturity 15,758 10,056 9,334 28,593 20,651 84,392 Mortgage loans held for sale 405 --- --- --- --- 405 -------- ------- ------- ------ ------ ------- Total interest-earning assets $ 97,515 27,998 53,535 139,519 62,743 381,310 ======== ======= ======= ======= ====== ======= Interest-bearing liabilities: Interest-bearing demand deposits $ 77,863 --- --- --- --- 77,863 Savings deposits 46,773 --- --- --- --- 46,773 Time deposits 45,021 30,768 53,531 45,320 498 175,138 Other borrowings 485 --- --- --- --- 485 -------- ------- ------- ------ ------ ------- Total interest-bearing liabilities $170,142 30,768 53,531 45,320 498 300,259 ======== ======= ======= ====== ====== ======= Cumulative ratio of interest- sensitive assets to interest- sensitive liabilities .57 .62 .70 1.06 1.27 1.27 ======== ======= ======= ====== ====== ======= Cumulative interest-sensitivity gap $(72,627) (75,397) (75,393) 18,806 81,051 81,051 ======== ======= ======= ====== ====== ======= (1) The Company is sensitive to interest rate changes, as liabilities generally reprice or mature before interest-earning assets. The above gap table reflects the Company's rate-sensitive position at December 31, 1997, and is not necessarily reflective of its position throughout the year. The carrying amounts of interest-rate sensitive assets and liabilities are presented in the periods in which they reprice to market rates or mature and are summed to show the interest-rate sensitivity gap. (2) Excludes nonaccrual loans.
-33- Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The following consolidated financial statements of the Registrant and the Independent Auditors' Report set forth on pages 15 through 41 of Bankshares' 1997 Annual Report to Stockholders are incorporated herein by reference: 1. Independent Auditors' Report 2. Consolidated Balance Sheets - December 31, 1997 and 1996 3. Consolidated Statements of Income - Years Ended December 31, 1997, 1996 and 1995 4. Consolidated Statements of Changes in Stockholders' Equity - Years Ended December 31, 1997, 1996 and 1995 5. Consolidated Statements of Cash Flows - Years Ended December 31, 1997, 1996 and 1995 6. Notes to Consolidated Financial Statements - December 31, 1997, 1996 and 1995 Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure - ----------------------------------------------------------------------------- None. PART III -------- Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------ Executive Officers of Bankshares as of December 31, 1997 are listed on page 30 herein. Information with respect to the directors of Bankshares is set out under the caption "Election of Directors" on pages 2 through 4 of Bankshares' Proxy Statement dated March 18, 1998, which information is incorporated herein by reference. Item 11. Executive Compensation - -------------------------------- The information set forth under "Executive Compensation" on pages 5 through 9 of Bankshares' Proxy Statement dated March 18, 1998 is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------ The information set forth under "Voting Securities and Stock Ownership" on page 1 and under "Election of Directors" on pages 2 through 4 of Bankshares' Proxy Statement dated March 18, 1998 is incorporated herein by reference. -34- Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------- The information contained under "Certain Transactions With Officers and Directors" on page 11 of Bankshares' Proxy Statement dated March 18, 1998 is incorporated herein by reference. PART IV ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K - ------------------------------------------------------------------------- (a) The following documents are filed as part of this report: 1997 Annual Report To Stockholders Page(s)* ------------------------ 1. Financial Statements: -------------------- Independent Auditors' Report 15 Consolidated Balance Sheets - December 31, 1997 and 1996 16 Consolidated Statements of Income - Years ended December 31, 1997, 1996 and 1995 17 Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 1997, 1996 and 1995 18 Consolidated Statements of Cash Flows - Years ended December 31, 1997, 1996 and 1995 19 Notes to Consolidated Financial Statements - December 31, 1997, 1996 and 1995 20-41 2. Financial Statement Schedules: ----------------------------- Independent Auditor's Report of Cook & Associates, LLP covering the financial statements of Bank of Tazewell County as of and for the years ended December 31, 1995 and 1994, is filed as an Exhibit and is incorporated by reference herein. Exhibit 99 * Incorporated by reference from the indicated pages of the 1997 Annual Report to Stockholders. -35- 3. Exhibits: -------- PAGE NO. IN EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM ----------- ----------- ----------------- 3(i) Articles of Incorporation, as (incorporated amended, of National herein by Bankshares, Inc. reference to Exhibit 3(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 3(ii) Bylaws, as amended, of National Bankshares, Inc. 4(i) Specimen copy of certificate (incorporated for National Bankshares, Inc. herein by common stock, $2.50 par value reference to Exhibit 4(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 4(i) Article Four of the Articles of (incorporated Incorporation of National herein by Bankshares, Inc. included in reference to Exhibit No. 3(a)) Exhibit 4(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 10(ii)(B) Computer software license (incorporated agreement dated June 18, 1990, herein by by and between Information reference to Technology, Inc. and The Exhibit 10(e) of National Bank of Blacksburg the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) Employment Agreement dated (incorporated January 1, 1992, by and between herein by National Bankshares, Inc. and reference to James G. Rakes Exhibit 10(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) Capital Accumulation Plan (incorporated (included in Exhibit No. 10(a)) herein by reference to Exhibit 10(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) -36- PAGE NO. IN EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM ----------- ----------- ----------------- *10(iii)(A) Employee Lease Agreement dated (incorporated May 7, 1992, by and between herein by National Bankshares, Inc. and reference to The National Bank of Blacksburg Exhibit 10(c) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) 13(i) 1997 Annual Report to Stockholders (such Report, except to the extent incorporated herein by reference, is being furnished for the information of the Commission only and is not deemed to be filed as part of this Report on Form 10-K) 21(i) Subsidiaries of National Bankshares, Inc. 27 Financial Data Schedule 99 Independent Auditor's Report of Cook & Associates, LLP on financial statements of Bank of Tazewell County as of and for the years ended December 31, 1995 and 1994 * Indicates a management contract or compensatory plan required to be filed herein. (b) Reports on Form 8-K filed during the last quarter of the period covered by this report: ---------------------------------------------------------------------- None. (c) Exhibits required by Item 601 of Regulation S-K: ----------------------------------------------- See Item 14(a)3 above. (d) Financial Statement Schedules required by Regulation S-X: -------------------------------------------------------- See Item 14(a)2 above. -37- SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, National Bankshares, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NATIONAL BANKSHARES, INC. BY: /s/James G. Rakes ------------------------------ James G. Rakes, President and Chief Executive Officer DATE: March 20, 1998 ------------------------------ BY: /s/J. Robert Buchanan ------------------------------ J. Robert Buchanan Treasurer DATE: March 27, 1998 ------------------------------ Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the date indicated. NAME DATE TITLE ---- ---- ----- /s/C. L. Boatwright March 23, 1998 Director and Vice ------------------------- -------------- Chairman of the Board C. L. BOATWRIGHT /s/T. C. Bowen, Jr. March 20, 1998 Director ------------------------- -------------- T. C. BOWEN, JR. /s/A. A. Crouse March 20, 1998 Director ------------------------- -------------- A. A. CROUSE /s/R. E. Christopher, Jr. March 23, 1998 Director and Chairman of ------------------------- -------------- the Board R. E. CHRISTOPHER, JR. Director ------------------------- -------------- R. E. DODSON Director ------------------------- -------------- P. A. DUNCAN /s/W. T. Peery March 20, 1998 Director ------------------------- -------------- W. T. PEERY /s/J. G. Rakes March 20, 1998 President and Chief ------------------------- -------------- Executive Officer - J. G. RAKES National Bankshares, Inc. /s/J. R. Stewart March 23, 1998 Director ------------------------- -------------- J. R. STEWART -38- INDEX TO EXHIBITS ----------------- PAGE NO. IN EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM ----------- ----------- ----------------- 3(i) Articles of Incorporation, as (incorporated amended, of National Bankshares, herein by Inc. reference to Exhibit 3(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 3(ii) Bylaws, as amended of National Bankshares, Inc. 4(i) Specimen copy of certificate for (incorporated National Bankshares, Inc. common herein by stock, $2.50 par value reference to Exhibit 4(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 4(i) Article Fourth of the Articles (incorporated of Incorporation of National herein by Bankshares, Inc. included in reference to Exhibit No. 3(a)) Exhibit 4(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 10(ii)(B) Computer software license (incorporated agreement dated June 18, 1990, herein by by and between Information reference to Technology, Inc. and The Exhibit 10(e) of National Bank of Blacksburg the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) Employment Agreement dated (incorporated January 1, 1992, by and between herein by National Bankshares, Inc. and reference to James G. Rakes Exhibit 10(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) Capital Accumulation Plan (incorporated (included in Exhibit No. 10(a)) herein by reference to Exhibit 10(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) -39- PAGE NO. IN EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM ----------- ----------- ----------------- *10(iii)(A) Employee Lease Agreement dated (incorporated May 7, 1992, by and between herein by National Bankshares, Inc. and reference to The National Bank of Blacksburg Exhibit 10(c) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) 13(i) 1997 Annual Report to Stockholders (such Report, except to the extent incorporated herein by reference, is being furnished for the information of the Commission only and is not deemed to be filed as part of this Report on Form 10-K) 21(i) Subsidiaries of National Bankshares, Inc. 27 Financial Data Schedule 99 Independent Auditor's Report of Cook & Associates, LLP on financial statements of Bank of Tazewell County as of and for the years ended December 31, 1995 and 1994 * Indicates a management contract or compensatory plan required to be filed herein. -40- EX-2 2 1997 ANNUAL REPORT National Bankshares 1997 Annual Report $ In thousands, except per share data. Financial Highlights 1997 1996 1995 ------ ------ ------ Net income per share $ 1.73 1.61 1.46 Cash dividends declared per share 0.68 0.62 0.57 Book value per share 14.73 13.56 12.70 Loans, net $214,552 193,598 163,193 Total securities 149,974 171,244 187,635 Total assets 402,907 388,850 380,915 Total deposits 344,867 334,584 330,313 Stockholders' equity 54,029 49,801 48,154 Contents Community Caring 2 -------------------------------- To Our Stockholders 4 -------------------------------- Selected Consolidated Financial Data 5 -------------------------------- Management's Discussion and Analysis 6 -------------------------------- Independent Auditors' Report 15 -------------------------------- Consolidated Financial Statements 16 -------------------------------- Notes to Consolidated Financial Statements 20 -------------------------------- Corporate Information 44 -------------------------------- Community Caring National Bankshares, Inc. "Picture of Community Breakfast" strives to be an exceptional (Lara Ramsey - Community community bank holding Oranizations and Businesses) company dedicated to providing shareholder value "Picture of Main Street Moments" by offering financial services (Carl Gillespie - Board Member and to customers through Sandra Viney - Head Teller) subsidiary financial institutions and affiliated "Picture of Boo Party" companies in an efficient, (Halloween Party hosted by BTC friendly, personalized and for the area pre-school and cost-effective manner. We head start students) recognize that to do this, our financial institutions must retain the ability to make decisions locally and must "Picture of Primeline Social" actively participate in the (Customers with Primeline Account) communities they serve. We are committed to offering competitive and fair employment opportunities and to maintaining the highest standards in all aspects of our business. NBB The National Bank BTC Bank of Tazewell County 2 "Picture of Crystal Artis" (COE Student - Cooperative Office Education) "Picture of Wilderness Trail Festival" (Phyllis Duncan - North Main Branch Manager) "Picture of Main Street Moments" (Anthony Dawson, T. C. Bowen and Connie Stallard) "Picture of Rich Creek Branch Opening" (Betty Johnson - Branch Manager) 3 National Bankshares "Picture of James G. Rakes" To Our Stockholders: technology and employee computer training. Late in the year, the It is always pleasant to report Board of Directors of Bank of positive financial results to you, Tazewell County determined that and there are a number of highlights during 1998 BTC will combine its in National Bankshares' performance data processing with that of NBB. for 1997. Net income reached a Consolidation will allow the record $6.56 million, up from the Tazewell bank to take advantage of $6.12 million earned in 1996, which NBB's updated equipment, and it will was itself a record total. permit both banks to realize some Stockholders shared in this success, economies of scale. with annual dividends in 1997 that were 9.68% higher than in 1996. In April 1997, The National Bank During the past year, the asset size opened its eighth branch office in of Bankshares and its bank Rich Creek, Virginia, the third subsidiaries topped the $400 million office in Giles County. At the end mark for the first time, and the of the year, NBB agreed to purchase Company ended 1997 with nearly $403 the Galax, Virginia office of First million in total assets. American Federal Savings Bank. We hope to complete that transaction Several areas that contributed to very soon, and to begin offering our 1997's final results deserve special style of personalized banking in a mention. A positive 10.82% increase new, but nearby, market area. in net loans accomplished two important things. First, funds were The year just past proved to be shifted from the securities profitable for our banks and our portfolio into higher yielding customers. We worked to attain our loans. Second, thousands of loans goal of being an exceptional were made to individuals and community bank holding company businesses throughout Southwest dedicated to providing value to our Virginia, keeping the deposits stockholders. We are firmly generated in our region at work in committed to the belief that there our localities. Reflecting the is a bright future for community strong economy, the quality of the banks, and therefore a great loan portfolio remained high and the opportunity for a progressive and level of total nonperforming assets competitive company like ours. I dropped significantly, from $1.1 would be remiss if I did not thank million in 1996 to $0.5 million in our directors, officers and 1997. The Company's already good employees for their contributions to capital level increased during the our success in 1997, and I also year, and at year end Bankshares and thank you for your continued subsidiaries had over $54 million in investment and confidence in stockholders' equity. A healthy National Bankshares. capital base is a positive indicator of the strength of our subsidiary banks, and, in addition, it allows us to actively consider new business James G. Rakes opportunities. President and Chief Executive Officer While enjoying the prosperity of 1997, we planned for the future. During the year, The National Bank made a significant investment in upgraded information processing 4 National Bankshares, Inc. and Subsidiaries Selected Consolidated Financial Data $ In thousands, except per share data. Years ended December 31, ---------------------------------------------------------------- 1997 1996 1995 1994 1993 ------ ------ ------ ------ ------ Selected Interest income $ 29,797 28,647 28,094 26,062 25,827 Income Interest expense 13,106 13,036 12,703 10,684 10,752 Statement Net interest income 16,691 15,611 15,391 15,378 15,075 Data: Provision for loan losses 435 331 282 553 953 Noninterest income 2,834 2,693 2,382 2,047 2,399 Noninterest expense 10,031 9,515 10,033 9,725 9,002 Income taxes 2,499 2,341 1,933 1,844 1,903 Net income 6,560 6,117 5,525 5,303 5,644 Per Share Net income $ 1.73 1.61 1.46 1.40 1.49 Data: Cash dividends declared 0.68 0.62 0.57 0.52 0.45 Book value per share(1) 14.73 13.56 12.70 11.25 10.81 Selected Loans, net $214,552 193,598 163,193 156,289 150,156 Balance Total securities 149,974 171,244 187,635 184,231 174,964 Sheet Total assets 402,907 388,850 380,915 373,132 357,773 Data at Total deposits 344,867 334,584 330,313 327,686 314,001 End Stockholders' of Year: equity 54,029 49,801 48,154 42,658 40,951 Selected Loans, net $204,540 177,419 160,643 152,976 149,027 Balance Total securities 157,179 177,403 183,994 185,365 154,740 Sheet Total assets 395,932 388,045 378,406 369,962 349,747 Daily Total deposits 339,439 335,938 330,261 325,167 307,645 Averages: Stockholders' equity(1) 53,712 49,459 45,726 42,402 39,435 Selected Return on average Ratios: assets 1.66 1.58 1.46 1.43 1.61 Return on average equity(1) 12.21 12.37 12.08 12.51 14.31 Dividend payout ratio 39.31 37.55 37.32 37.13 32.18 Average equity to average assets(1) 13.57 12.75 12.08 11.46 11.28 (1) Includes amount related to common stock subject to ESOP put option excluded from stockholders' equity on the Consolidated Balance Sheets. (Dollars) (Dollars) Book Value Per Share Graph Cash Dividends Per Share Graph 1993 1994 1995 1996 1997 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- $10.81 11.25 12.70 13.56 14.73 $0.45 0.52 0.57 0.62 0.68 5 Management's Discussion and Analysis ($ In thousands, except per share data.) Net Income Graph ($ In millions) 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- $5.6 5.3 5.5 6.1 6.6 Average Equity to Average Assets Graph 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- 11.28% 11.46% 12.08% 12.75% 13.57% PERFORMANCE SUMMARY Net income in 1997 for National Bankshares, Inc. (Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg (NBB) and Bank of Tazewell County (BTC), (the Company), was $6,560, an increase of $443 or 7.24%. This produced a return on average assets and a return on average equity of 1.66% and 12.21%, respectively. Net income for the Company for 1996 was $6,117, an increase of $592 or 10.71% over 1995. The return on average assets and return on average equity for 1996 were 1.58% and 12.37%, respectively. The Company's net income for 1995 was $5,525 which produced a return on average assets of 1.46% and a return on average equity of 12.08%. Earnings per share increased steadily over the three year period rising from $1.46 per share in 1995, to $1.61 in 1996 and $1.73 in 1997. The Company continues to enjoy good profitability as indicated by the return on average assets and steadily increasing earnings per share. The decline in the return on average equity in 1997 was due to a net increase in the Company's capital resulting from continued good earnings offset by dividends paid to the Company's stockholders. The dividend payout ratio for 1997 was 39.31%, which compares to 37.55% in 1996 and 37.32% in 1995. NET INTEREST INCOME Net interest income for 1997 was $16,691, an increase of $1,080 or 6.92% over 1996. In 1996, net interest income was $15,611, up $220 or 1.43% from 1995 net interest income of $15,391. The net yield on earnings assets for 1997 was 4.75%. In 1996 and 1995, the net yields on earning assets were 4.59% and 4.63%, respectively. Throughout the three year period, management's strategy was to fund increases in the loan portfolio through liquidity generated principally from the securities portfolio. In 1997, overall loan growth remained strong, particularly in commercial loans and loans to individuals. In 1996, a substantial amount of loan growth took place in the highly rate-competitive commercial loan area. This limited the effect of the loan growth on net interest income. 6 INTEREST RATE SENSITIVITY The Company considers interest rate risk to be a significant market risk and has systems in place to measure the exposure of net interest income and fair market values to adverse movement in interest rates. Interest rate sensitivity analyses indicate repricing opportunities, and interest rate shock simulations indicate potential economic loss due to future interest rate changes. Management realizes certain risks are inherent and minimizes these by adjusting asset/liability management responses to changing economic conditions. The Company reduces the volatility of its net interest income by managing the relationship of interest-rate sensitive assets to interest-rate sensitive liabilities. The Company would be impacted by rising interest rate changes, as it is liability sensitive for the time period up to one year. Beyond one year, the cumulative interest rate position is asset sensitive, indicating that the effect of rising rates would dissipate in the one to five year time period. The impact of rate fluctuations is dependent, however, upon the magnitude, the length of the rising or falling rate trend and the period of time rates remain stable at a given level. Based on the information and assumptions in effect at December 31, 1997, management believes that an immediate 200 basis point rate shock, up or down, over a twelve month period could significantly affect the Company's annualized net interest income or net economic value if not countered by management's pricing strategies. PROVISION AND ALLOWANCE FOR LOAN LOSSES The adequacy of the allowance for loan losses is based on management's judgement and analysis of current and historical loss experience, risk characteristics of the loan portfolio, concentrations of credit and asset quality, as well as other internal and external factors such as general economic conditions. An internal credit review department performs pre-credit analyses of large credits and also conducts credit review activities that provide management with an early warning of asset quality deterioration. Changing trends in the loan mix are also evaluated in determining the adequacy of the allowance for loan losses. Loan loss and other industry indicators related to asset quality are presented in the Loan Loss Data table. 7 Management's Discussion and Analysis Loan Loss Data ($ In thousands) 1997 1996 1995 ------ ------ ------ Provision for loan losses $ 435 331 282 Net charge-offs to average net loans 0.28% 0.21% 0.13% Allowance for loan losses to loans, net of unearned interest and deferred fees 1.12% 1.31% 1.58% Allowance for loan losses to nonperforming loans 2,802.30% 418.02% 365.60% Allowance for loan losses to nonperforming assets 479.92% 236.24% 177.37% Nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned 0.23% 0.55% 0.89% Nonaccrual loans $ 87 616 718 Other real estate owned, net 421 474 762 --------- ------ ------ Total nonperforming assets $ 508 1,090 1,480 ========= ====== ====== Accruing loans past due 90 days or more $ 672 458 574 Nonperforming loans include nonaccrual loans and do not include accruing loans past due 90 days or more. Nonperforming assets for 1997 have decreased $582 or 53.39% from 1996 and represent the continuation of a declining trend. Nonperforming assets for 1996 decreased by $390 or 26.35% from the 1995 total of $1,480. Net charge-offs to average net loans for 1997 were .28%, up .07% when compared to 1996. Allocations for these net charge-offs were made in previous periods. In 1997, overall asset quality continued to improve and general economic conditions were favorable. While the provision for loan loss increased by $104 or 31.42%, the previously mentioned loan charge-offs and the level of loan growth resulted in a lower ratio of the allowance to loans. Net charge-offs to average net loans for 1996 were .21%, up from 1995 when that ratio was .13%. While the Company did experience an increase in net charge-offs, there was an overall trend of improving asset quality. The provision for loan losses, which was up $49 in 1996 or 17.38% over 1995's provision of $282, was increased to cover 1996's net charge-offs. See note 5 of Notes to Consolidated Financial Statements for additional information relating to nonperforming assets, past due loans, impaired loans and allowance for loan losses. 8 National Bankshares, Inc. and Subsidiaries While past efforts directed at improving asset quality have been largely successful, management is unable to estimate when and under what exact terms problem credits will be resolved. With the information available, management does not anticipate any significant deterioration in asset quality. However, changing economic conditions, the timing and extent of changes and the ultimate impact on the Company's asset quality is not within management's ability to predict with any degree of precision. NONINTEREST INCOME Noninterest income for 1997 was $2,834, an increase of $141 or 5.24% over 1996. Noninterest income for 1996 was $2,693, up $311 or 13.06% from 1995. Service charges on deposits for 1997 totalled $1,131, a decrease of $52 or 4.40% from 1996. Service charges on deposit accounts in 1996 were up $190 or 19.13% from the previous year. The level of these charges is driven by demand deposit volume, types of accounts opened, service charge rates in effect, the level of charges such as overdraft fees and the waiver policy concerning these fees. The decrease for 1997 and the increase for 1996 were largely attributable to fluctuations in overdraft volumes. Other service charges and fees are composed of safe deposit box rent, charges associated with letters of credit and other miscellaneous items. In 1997, these charges were $250, a decrease of $19 or 7.06% from 1996. For 1996, these charges totalled $269, an increase of $41 or 17.98% over 1995. Trust income for 1997 was $738 which represents an increase of $135 or 22.39% over 1996. In 1996, trust income was $603, an increase of $123 or 25.63% over 1995. Factors affecting the growth in trust income include an increase in the number of accounts managed, an increase in the average value of the accounts managed and an increase in both the number and value of estates settled. Due to its nature, estate business volume and the related income is not within management's ability to predict. Credit card income is composed of several types of fees and charges, including transaction or interchange fees, merchant discount fees and overlimit charges. In 1997, credit card income totalled $606, an increase of $95 or 18.59% over 1996. Credit card income for 1996 was $511, up $61 or 13.56% over 1995. Credit card income increased in 1997 largely because of a higher volume of interchange transactions, created in part by the introduction of a debit card product. The increase in credit card income was offset somewhat by the discontinuation early in 1997 of annual membership fees charged to customers. Given the highly competitive market which limits the amount of charges set, revenue increases result from growth in the number of merchant accounts processed and increases in the number of customer credit and debit card accounts that result in higher transaction volume. Net securities gains were $37 in 1997, down $60 or 61.86% from 1996. In 1996, net securities gains were $97, down 46.70% from 1995. Gains and losses can occur as a result of portfolio restructuring, called securities and certain market adjustments. The majority of the gains for 1996 consisted of market adjustments to an allowance set up to cover potential losses on certain bonds held by BTC. These bonds were disposed of in 1997 and a gain of approximately $10 was recognized. NONINTEREST EXPENSE Noninterest expense in 1997 totalled $10,031, up $516 or 5.42% from 1996. In 1996, noninterest expense was $9,515, a decrease of $518 or 5.16% from 1995. 9 Management's Discussion and Analysis Salaries and benefits increased $120 or 2.27% from 1996. The increase resulted from the addition of staff in connection with NBB's opening of a new branch office early in 1997 and from salary adjustments, promotions and other normal compensation related items, offset by a $119 decrease in net pension cost. In 1996, salaries and benefits expense totalled $5,278, up $244 or 4.85% from 1995. This was largely due to a $177 increase in net pension cost and other normal compensation related items. Occupancy and furniture and fixtures expense increased $74 or 8.37% for 1997 when compared to 1996. This increase was due to higher costs associated with the new branch office constructed and opened by NBB and also to regular planned maintenance of facilities. Management anticipates occupancy and furniture and fixtures expense to continue to increase. NBB expects to purchase a branch office in Galax, Virginia in early 1998 and will also start construction of a new office building during the year. The expected increase in occupancy and furniture and fixtures expense will be somewhat moderated by a future reduction in expenses for leased premises. Occupancy and furniture and fixtures expense experienced a slight decrease in 1996 of 3.91% over 1995. Data processing and ATM expense was $578 for 1997, an increase over 1996 of $81 or 16.30%. This increase was due to costs associated with the upgrade of information system hardware and software and costs related to an expanded microcomputer network. Data processing and ATM expense is also likely to increase in 1998, as BTC completes a planned upgrade of its information system hardware and software and an expansion of its microcomputer network. In 1996, data processing and ATM expense was $497, an increase of $35 or 7.58% over 1995. The expansion of a microcomputer network and increased costs of maintenance on older equipment were the primary causes of the increase. The cost of Federal Deposit Insurance increased in 1997 by $39 over 1996. While the banks' base premiums remain at the minimum required by law, legislation enacted in late 1996 levied an assessment on banks for the purpose of financing certain costs associated with the resolution of the savings and loan crisis. This additional levy is expected to remain in effect until 2018-2019. In 1996, the Company's affiliates paid the base premium of $4, the minimum payment required by law, which was a 98.94% decrease from 1995's assessment. Credit card processing expense for 1997 was $551, an increase of $85 or 18.24% over 1996. This increase reflects additional expense due to the introduction of a debit card product, higher merchant processing costs and an overall increase in business activity. In 1996, credit card processing expense increased by $55 or 13.38%, which was primarily the result of increased business activity. Net costs of other real estate owned for 1997 were $8, a decrease of $3 or 60.00% from 1996. Other real estate owned net of valuation allowance decreased in 1997 by $53. Efforts to market existing properties continue, however, the exact timing, terms and conditions of the sale of the properties remain unknown. In 1996, net costs of other real estate owned decreased by $190 or 97.44% from 1995, primarily due to a $119 reduction in the valuation allowance for other real estate in 1996. Other operating expenses were $2,465 in 1997, up $114 or 4.85% from 1996. The other operating expense category in 1996 decreased by $251 or 9.65% from 1995 and was due primarily to a $111 reduction in merger expenses, from $268 in 1995 to $157 in 1996. Other operating expenses in 1995 included a contribution to a community development corporation which was not incurred in 1996. 10 National Bankshares, Inc. and Subsidiaries INCOME TAXES Higher pre-tax income in 1997 resulted in a $158 increase in income tax expense when compared to 1996. Tax exempt interest income continues to be the primary difference between the "expected" and reported income tax expense. The Company's effective tax rates for 1997, 1996 and 1995 were 27.59%, 27.68% and 25.92%, respectively. The increase in the effective tax rate for 1996 was due primarily to the level of tax exempt interest income being comparable to 1995. See note 9 of Notes to Consolidated Financial Statements for additional information relating to income taxes. EFFECTS OF INFLATION The Company's consolidated statements of income generally reflect the effects of inflation. Since interest rates, loan demand and deposit levels are related to inflation, the resulting changes are included in net income. The most significant item which does not reflect the effects of inflation is depreciation expense, because historical dollar values used to determine this expense do not reflect the effect of inflation on the market value of depreciable assets after their acquisition. BALANCE SHEET Total assets at year end 1997 were $402,907 which represents an increase of $14,057 or 3.62% over the previous year. The Company's primary methods of achieving growth are to seek to increase deposits at its bank subsidiaries and to grow through corporate acquisitions and mergers. In both 1997 and 1996, the Company experienced excess liquidity, and because management stressed profitability over growth, management's strategy was to utilize those funds before aggressively pursuing new deposits. In 1997 and 1996, total average deposits grew by $3,501 and $5,677, respectively, which represents growth rates of 1.04% and 1.72%, respectively. Total Assets Graph (Millions) 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- $357.8 373.1 380.9 388.9 402.9 LOANS Loans, net of unearned income and deferred fees, grew by $20,817 or 10.61% in 1997. Commercial loans grew by $13,860 or 15.84% with loans to individuals increasing by $5,644 or 9.25%. In 1996, loans, net of unearned income and deferred fees, grew by $30,355 or 18.31%. Commercial loans, which grew by $27,910 or 46.82%, accounted for the largest portion of the increase. The Company engages in the origination and sale of mortgage loans in the secondary market. In 1997 and 1996, the Company originated $19,120 and $17,907, respectively, and sold $19,231 and $18,271 in 1997 and 1996, respectively, of mortgage loans. SECURITIES In 1997, bank-owned securities declined by $21,270 or 12.42% compared to 1996. The decrease took place in the held to maturity portfolio which declined by $24,318 or 22.37%. Securities available for sale increased $3,048 or 4.87% offsetting a portion of that decline. In 1996, total bank- 11 Management's Discussion and Analysis owned securities were $171,244, a decrease of $16,391 or 8.74% from 1995. In 1997 and 1996, cash flows resulting from the reduction in the securities portfolio were used to fund loan growth. The Company's investment policy stresses safety with a program of purchasing high quality securities such as U.S. Treasury and U.S. Government agency issues, state, county, and municipal bonds, corporate bonds, mortgage- backed securities and other bank qualified investments. The Company has classified all of its investment securities as either held to maturity or available for sale, as the Company does not engage in trading activities. Investment strategies are adjusted in response to market conditions and available investment vehicles. At December 31, 1997 and 1996, the Company had no investment concentrations in any single issues (excluding U.S. Government) that exceeded ten percent of capital. DEPOSITS At year end 1997, total deposits were $344,867 which represent a $10,283 or a 3.07% increase over 1996. At December 31 1996, total deposits were $334,584, an increase of 1.29% over 1995. Average noninterest-bearing deposits of $44,193 grew by $2,196 or 5.23% in 1997, $3,164 or 8.15% in 1996 and $2,109 or 5.74% in 1995. Average interest-bearing deposits were $295,246 in 1997, an increase of $1,305 over 1996. In 1996, average interest-bearing deposits of $293,941 increased $2,513 from the 1995 total of $291,428. DERIVATIVES AND MARKET RISK EXPOSURES The Company is not a party to derivative financial instruments with off- balance sheet risks such as futures, forwards, swaps and options. The Company is a party to financial instruments with off-balance sheet risks such as commitments to extend credit, standby letters of credit, and recourse obligations in the normal course of business to meet the financing needs of its customers. See note 13 of Notes to Consolidated Financial Statements for additional information relating to financial instruments with off-balance sheet risk. Management does not plan any future involvement in high risk derivative products. The Company has investments in mortgage-backed securities, collateralized mortgage obligations, structured notes and other similar instruments which are included in securities available for sale and securities held to maturity. The fair value of these investments at December 31, 1997 approximated $11,144. See note 3 of Notes to Consolidated Financial Statements for additional information relating to securities. The Company's securities and loans are subject to credit and interest rate risk and its deposits are subject to interest rate risk. Management considers its credit risk when a loan is granted and monitors its credit risk after the loan is granted. The Company maintains an allowance for loan losses to absorb losses in the collection of its loans. See note 5 of Notes to Consolidated Financial Statements for information relating to nonperforming assets, past due loans, impaired loans and allowance for loan losses. See note 14 of Notes to Consolidated Financial Statements for information relating to concentrations of credit risk. The Company has an asset/liability program to manage its interest rate risk. This program provides management with information related to the rate sensitivity of certain assets and liabilities and the effect of changing rates on profitability and capital accounts. While this planning process is designed to protect the Company over the long term, it does not provide near term protection from interest rate shocks, as interest rate sensitive assets and liabilities do not, by their nature, move up or down in tandem in response to 12 National Bankshares, Inc. and Subsidiaries changes in the overall rate environment. The Company's profitability in the near term may temporarily be affected, either positively by a falling interest rate scenario or negatively by a period of rising rates. See note 15 of Notes to Consolidated Financial Statements for information relating to fair value of financial instruments. LIQUIDITY Liquidity is the ability to provide sufficient cash flow to meet financial commitments and to fund additional loan demand or withdrawal of existing deposits. Sources of liquidity include deposits, loan principal and interest repayments, sales, calls and maturities of securities and short-term borrowings. The Company maintained an adequate liquidity level during 1997 and 1996. Management is not aware of any trends, commitments or events that will result in or that are reasonably likely to result in a material increase or decrease in liquidity. Net cash from operating activities of $7,573 in 1997 decreased $395 from 1996 due primarily to the increase in net income offset by the change in other liabilities. Net cash flows provided by operating activities, securities and financing activities for 1997 of $7,573, $21,966 and $7,562, respectively, were used to fund the net increases in federal funds sold, interest-bearing deposits, loans made to customers and purchases of loan participations of $2,390, $9,637, $17,400 and $6,189, respectively. Net cash from operating activities of $7,968 in 1996 increased $1,604 from 1995 and was primarily attributable to the increase in net income and the change in the mortgage loans held for sale category which fluctuates based upon loan demand and the timing of loan sales in the secondary market. Cash flows from investing activities in 1996 continued to reflect the shifting of securities to the loan portfolio and from securities held to maturity to available for sale. Net cash flows provided by operating activities, federal funds sold, securities and financing activities for 1996 of $7,968, $5,815, $15,542 and $1,930, respectively, were used principally to fund the net increase in loans of $31,633. A pending acquisition by NBB of the Galax branch of First American Federal Savings Bank, which is expected to close in early 1998, is not anticipated to have a material impact on the Company's liquidity. See "Future Management Considerations." CAPITAL RESOURCES Total stockholders' equity increased $4,228 from 1996 to 1997 and $1,647 from 1995 to 1996. Net income, less cash dividends on common stock of $2,579 in 1997 and $2,297 in 1996, accounted primarily for the increase. Net unrealized gains (losses) on securities available for sale, net of deferred income taxes, were $194 at December 31, 1997, $(248) at December 31, 1996 and $282 at December 31, 1995. These unrealized net gains and losses are recorded as a separate component of stockholders' equity and will continue to be subject to change in future years due to fluctuations in fair values, sales, purchases, maturities and calls of securities classified as available for sale. The Company has operated from a consistently strong capital position. The ratio of total stockholders' equity to total assets was 13.41% at year end 1997 compared to 12.81% at year end 1996 and 12.64% at year end 1995. Banks are required to apply percentages to various assets, including off- balance sheet assets, to reflect their perceived risk. Regulatory defined capital is divided by risk weighted assets in determining the bank's risk- based capital ratio. No regulatory authorities have advised National Bankshares, Inc., The National Bank of Blacksburg or Bank of Tazewell County 13 Management's Discussion and Analysis of any specific leverage ratios applicable to them. National Bankshares, Inc., The National Bank of Blacksburg and Bank of Tazewell County's capital adequacy ratios exceed regulatory requirements and provide added flexibility to take advantage of business opportunities as they arise. See note 10 of Notes to Consolidated Financial Statements for additional information. Stockholders' Equity Graph (Millions) 1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- $41.0 42.7 48.2 49.8 54.0 RECENT ACCOUNTING PRONOUNCEMENTS See notes 1 and 17 of Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements. MERGER On June 1, 1996, Bankshares issued 1,888,209 shares of its common stock in a one-for-one exchange for all the outstanding common stock of Bank of Tazewell County, Tazewell, Virginia. This business combination has been accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements for the periods prior to the combination have been restated to include the accounts and results of operations of Bank of Tazewell County. There were no adjustments of a material amount resulting from Bank of Tazewell County's adoption of Bankshares' accounting policies. In May 1996, Bankshares declared a stock split of .11129 per share effected in the form of a stock dividend to the holders of Bankshares common stock just prior to the merger effective date to facilitate the one-for-one common stock exchange ratio. All stockholders' equity accounts, share and per share data have been adjusted retroactively to reflect the stock split. Bank of Tazewell County is well capitalized with excess liquidity, and provides the Company with an expanded market place. FUTURE MANAGEMENT CONSIDERATIONS Year 2000 The Company is cognizant of the risks and challenges presented by the impact of the century date change on information processing and other computer controlled systems. The Year 2000 presents two related but distinct issues for financial institutions. The Company's internal information processing and computer controlled systems must be Year 2000 compliant, and the subsidiary banks' compliance efforts are subject to regulatory review. In addition, banks face credit risk should their commercial loan customers suffer significant business disruptions as a result of the impact of computer failures in their own operations or in those of their suppliers or customers. As a normal part of business operations, the Company's subsidiaries are currently in the process of upgrading information processing systems which will include the acquisition of new information processing hardware and software. The primary goal of this project is to provide a shared information processing system for affiliates, additional capacity and the ability to use the most advanced software available from vendors. 14 National Bankshares, Inc. and Subsidiaries While the overall costs associated with the upgrade are substantial, it is not anticipated that the Year 2000 component of this upgrade will have a material effect on the Company's consolidated financial statements. Pending Acquisition On December 26, 1997, NBB entered into an agreement to purchase the assets, including real estate and improvements, and assume the liabilities of the Galax, Virginia, branch office of First American Federal Savings Bank. The transaction, which is subject to regulatory approval, is expected to close in early 1998. COMMON STOCK INFORMATION AND DIVIDENDS National Bankshares, Inc.'s common stock is traded on a limited basis in the over-the-counter market and is not listed on any exchange or quoted on NASDAQ. Some trades in the Company's stock are reported on the OTC Bulletin Board under the trading symbol NKSH. Local brokerage firms are familiar with and active in trading in the common stock of National Bankshares, Inc. As of December 31, 1997, there were 1,163 stockholders of Bankshares common stock. The following is a summary of the market price per share and cash dividend per share of the common stock of National Bankshares, Inc. for 1997 and 1996. Prices do not necessarily reflect the prices which would have prevailed had there been an active trading market, nor do they reflect unreported trades, which may have been at lower or higher prices. Common Stock Market Prices Dividends 1997 1996 Per Share ----------- ---------- ----------- High Low High Low 1997 1996 ---- --- ---- --- ---- ---- First Quarter $26.25 25.00 $26.50 24.00 --- --- Second Quarter 25.87 23.50 26.25 24.50 .33 .30 Third Quarter 25.75 23.81 27.00 24.50 --- --- Fourth Quarter 26.50 23.50 26.50 25.00 .35 .32 Bankshares' primary source of funds for dividend payments is dividends from its subsidiaries, The National Bank of Blacksburg and Bank of Tazewell County. Bank regulatory agencies restrict dividend payments of the subsidiaries as more fully disclosed in note 10 of Notes to Consolidated Financial Statements. 15 Independent Auditors' Report The Board of Directors and Stockholders National Bankshares, Inc.: We have audited the accompanying consolidated balance sheets of National Bankshares, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the 1995 financial statements of Bank of Tazewell County, a wholly- owned subsidiary, which statements reflect total assets constituting 47 percent and total interest income constituting 43 percent of the related 1995 consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Bank of Tazewell County for 1995, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting 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 and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Bankshares, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997 in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Roanoke, Virginia February 6, 1998 16 National Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets $ In thousands except share and per share data. December 31, 1997 and 1996 1997 1996 ------ ------ Assets Cash and due from banks (notes 2 and 15) $ 12,435 9,989 Interest-bearing deposits (note 15) 9,728 91 Federal funds sold (note 15) 4,300 1,910 Securities available for sale (notes 3 and 15) 65,582 62,534 Securities held to maturity (fair value $85,005 in 1997 and $108,755 in 1996) 84,392 108,710 Mortgage loans held for sale (notes 13, 14 and 15) 405 516 Loans (notes 4, 5, 14 and 15): Real estate construction loans 8,510 6,295 Real estate mortgage loans 42,969 43,917 Commercial and industrial loans 101,379 87,519 Loans to individuals 66,635 60,991 -------- ------- Total loans 219,493 198,722 Less unearned income and deferred fees (2,503) (2,549) -------- ------- Loans, net of unearned income and deferred fees 216,990 196,173 Less allowance for loan losses (note 5) (2,438) (2,575) -------- ------- Loans, net 214,552 193,598 -------- ------- Bank premises and equipment, net (note 6) 5,739 5,037 Accrued interest receivable 3,445 3,510 Other real estate owned, net (note 5) 421 474 Other assets (note 9) 1,908 2,481 -------- ------- Total assets $402,907 388,850 ======== ======= Liabilities Noninterest-bearing demand deposits $ 45,093 44,096 and Interest-bearing demand deposits 77,863 73,804 Stockholders'Savings deposits 46,773 48,164 Equity Time deposits (note 7) 175,138 168,520 -------- ------- Total deposits (note 15) 344,867 334,584 -------- ------- 17 Other borrowed funds (note 15) 485 627 Accrued interest payable 722 700 Other liabilities (note 8) 966 1,495 -------- ------- Total liabilities 347,040 337,406 -------- ------- Common stock subject to ESOP put option (note 8) 1,838 1,643 -------- ------- Stockholders' equity (notes 9, 10 and 16): Preferred stock of no par value. Authorized 5,000,000 shares; none issued and outstanding --- --- Common stock of $2.50 par value. Authorized 5,000,000 shares; issued and outstanding 3,792,833 shares 9,482 9,482 Retained earnings 46,191 42,210 Net unrealized gains (losses) on securities available for sale 194 (248) Common stock subject to ESOP put option (72,783 shares at $25.25 per share in 1997 and 64,796 shares at $25.35 per share in 1996) (note 8) (1,838) (1,643) -------- ------- Total stockholders' equity 54,029 49,801 Commitments and contingent liabilities (notes 6, 8, 13 and 16) -------- ------- Total liabilities and stockholders' equity $402,907 388,850 ======== ======= See accompanying notes to consolidated financial statements. 18 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income $ In thousands, except per share data. Years ended December 31, 1997, 1996 and 1995 1997 1996 1995 ------ ------ ------ Interest Interest and fees on loans $19,553 17,232 15,761 Income Interest on federal funds sold 451 476 704 Interest on interest-bearing deposits 230 91 --- Interest on securities - taxable 7,776 8,877 9,723 Interest on securities - nontaxable 1,787 1,971 1,906 ------- ------- ------- Total interest income 29,797 28,647 28,094 ------- ------- ------- Interest Interest on time deposits of $100,000 Expense or more 2,335 2,070 1,898 Interest on other deposits 10,754 10,939 10,770 Interest on borrowed funds 17 27 35 ------- ------- ------- Total interest expense 13,106 13,036 12,703 ------- ------- ------- Net interest income 16,691 15,611 15,391 Provision for loan losses (note 5) 435 331 282 ------- ------- ------- Net interest income after provision for loan losses 16,256 15,280 15,109 ------- ------- ------- Noninterest Service charges on deposit accounts 1,131 1,183 993 Income Other service charges and fees 250 269 228 Credit card fees 606 511 450 Trust income 738 603 480 Other income 72 30 49 Realized securities gains, net (note 3) 37 97 182 ------- ------- ------- Total noninterest income 2,834 2,693 2,382 ------- ------- ------- Noninterest Salaries and employee benefits (note 8) 5,398 5,278 5,034 Expense Occupancy and furniture and fixtures 958 884 920 Data processing and ATM 578 497 462 FDIC assessment 43 4 379 Credit card processing 551 466 411 Goodwill amortization 30 30 30 Net costs of other real estate owned 8 5 195 Other operating expense 2,465 2,351 2,602 ------- ------- ------- Total noninterest expense 10,031 9,515 10,033 ------- ------- ------- 19 Income before income tax expense 9,059 8,458 7,458 Income tax expense (note 9) 2,499 2,341 1,933 ------- ------- ------- Net income $ 6,560 6,117 5,525 ======= ======= ======= Net income per share (note 1) $ 1.73 1.61 1.46 ======= ======= ======= See accompanying notes to consolidated financial statements. 20 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity Net Unrealized Common Gains Stock (Losses) on Subject $ In thousands, except per share Securities to ESOP data. Years ended December 31, Common Retained Available Put 1997, 1996 and 1995. Stock Earnings For Sale Option Total ------- -------- ----------- ------- ------- Balances, December 31, 1994 $ 9,482 34,927 (1,751) --- 42,658 Net income --- 5,525 --- --- 5,525 Cash dividends ($.57 per share) --- (1,080) --- --- (1,080) Cash dividends of BTC declared prior to merger --- (982) --- --- (982) Change in net unrealized gains (losses) on securities available for sale, net of income tax expense of $1,047 --- --- 2,033 --- 2,033 ------- ------ ------ ------ ------ Balances, December 31, 1995 9,482 38,390 282 --- 48,154 Net income --- 6,117 --- --- 6,117 Cash dividends ($.62 per share) --- (1,787) --- --- (1,787) Cash dividends of BTC declared prior to merger --- (510) --- --- (510) Change in net unrealized gains (losses) on securities available for sale, net of income tax benefit of $273 --- --- (530) --- (530) Common stock subject to ESOP put option --- --- --- (1,643) (1,643) ------- ------ ------ ------ ------ Balances, December 31, 1996 9,482 42,210 (248) (1,643) 49,801 Net income --- 6,560 --- --- 6,560 Cash dividends ($.68 per share) --- (2,579) --- --- (2,579) Change in net unrealized gains (losses) on securities available for sale, net of income tax expense of $228 --- --- 442 --- 442 Change in common stock subject to ESOP put option --- --- --- (195) (195) ------- ------ ------ ------ ------ Balances, December 31, 1997 $ 9,482 46,191 194 (1,838) 54,029 ======= ====== ====== ====== ====== See accompanying notes to consolidated financial statements. 21 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows
$ In thousands. Years ended December 31, 1997, 1996 and 1995 1997 1996 1995 ------ ------ ------ Cash Flows Net income $ 6,560 6,117 5,525 from Adjustments to reconcile net income to net cash Operating provided by operating activities: Activities Provision for loan losses 435 331 282 (Note 12) Recovery of bond losses (10) (89) --- Provision for deferred income taxes 300 (4) (120) Depreciation of bank premises and equipment 586 517 535 Amortization of intangibles 121 121 145 Amortization of premiums and accretion of discounts, net 11 52 (32) (Gains) losses on bank premises and equipment disposals 8 7 (9) Gains on sales and calls of securities available for sale, net (5) (3) (2) Gains on calls of securities held to maturity, net (22) (5) (180) (Gains) losses and write-downs on other real estate owned (4) (9) 168 (Increase) decrease in: Mortgage loans held for sale 111 364 (488) Accrued interest receivable 65 111 88 Other assets (76) 40 129 Increase (decrease) in: Accrued interest payable 22 (44) 170 Other liabilities (529) 462 153 ------- ------- ------- Net cash provided by operating activities 7,573 7,968 6,364 ------- ------- ------- Cash Flows Net (increase) decrease in federal funds sold (2,390) 5,815 (100) from Net increase in interest-bearing deposits (9,637) (91) --- Investing Proceeds from sales of securities available for Activities sale --- 1,000 1,867 (Note 12) 22 Proceeds from calls and maturities of securities available for sale 9,839 21,938 8,134 Proceeds from calls and maturities of securities held to maturity 35,673 35,569 28,592 Purchases of securities available for sale (12,201) (10,397) (16,432) Purchases of securities held to maturity (11,345) (32,477) (22,271) Purchases of loan participations (6,189) (1,704) --- Collection of loan participations 1,934 2,448 1,928 Net increase in loans made to customers (17,400) (31,633) (9,197) Proceeds from disposal of other real estate owned 216 325 220 Recoveries on loans charged off 107 125 83 Bank premises and equipment expenditures (1,304) (882) (492) Proceeds from sale of bank premises and equipment 8 --- 9 ------- ------- ------- Net cash used in investing activities (12,689) (9,964) (7,659) ------- ------- ------- Cash Flows Net increase in time deposits 6,618 1,672 18,179 from Net increase (decrease) in other deposits 3,665 2,599 (15,552) Financing Net increase (decrease) in other borrowed funds (142) 466 (630) Activities Cash dividends paid (2,579) (2,807) (2,056) (Note 12) ------- ------- ------- Net cash provided by (used in) financing activities 7,562 1,930 (59) ------- ------- ------- Net increase (decrease) in cash and due from banks 2,446 (66) (1,354) Cash and due from banks at beginning of year 9,989 10,055 11,409 ------- ------- ------- Cash and due from banks at end of year $12,435 9,989 10,055 ======= ======= ======= See accompanying notes to consolidated financial statements.
23 Notes to Consolidated Financial Statements $ In thousands, except share and per share data. December 31, 1997, 1996 and 1995 Note 1: Summary of Significant Accounting Policies The accounting and reporting policies of National Bankshares, Inc. (Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg (NBB) and Bank of Tazewell County (BTC), conform to generally accepted accounting principles and general practices within the banking industry (see note 16 for merger with BTC). The following is a summary of the more significant accounting policies. (A) Consolidation The consolidated financial statements include the accounts of National Bankshares, Inc. and its wholly-owned subsidiaries (the Company). All significant intercompany balances and transactions have been eliminated. (B) Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand and due from banks. (C) Securities Securities available for sale are reported at fair value, with unrealized gains and losses excluded from net income and reported, net of income taxes, in a separate component of stockholders' equity. Securities held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts on a basis which approximates the level yield method. The Company does not engage in securities trading. Gains and losses on securities are accounted for on the completed transaction basis by the specific identification method. A decline in the fair value of any available for sale or held to maturity security below cost that is deemed other than temporary is charged to income resulting in the establishment of a new cost basis for the security. (D) Loans Loans are stated at the amount of funds disbursed plus the applicable amount, if any, of unearned income and deferred fees less payments received. Income on installment loans, including impaired installment loans that have not been placed in nonaccrual status, is recognized on methods which approximate the level yield method. Interest on all other loans, including impaired other loans that have not been placed in nonaccrual status, is accrued based on the balance outstanding times the applicable interest rate. Interest is recognized on the cash basis for all loans carried in nonaccrual status. Loans generally are placed in nonaccrual status when the collection of principal or interest is 90 days or more past due, unless the obligation is both well-secured and in the process of collection. Loan origination and commitment fees and certain direct costs are being deferred, and the net amount amortized as an adjustment to the related loan's yield. These amounts are being amortized over the contractual life of the related loans. Effective January 1, 1995, the Company adopted the provisions of Statement of Financial Accounting Standards (Statement) No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by Statement 118, "Accounting by Creditors for Impairment of a Loan - Income 24 National Bankshares, Inc. and Subsidiaries Recognition and Disclosures." Statement 114, as amended by Statement 118, requires that impaired loans within the scope of the Statements be presented in the financial statements at the present value of expected future cash flows or at the fair value of the loan's collateral if the loan is deemed "collateral dependent." A valuation allowance is required to the extent that the measure of the impaired loans is less than the recorded investment. Statement 114 does not apply to large groups of small-balance homogeneous loans such as residential real estate mortgage, consumer installment, home equity and bank card loans, which are collectively evaluated for impairment. Statement 118 allows a creditor to use existing methods for recognizing interest income on an impaired loan. Adoption of this Statement did not have a material impact on the Company's financial position, result of operations or liquidity. Mortgage loans held for sale are carried at the lower of cost or fair value on an individual loan basis. (E) Allowance for Loan Losses The allowance for loan losses is a valuation allowance consisting of the cumulative effect of the provision for loan losses, plus any amounts recovered on loans previously charged off, minus loans charged off. The provision for loan losses charged to expense is the amount necessary in management's judgement to maintain the allowance for loan losses at a level it believes adequate to absorb losses in the collection of its loans. (F) Bank Premises and Equipment Bank premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is charged to expense over the estimated useful lives of the assets on the straight-line basis. Depreciable lives include 40 years for premises, 3-10 years for furniture and equipment, and 5 years for computer software. Costs of maintenance and repairs are charged to expense as incurred and improvements are capitalized. (G) Other Real Estate Owned Other real estate, acquired through foreclosure or deed in lieu of foreclosure, is carried at the lower of the recorded investment or its fair value, less estimated costs to sell (net realizable value). When the property is acquired, any excess of the loan balance over net realizable value is charged to the allowance for loan losses. Increases or decreases in the net realizable value of such properties are credited or charged to income by adjusting the valuation allowance for other real estate owned. Net costs of maintaining or operating foreclosed properties are expensed as incurred. (H) Intangible Assets Included in other assets are deposit intangibles of $575 and $666 at December 31, 1997 and 1996, respectively, and goodwill of $337 and $367 at December 31, 1997 and 1996, respectively. Deposit intangibles are being amortized on a straight-line basis over a ten-year period and goodwill is being amortized on a straight-line basis over a fifteen-year period. 25 Notes to Consolidated Financial Statements (I) Pension Plans The Company sponsors two separate defined benefit pension plans which cover substantially all full-time officers and employees. The benefits are based upon length of service and a percentage of the employee's compensation during the final years of employment. Pension costs are computed based upon the provisions of Statement 87. The Company contributes to the pension plans amounts deductible for federal income tax purposes. (J) Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (K) Trust Assets and Income Assets (other than cash deposits) held by the Trust Departments in a fiduciary or agency capacity for customers are not included in the consolidated financial statements since such items are not assets of the Company. Trust income is recognized on the accrual basis. (L) Net Income Per Share Net income per share is based upon the weighted average number of common shares outstanding (3,792,833 shares in 1997, 1996 and 1995). In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share." Statement 128 establishes new standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation of the numerator and denominator of the basic EPS computation to the numerator and denominator of the diluted EPS computation. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. Statement 128 was adopted by the Company at December 31, 1997. The Statement requires restatement of prior years EPS data previously presented. Adoption of this Statement did not have any effect on current or prior years' EPS data presented due to the Company's simple capital structure. 26 National Bankshares, Inc. and Subsidiaries (M) Off-Balance Sheet Financial Instruments In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. (N) Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value: (1) Cash and Due from Banks, Interest-Bearing Deposits and Federal Funds Sold The carrying amounts are a reasonable estimate of fair value. (2) Securities The fair values of securities are determined by quoted market prices or dealer quotes. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued. (3) Loans Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as mortgage loans held for sale, commercial, real estate - commercial, real estate - construction, real estate - mortgage, credit card and other consumer loans. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan, as well as estimates for prepayments. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. Fair value for significant nonperforming loans is based on estimated cash flows which are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information. (4) Deposits The fair value of demand and savings deposits is the amount payable on demand. The fair value of fixed maturity time deposits and certificates of deposit is estimated using the rates currently offered for deposits with similar remaining maturities. 27 Notes to Consolidated Financial Statements (5) Other Borrowed Funds Other borrowed funds represents treasury tax and loan deposits. The carrying amount is a reasonable estimate of fair value because the deposits are generally repaid within 1 to 120 days from the transaction date. (6) Commitments to Extend Credit and Standby Letters of Credit The only amounts recorded for commitments to extend credit, standby letters of credit and financial guarantees written are the deferred fees arising from these unrecognized financial instruments. These deferred fees are not deemed significant at December 31, 1997 and 1996, and as such, the related fair values have not been estimated. (O) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of The Company adopted the provisions of Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," on January 1, 1996. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of this Statement did not have a material impact on the Company's financial position, results of operations or liquidity. (P) Transfers and Servicing of Financial Assets and Extinguishments of Liabilities The Company adopted the provisions of Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," on January 1, 1997. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement also provides implementation guidance for assessing isolation of transferred assets and for accounting for transfers of partial interests, servicing of financial assets, securitizations, transfers of sales-type and direct financing lease receivables, securities lending transactions, repurchase agreements including "dollar rolls," "wash sales," loan syndications and participations, risk participations in banker's acceptances, factoring arrangements, transfers of receivables with recourse, and extinguishments of liabilities. Statement No. 127, "Deferral of the Effective Date of Certain Provisions of Statement 125," issued in December 1996, deferred until January 1, 1998 the effective date (a) of paragraph 15 of Statement 125 and (b) for repurchase agreement, dollar-roll, securities lending, 28 National Bankshares, Inc. and Subsidiaries and similar transactions, of paragraphs 9-12 and 237(b) of Statement 125. Statement 125 was required to be adopted on a prospective basis and its adoption did not have a material impact on the Company's financial position, results of operations or liquidity. (Q) Use of Estimates In preparing the consolidated financial statements, management is required to make certain estimates, assumptions and loan evaluations that affect its consolidated financial statements for the period. Actual results could vary significantly from those estimates. Changing economic conditions, adverse economic prospects for borrowers, as well as regulatory agency action as a result of an examination, could cause NBB and BTC to recognize additions to the allowance for loan losses and may also affect the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. (R) Reclassifications Certain reclassifications have been made to prior years' consolidated financial statements to place them on a basis comparable with the 1997 consolidated financial statements. Note 2: Restrictions on Cash To comply with Federal Reserve regulations, the Company is required to maintain certain average reserve balances. The daily average reserve requirements were $3,699 and $2,914 for the weeks including December 31, 1997 and 1996, respectively. Note 3: Securities The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities available for sale by major security type as of December 31, 1997 and 1996 are as follows: December 31, 1997 ---------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- -------- Available for sale: U.S. Treasury $ 6,742 131 (11) 6,862 U.S. Government agencies and corporations 36,252 141 (117) 36,276 States and political subdivisions 9,540 101 (2) 9,639 Mortgage-backed securities 4,172 34 (87) 4,119 Other securities 8,582 121 (17) 8,686 -------- ----- ------ ------ Total securities available for sale $ 65,288 528 (234) 65,582 ======== ===== ====== ====== 29 Notes to Consolidated Financial Statements December 31, 1996 ---------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- -------- Available for sale: U.S. Treasury $ 8,740 116 (66) 8,790 U.S. Government agencies and corporations 33,840 149 (349) 33,640 States and political subdivisions 8,688 86 (155) 8,619 Mortgage-backed securities 4,568 12 (128) 4,452 Other securities 7,074 25 (66) 7,033 -------- ---- ----- ------ Total securities available for sale $ 62,910 388 (764) 62,534 ======== ==== ===== ====== The amortized costs and fair values of single maturity securities available for sale at December 31, 1997, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities included in these totals are allocated based upon estimated cash flows at December 31, 1997. December 31, 1997 ------------------ Amortized Fair ($ In thousands) Costs Values --------- -------- Due in one year or less $ 8,952 8,926 Due after one year through five years 25,758 25,894 Due after five years through ten years 21,950 22,099 Due after ten years 7,826 7,801 No maturity 802 862 -------- ------ $ 65,288 65,582 ======== ====== The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities held to maturity by major security type as of December 31, 1997 and 1996 are as follows: December 31, 1997 ---------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- -------- Held to maturity: U.S. Treasury $ 7,527 27 (41) 7,513 U.S. Government agencies and corporations 36,853 167 (362) 36,658 States and political subdivisions 32,949 696 (32) 33,613 Mortgage-backed securities 630 28 --- 658 Other securities 6,433 131 (1) 6,563 ------- ----- ---- ------ Total securities held to maturity $84,392 1,049 (436) 85,005 ======= ===== ==== ====== 30 National Bankshares, Inc. and Subsidiaries December 31, 1996 ---------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- -------- Held to maturity: U.S. Treasury $ 11,547 36 (148) 11,435 U.S. Government agencies and corporations 54,804 215 (604) 54,415 States and political subdivisions 34,144 530 (105) 34,569 Mortgage-backed securities 767 29 --- 796 Other securities 7,448 103 (11) 7,540 -------- ----- ----- ------- Total securities held to maturity $108,710 913 (868) 108,755 ======== ===== ===== ======= The amortized costs and fair values of single maturity securities held to maturity at December 31, 1997, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities included in these totals are allocated based upon estimated cash flows at December 31, 1997. December 31, 1997 ------------------- Amortized Fair ($ In thousands) Costs Values --------- -------- Due in one year or less $ 18,150 18,128 Due after one year through five years 44,924 45,225 Due after five years through ten years 17,074 17,308 Due after ten years 4,244 4,344 -------- ------ $ 84,392 85,005 ======== ====== There were no sales of securities held to maturity during 1997, 1996 or 1995. The carrying value of securities pledged to secure public and trust deposits, and for other purposes as required or permitted by law, was $21,257 at December 31, 1997 and $18,446 at December 31, 1996. Note 4: Loans to Officers and Directors In the normal course of business, loans have been made to executive officers and directors of Bankshares and its subsidiaries. As of December 31, 1997 and 1996, there were direct loans to executive officers and directors of $1,351 and $2,567, respectively. In addition, there were loans of $3,566 and $2,145 at December 31, 1997 and 1996, respectively, which were endorsed by directors and/or executive officers or had been made to companies in which directors and/or executive officers had an equity interest. The following schedule summarizes amounts receivable from executive officers and directors of Bankshares and its subsidiaries, and their immediate families or associates: 31 Notes to Consolidated Financial Statements Year ended December 31, ($ In thousands) 1997 ------ Aggregate balance, beginning of year $ 4,712 Additions 4,852 Collections (4,647) ------- Aggregate balance, end of year $ 4,917 ======= Note 5: Nonperforming Assets, Past Due Loans, Impaired Loans and Allowance for Loan Losses Nonperforming assets consist of the following: December 31, ---------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Nonaccrual loans $ 87 616 718 Other real estate owned, net 421 474 762 -------- ------ ------ Total nonperforming assets $ 508 1,090 1,480 ======== ====== ====== Accruing loans past due 90 days or more $ 672 458 574 There were no material commitments to lend additional funds to customers whose loans were classified as nonperforming at December 31, 1997. The following table shows the interest that would have been earned on nonaccrual loans if they had been current in accordance with their original terms and the recorded interest that was earned and included in income on these loans: Years ended December 31, ---------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Scheduled interest: Nonaccrual loans $ 8 68 59 ======== ======= ====== Recorded interest: Nonaccrual loans $ 1 24 5 ======== ======= ====== Changes in the valuation allowance for other real estate owned are as follows: 32 National Bankshares, Inc. and Subsidiaries Years ended December 31, --------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Balances, beginning of year $ 96 91 49 Provision for other real estate owned --- 5 124 Write-offs (28) --- (82) -------- ----- ---- Balances, end of year $ 68 96 91 ======== ===== ==== At December 31, 1997, the recorded investment in loans which have been identified as impaired loans, in accordance with Statement 114, totaled $177. Of this amount, $124 related to loans with no valuation allowance and $53 related to loans with a corresponding valuation allowance of $53. At December 31, 1996, the recorded investment in loans which have been identified as impaired loans totaled $725. Of this amount, $354 related to loans with no valuation allowance and $371 related to loans with a corresponding valuation allowance of $290. For the year ended December 31, 1997, the average recorded investment in impaired loans was approximately $458, and the total interest income recognized on impaired loans was $23 of which $12 was recognized on a cash basis. For the year ended December 31, 1996, the average recorded investment in impaired loans was approximately $800, and the total interest income recognized on impaired loans was $33 of which $23 was recognized on a cash basis. Changes in the allowance for loan losses are as follows: Years ended December 31, ---------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Balances, beginning of year $ 2,575 2,625 2,551 Provision for loan losses 435 331 282 Recoveries 107 125 83 Loans charged off (679) (506) (291) ------- ------ ------ Balances, end of year $ 2,438 2,575 2,625 ======= ====== ====== Note 6: Bank Premises and Equipment Bank premises and equipment stated at cost, less accumulated depreciation, are as follows: December 31, -------------------- ($ In thousands) 1997 1996 ------ ------ Premises $ 6,148 5,787 Furniture and equipment 4,458 3,936 Construction-in-progress 33 249 -------- ------ 10,639 9,972 Less accumulated depreciation (4,900) (4,935) -------- ------ Total bank premises and equipment $ 5,739 5,037 ======== ====== 33 Notes to Consolidated Financial Statements The Company leases a branch facility as well as certain other office space under noncancellable operating leases that expire over the next six years. The future minimum lease payments under these leases (with initial or remaining lease terms in excess of one year) as of December 31, 1997 are as follows: $78 in 1998, $38 in 1999, $13 in years 2000, 2001 and 2002 and $10 in 2003. Note 7: Time Deposits Included in time deposits are certificates of deposit and other time deposits of $100 or more in the aggregate amounts of $42,547 at December 31, 1997 and $37,414 at December 31, 1996. At December 31, 1997, the scheduled maturities of time deposits are as follows: $128,929 in 1998, $19,451 in 1999, $19,338 in 2000, $3,419 in 2001 and $4,001 in 2002. Note 8: Employee Benefit Plans NBB has a Retirement Accumulation Plan qualifying under IRS Code Section 401(k). Eligible participants in the plan can contribute up to 10% of their total annual compensation to the plan. Employee contributions are matched by NBB based on a percentage of an employee's total annual compensation contributed to the plan. For the years ended December 31, 1997, 1996 and 1995, NBB contributed $87, $83 and $78, respectively, to the plan. Bankshares has a nonleveraged Employee Stock Ownership Plan (ESOP) which enables employees of the sole participating employer, NBB, who have one year of service and who have attained the age of 21 prior to the plan's January 1 and July 1 enrollment dates to own Bankshares common stock. Contributions to the ESOP are determined annually by the Board of Directors. Contribution expense amounted to $219, $200 and $163 for the years ended December 31, 1997, 1996 and 1995, respectively. Dividends on ESOP shares are charged to retained earnings. As of December 31, 1997, the number of allocated shares held by the ESOP was 50,615 and the number of unallocated shares was 22,168. All shares held by the ESOP are treated as outstanding in computing the Company's net income per share. Bankshares or the ESOP has the right of first refusal for any shares distributed to a participant in the event the participant elects to sell the shares. Upon reaching age 55 with ten years of plan participation, a vested participant has the right to diversify 50% of his or her allocated ESOP shares and Bankshares or the ESOP, with the agreement of the Trustee, would be obligated to purchase those shares. The ESOP contains a put option which allows a withdrawing participant to require Bankshares or the ESOP, if the plan administrator agrees, to purchase his or her allocated shares if the shares are not readily tradeable on an established market at the time of its distribution. Since the shares are not readily tradeable, at December 31, 1997, 72,783 shares of stock held by the ESOP, at their estimated fair value, which is based on the most recent available independent valuation, is recorded outside of stockholders' equity. Bankshares does not anticipate any material cash requirements in each of the next five years relating to the purchase of shares held by the ESOP participants. The Company also sponsors two separate noncontributory defined benefit pension plans which cover substantially all of its employees. The pension plans' benefit formulas generally base payments to retired employees upon their length of service and a percentage of qualifying compensation during their final years of employment. The NBB pension plan's assets are invested principally in U.S. Government agency obligations (47%), mutual funds (25%) and equity securities (28%). BTC's pension plan's assets are invested principally in BTC certificates of deposit (22%), U.S. Government agency obligations (36%), U.S. Treasury securities (11%), money market funds (24%) and equity securities (7%). 34 National Bankshares, Inc. and Subsidiaries The plans' funded status at December 31, 1997 and 1996 is as follows: December 31, ---------------- ($ In thousands) 1997 1996 ------ ------ Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $3,027 in 1997 and $3,148 in 1996 $ 3,150 3,252 ======= ======= Projected benefit obligation for service rendered to date (4,967) (5,160) Plan assets at fair value 4,337 3,950 ------- ------- Projected benefit obligation in excess of plan assets (630) (1,210) Unrecognized net transition asset (205) (228) Unrecognized net loss from past experience different from that assumed 459 989 Prior service cost not yet recognized in net pension cost 231 246 ------- ------- Net accrued pension cost (includes accrued pension cost of $352 in 1997 and $346 in 1996 included in other liabilities, and prepaid pension cost of $207 in 1997 and $143 in 1996 included in other assets) $ (145) (203) ======= ======= Net pension cost includes the following (income) expense components: Years ended December 31, -------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Service cost-benefits earned during the year $ 281 327 223 Interest cost on projected benefit obligation 367 353 288 Actual return on plan assets (327) (185) (304) Net amortization and deferral (37) (92) 19 ------ ------ ----- Net pension cost $ 284 403 226 ====== ====== ===== 35 Notes to Consolidated Financial Statements Assumptions used in accounting for the pension plans as of December 31, 1997, 1996 and 1995 are as follows: NBB BTC ----------------------- ---------------------- 1997 1996 1995 1997 1996 1995 ------ ------ ------ ------ ------ ------ Weighted average discount rate 7.50% 7.75% 7.00% 7.50% 7.00% 7.00% Expected long-term rate of return 9.00% 9.00% 9.00% 9.00% 9.00% 7.50% Rate of increase in future compensation 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% Note 9: Income Taxes Total income taxes were allocated as follows: Years ended December 31, -------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Income $ 2,499 2,341 1,933 Stockholders' equity, for net unrealized gains (losses) on securities available for sale recognized for financial reporting purposes 228 (273) 1,047 ------- ------ ----- Total income taxes $ 2,727 2,068 2,980 ======= ====== ===== The components of federal income tax expense attributable to income before income tax expense are as follows: Years ended December 31, -------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Current $ 2,199 2,345 2,053 Deferred 300 (4) (120) ------- ------ ------ Total income tax expense $ 2,499 2,341 1,933 ======= ====== ====== Taxes resulting from securities transactions amounted to a tax expense of $13 for the year ended December 31, 1997, $33 for the year ended December 31, 1996 and $62 for the year ended December 31, 1995. The following is a reconciliation of the "expected" income tax expense, computed by applying the U.S. Federal income tax rate of 34% to income before income tax expense, with the reported income tax expense: 36 National Bankshares, Inc. and Subsidiaries Years ended December 31, -------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Expected income tax expense (34%) $ 3,080 2,876 2,536 Tax-exempt interest income (700) (756) (744) Nondeductible interest expense 90 99 88 Other, net 29 122 53 ------- ------ ------ Reported income tax expense $ 2,499 2,341 1,933 ======= ====== ====== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1997 and 1996 are presented below: December 31, --------------- ($ In thousands) 1997 1996 ------ ------ Deferred tax assets: Loans, principally due to allowance for loan losses and unearned fee income $ 344 545 Other real estate owned, principally due to valuation allowance 23 33 Deferred compensation and other liabilities, due to accrual for financial reporting purpose 114 138 Deposit intangibles and goodwill 42 35 Nonaccrual interest on loans --- 23 Community development corporation related tax credit 26 30 Net unrealized losses on securities available for sale --- 128 ------- ------- Total gross deferred tax assets 549 932 Less valuation allowance --- --- ------- ------- Net deferred tax assets 549 932 ------- ------- Deferred tax liabilities: Bank premises and equipment, principally due to differences in depreciation (16) (12) Securities, due to differences in discount accretion (77) (43) Other assets (62) (55) Net unrealized gains on securities available for sale (100) --- ------- ------- Total gross deferred liabilities (255) (110) ------- ------- Net deferred tax asset included in other assets $ 294 822 ======= ======= 37 Notes to Consolidated Financial Statements The Company has determined that a valuation allowance for the gross deferred tax assets is not necessary at December 31, 1997 and 1996 due to the fact that the realization of the entire gross deferred tax assets can be supported by the amount of taxes paid during the carryback period available under current tax laws. Note 10: Restrictions on Payments of Dividends and Capital Requirements Bankshares' principal source of funds for dividend payments is dividends received from its subsidiary banks. For the years ended December 31, 1997, 1996 and 1995, dividends received from subsidiary banks were $2,712, $1,901 and $1,055, respectively. Substantially all of Bankshares' retained earnings are undistributed earnings of its banking subsidiaries, which are restricted by various regulations administered by federal and state bank regulatory agencies. Bank regulatory agencies restrict, without prior approval, the total dividend payments of a bank in any calendar year to the bank's retained net income of that year to date, as defined, combined with its retained net income of the preceding two years, less any required transfers to surplus. At December 31, 1997, retained net income which was free of such restriction amounted to approximately $7,828. Bankshares and its subsidiaries are subject to various regulatory capital requirements administered by the bank regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bankshares and its subsidiaries must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Bankshares' and its subsidiaries' capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require Bankshares and its subsidiaries to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1997, that Bankshares and its subsidiaries meet all capital adequacy requirements to which they are subject. Bankshares' and its subsidiaries' actual regulatory capital amounts and ratios are also presented in the following tables. 38 National Bankshares, Inc. and Subsidiaries To Be Well Capitalized Under Prompt For Capital Corrective Adequacy Action Actual Purposes Provisions ------------- ------------- ------------- ($ In thousands) Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- December 31, 1997 Total capital (to risk weighted assets) Bankshares consolidated $57,198 23.3% 19,652 8.0% N/A N/A NBB 28,825 17.4% 13,232 8.0% 16,540 10.0% BTC 28,313 34.7% 6,527 8.0% 8,159 10.0% Tier I capital (to risk weighted assets) Bankshares consolidated $54,760 22.3% 9,826 4.0% N/A N/A NBB 27,084 16.4% 6,616 4.0% 9,924 6.0% BTC 27,616 33.9% 3,264 4.0% 4,895 6.0% Tier I capital (to average assets) Bankshares consolidated $54,760 13.7% 15,988 4.0% N/A N/A NBB 27,084 12.1% 8,985 4.0% 11,231 5.0% BTC 27,616 15.8% 7,003 4.0% 8,754 5.0% To Be Well Capitalized Under Prompt For Capital Corrective Adequacy Action Actual Purposes Provisions ------------- ------------- ------------- ($ In thousands) Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- December 31, 1996 Total capital (to risk weighted assets) Bankshares consolidated $53,193 23.0% 18,497 8.0% N/A N/A NBB 26,175 16.3% 12,855 8.0% 16,069 10.0% BTC 27,007 38.3% 5,642 8.0% 7,052 10.0% Tier I capital (to risk weighted assets) Bankshares consolidated $50,618 21.9% 9,249 4.0% N/A N/A NBB 24,171 15.0% 6,428 4.0% 9,641 6.0% BTC 26,436 37.5% 2,821 4.0% 4,231 6.0% Tier I capital (to average assets) Bankshares consolidated $50,618 13.0% 15,620 4.0% N/A N/A NBB 24,171 11.2% 8,636 4.0% 10,795 5.0% BTC 26,436 15.1% 6,984 4.0% 8,730 5.0% As of December 31, 1997, the most recent notifications from the appropriate regulatory authorities categorized Bankshares and its subsidiaries as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized, Bankshares and its subsidiaries must maintain minimum total risk-based, Tier 39 Notes to Consolidated Financial Statements I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since those notifications that management believes have changed Bankshares' and its subsidiaries' category. Note 11: Parent Company Financial Information Condensed financial information of National Bankshares, Inc. (Parent) is presented below: Condensed Balance Sheets December 31, ----------------- ($ In thousands, except share and per share data) 1997 1996 ------ ------ Assets Cash due from subsidiaries $ 69 20 Investment in subsidiaries, at equity 55,807 51,434 Refundable income taxes due from subsidiaries 22 25 -------- ------- Total assets $ 55,898 51,479 ======== ======= Liabilities Other liabilities $ 31 35 and -------- ------- Stockholders' Common stock subject to ESOP Equity put option (note 8) 1,838 1,643 -------- ------- Stockholders' equity (notes 9, 10 and 16): Preferred stock of no par value. Authorized 5,000,000 shares; none issued and outstanding --- --- Common stock of $2.50 par value. Authorized 5,000,000 shares; issued and outstanding 3,792,833 shares 9,482 9,482 Retained earnings 46,191 42,210 Net unrealized gains (losses) on securities available for sale 194 (248) Common stock subject to ESOP put option (72,783 shares at $25.25 per share in 1997 and 64,796 shares at $25.35 per share in 1996) (note 8) (1,838) (1,643) -------- ------- Total stockholders' equity 54,029 49,801 Commitments and contingent liabilities (notes 6, 8, 13 and 16) -------- ------- Total liabilities and stockholders' equity $ 55,898 51,479 ======== ======= 40 National Bankshares, Inc. and Subsidiaries Condensed Statements of Income Years ended December 31, ---------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Income Dividends from subsidiaries (note 10) $2,712 1,901 1,055 Expenses Other expenses 125 232 285 ------ ------ ------ Income before income tax benefit and equity in undistributed net income of subsidiaries 2,587 1,669 770 Applicable income tax benefit 42 41 97 ------ ------ ------ Income before equity in undistributed net income of subsidiaries 2,629 1,710 867 Equity in undistributed net income of subsidiaries 3,931 4,407 4,658 ------ ------ ------ Net income $6,560 6,117 5,525 ====== ====== ====== 41 Notes to Consolidated Financial Statements Condensed Statements of Cash Flows Years ended December 31, ---------------------------- ($ In thousands) 1997 1996 1995 ------ ------ ------ Cash Flows Net income $ 6,560 6,117 5,525 from Adjustments to reconcile Operating net income to net cash Activities provided by operating activities: Equity in undistributed net income of subsidiaries (3,931) (4,407) (4,658) Decrease in other assets --- --- 3 Decrease in refundable income taxes due from subsidiaries 3 88 162 Decrease in other liabilities (4) (5) (9) ------- ------ ------ Net cash provided by operating activities 2,628 1,793 1,023 ------- ------ ------ Cash Flows Cash dividends paid (2,579) (1,787) (1,080) from ------- ------ ------ Financing Activities Net cash used in financing activities (2,579) (1,787) (1,080) ------- ------ ------ Net increase (decrease) in cash 49 6 (57) Cash due from subsidiary at beginning of year 20 14 71 ------- ------ ------ Cash due from subsidiary at end of year $ 69 20 14 ======= ====== ====== Note 12: Supplemental Cash Flow Information The Company paid $13,084, $13,080 and $12,533 for interest and $2,719, $1,839 and $1,942 for income taxes, net of refunds, in 1997, 1996 and 1995, respectively. Noncash investing activities consisted of $679, $506 and $291 of loans charged against the allowance for loan losses in 1997, 1996 and 1995, respectively. Noncash investing activities also included $159 in 1997 and $28 in 1996 of loans transferred to other real estate owned. In addition, for the years ended December 31, 1997, 1996 and 1995, noncash investing activities included changes in net unrealized gains (losses) on securities available for sale of $670, ($803) and $3,080, respectively, changes in deferred tax assets included in other assets of ($228), $273 and ($1,047), respectively, and changes in net unrealized gains (losses) on securities available for sale included in stockholders' equity of $442, ($530) and $2,033, respectively. Securities, classified as held to maturity, totaling approximately $30,200, were transferred to securities available for sale in 1995. This was in accordance with the one-time reassessment of the classification of securities allowed by the Financial Accounting Standards Board. 42 National Bankshares, Inc. and Subsidiaries Note 13: Financial Instruments with Off-Balance Sheet Risk The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company may require collateral or other security to support the following financial instruments with credit risk: December 31, -------------------- ($ In thousands) 1997 1996 ------ ------ Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $37,700 32,087 ======= ====== Standby letters of credit $ 1,949 1,380 ======= ====== Mortgage loans sold with potential recourse $19,231 18,271 ======= ====== Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if required by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. Extensions of credit arising from these commitments are predominantly variable rate in nature; the principal exception being construction loans which are at fixed rates, but have terms generally less than one year. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. The Company originates mortgage loans for sale to secondary market investors subject to contractually specified and limited recourse provisions. In 1997, the Company originated $19,120 and sold $19,231 to investors, 43 Notes to Consolidated Financial Statements compared to $17,907 originated and $18,271 sold in 1996. Every contract with each investor contains certain recourse language. In general, the Company may be required to repurchase a previously sold mortgage loan if there is major noncompliance with defined loan origination or documentation standards, including fraud, negligence or material misstatement in the loan documents. Repurchase may also be required if necessary governmental loan guarantees are canceled or never issued, or if an investor is forced to buy back a loan after it has been resold as a part of a loan pool. In addition, the Company may have an obligation to repurchase a loan if the mortgagor has defaulted early in the loan term. This potential default period is approximately twelve months after sale of a loan to the investor. Note 14: Concentrations of Credit Risk The Company does a general banking business, serving the commercial, agricultural and personal banking needs of its customers. NBB's trade territory, commonly referred to as the New River Valley, consists of Montgomery and Giles Counties, Virginia and portions of adjacent counties. NBB's operating results are closely correlated with the economic trends within this area which are, in turn, influenced by the area's three largest employers, Virginia Polytechnic Institute and State University, Montgomery County Schools and Celanese. Other industries include a wide variety of manufacturing, retail and service concerns. Most of BTC's business originates from the communities of Tazewell and Bluefield and other communities in Tazewell County, Virginia and in Mercer County, West Virginia. BTC's service area has largely depended on the coal mining industry and farming for its economic base. In recent years, coal companies have mechanized and reduced the number of persons engaged in the production of coal. There are still a number of support industries for the coal mining business that continue to provide employment in the area. Additionally, several new businesses have been established in the area and Bluefield, West Virginia has begun to emerge as a regional medical center. The ultimate collectibility of the loan portfolios and the recovery of the carrying amounts of repossessed property are susceptible to changes in the market conditions of these areas. At December 31, 1997 and 1996, approximately $80,000 and $71,000, respectively, of the loan portfolio were concentrated in commercial real estate. This represents approximately 37% and 36% of the loan portfolio at December 31, 1997 and 1996, respectively. Included in commercial real estate at December 31, 1997 and 1996 was approximately $50,000 and $49,000, respectively, in loans for college housing and professional office buildings. Loans secured by residential real estate were approximately $65,000 and $60,000 at December 31, 1997 and 1996, respectively. This represents approximately 30% and 31% of the loan portfolio at December 31, 1997 and 1996, respectively. Loans secured by automobiles were approximately $34,000 and $29,000 at December 31, 1997 and 1996, respectively. This represents approximately 16% of the loan portfolio at December 31, 1997 and 15% at December 31, 1996. The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property and with loan amounts established based on certain percentage limitations of the property's total stated or appraised value. Credit approval is primarily a function of collateral and the evaluation of the creditworthiness of the individual borrower or project based on available financial information. Interest-bearing deposits with banks represent deposits with the Federal Home Loan Bank of Atlanta. Management considers the concentration of credit risk to be minimal. 44 National Bankshares, Inc. and Subsidiaries Note 15: Fair Value of Financial Instruments The estimated fair values of the Company's financial instruments at December 31, 1997 and 1996 are as follows: December 31, ------------------------------------------ 1997 1996 -------------------- -------------------- ($ In thousands) Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------- ---------- -------- ---------- Financial assets: Cash and due from banks $ 12,435 12,435 9,989 9,989 Interest-bearing deposits 9,728 9,728 91 91 Federal funds sold 4,300 4,300 1,910 1,910 Securities 149,974 150,587 171,244 171,289 Mortgage loans held for sale 405 405 516 516 Loans, net 214,552 215,285 193,598 192,201 -------- ------- ------- ------- Total financial assets $391,394 392,740 377,348 375,996 ======== ======= ======= ======= Financial liabilities: Deposits 344,867 344,589 334,584 331,758 Other borrowed funds 485 485 627 627 -------- ------- ------- ------- Total financial liabilities $345,352 345,074 335,211 332,385 ======== ======= ======= ======= Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgements regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in assumptions could significantly affect these estimates. Fair value estimates are based on existing on-and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred tax assets and the bank premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. Note 16: Business Combination and Pending Acquisition On June 1, 1996, Bankshares issued 1,888,209 shares of its common stock in a one-for-one exchange for all the outstanding common stock of Bank of Tazewell County, Tazewell, Virginia. This business combination has been 45 Notes to Consolidated Financial Statements accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements for the periods prior to the combination have been restated to include the accounts and results of operations of Bank of Tazewell County. There were no adjustments of a material amount resulting from Bank of Tazewell County's adoption of Bankshares' accounting policies. In May 1996, Bankshares declared a stock split of .11129 per share effected in the form of a stock dividend to the holders of Bankshares common stock just prior to the merger effective date to facilitate the one-for-one common stock exchange ratio. All stockholders' equity accounts, share and per share data have been adjusted retroactively to reflect the stock split. The results of operations previously reported by the separate enterprises and the combined amounts presented in the accompanying financial statements are summarized below: Six months Year ended ended June 30, December 31, ($ In thousands) 1996 1995 ------ ------ Revenues: National Bankshares, Inc. $ 9,286 17,848 Bank of Tazewell County 6,166 12,628 ------- ------- Combined $15,452 30,476 ======= ======= Net Income: National Bankshares, Inc. $ 1,883 3,256 Bank of Tazewell County 1,106 2,269 ------- ------- Combined $ 2,989 5,525 ======= ======= On December 26, 1997, NBB entered into an agreement to purchase the assets, including real estate and improvements, and assume the liabilities of the Galax, Virginia, branch office of First American Federal Savings Bank. The transaction, which is subject to regulatory approval, is expected to close in early 1998 and is not expected to have a material impact on the Company's results of operations or liquidity. Note 17: Future Accounting Considerations In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." Statement 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements. Statement 130 was issued to address concerns over the practice of reporting elements of comprehensive income directly in equity. This Statement requires all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed in equal prominence with the other financial statements. It does not require a specific format for that financial statement but requires that an enterprise display an amount representing total comprehensive income for the period in that financial statement. Enterprises are required to classify items of "other 46 National Bankshares, Inc. and Subsidiaries comprehensive income" by their nature in the financial statement and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in-capital in the equity section of a statement of financial position. It does not require per share amounts of comprehensive income to be disclosed. Statement 130 is effective for fiscal years beginning after December 15, 1997. Earlier application is permitted. Comparative financial statements provided for earlier periods are required to be reclassified to reflect the provisions of this statement. Publicly traded enterprises that issue condensed financial statements for interim periods are required to report a total for comprehensive income in those financial statements. Adoption of Statement 130 on January 1, 1998 will not have any effect on the Company's consolidated financial position, results of operation or liquidity. However, Statement 130 will have an effect on future financial statement displays presented by the Company since the Company has net unrealized gains (losses) on securities available for sale, an item of other comprehensive income, which is included in the consolidated statements of changes in stockholders' equity. In June 1997, the FASB issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information." Statement 131 establishes standards for the way public business enterprises are to report information about operating segments in annual financial statements and requires those enterprises to report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. Statement 131 is effective for financial statements for periods beginning after December 15, 1997. It is not anticipated that Statement 131 will have any material effect on current or prior period disclosures presented by the Company. In February 1998, the FASB issued Statement No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement standardizes the disclosure requirements for pensions and other postretirement benefits, requires additional information on changes in the benefit obligations and fair values of assets and eliminates certain existing disclosure requirements. Statement 132 is effective for fiscal years beginning after December 15, 1997 and will impact future disclosures of the Company's defined benefit pension plans. 47 National Bankshares, Inc. Board of Directors (Picture of National Bankshares, Inc. Board of Directors) Paul A. Duncan, Holiday Motor Corp., President; Alonzo A. Crouse, Bank of Tazewell County, Executive Vice President, Secretary and Cashier; R.E. Dodson, Bank of Tazewell County, President and Chief Executive Officer; Charles L. Boatwright, Vice Chairman of the Board, Physician; James G. Rakes, National Bankshares, Inc., The National Bank, President and Chief Executive Officer; William T. Peery, Cargo Oil Co., Inc., President; Robert E. Christopher, Jr., Chairman of the Board, Retired; Jeffrey R. Stewart, Educational Consultant; T.C. Bowen, Jr., Attorney 48 The National Bank and Bank of Tazewell County Boards of Directors (Picture of The James G. Rakes, National Bankshares, Inc., The National National Bank Bank, President and Chief Executive Officer; Charles Board of Directors) L. Boatwright, Vice Chairman of the Board, Physician; Robert E. Christopher, Jr., Chairman of the Board, Retired; L. Allen Bowman, Litton Poly-Scientific, Retired President; Jeffrey R. Stewart, Educational Consultant; Paul A. Duncan, Holiday Motor Corp., President; James M. Shuler, Companion Animal Clinic, Inc., President, Virginia House of Delegates, Delegate; Paul P. Wisman, Grundy National Bank, Vice President of Investments, Nicewonder Investments, Manager of Assets; J. Lewis Webb, Jr., Dentist (Picture of Bank Alonzo A. Crouse, Bank of Tazewell County, Executive Vice of Tazewell County President, Secretary and Cashier; James G. Rakes, Board of Directors) National Bankshares, Inc., The National Bank, President and Chief Executive Officer; William T. Peery, Cargo Oil Co., Inc. President; R. E. Dodson, Bank of Tazewell County, President and Chief Executive Officer; James S. Gillespie, Jr., Jim Sam Gillespie Farm, President; T.C. Bowen, Jr., Chairman of the Board, Attorney; James A. Deskins, Deskins Super Market, Inc., President; Carl C. Gillespie, Honorary Chairman of the Board, Attorney; Jack H. Harry, Harry's Enterprises, Inc., President; J.M. Pope, Retired, Charles E. Green, III, Registered Representative, The Equitable Life Assurance Society of the United States; E.P.Greever, Retired; William H. VanDyke, Candlewax Smokeless Fuel Co., Vice President The National Bank Advisory Boards Montgomery County Advisory Board Dan A. Dodson, W. Clinton Graves, James J. Owen, Arlene A. Saari, James C. Stewart, T. Cooper Via Giles Advisory Board Paul B. Collins, John H. Givens, Jr., Ross E. Martin, Kenneth L. Rakes, Scarlet B. Ratcliffe, H.M. Scanland, Jr., Buford Steele 49 Corporate Information National Bankshares, Inc. Officers James G. Rakes Joan C. Nelson President and Chief Executive Officer Corporate Officer J. Robert Buchanan Shelby M. Evans Treasurer Corporate Compliance Officer Marilyn B. Buhyoff David K. Skeens Secretary and Counsel Corporate Auditor F. Brad Denardo Corporate Officer Annual Meeting The Annual Meeting of Stockholders will be held on Tuesday, April 14, 1998 at 3:00 p.m. at the Best Western Red Lion Inn, 900 Plantation Road, Blacksburg, Virginia. Corporate Stock The common stock of National Bankshares, Inc. is traded over the counter, and certain trades are reported on the OTC Bulletin Board under the symbol "NKSH." Financial Information Investors and analysts seeking financial information about National Bankshares, Inc. should contact: James G. Rakes or J. Robert Buchanan President and Chief Executive Officer Treasurer (540)552-2011 or (540)552-2011 or (800)552-4123 (800)552-4123 Written requests may be directed to: National Bankshares, Inc., P.O. Box 90002, Blacksburg, VA 24062-9002. Stockholder Services and Stock Transfer Agent Stockholders seeking information about National Bankshares, Inc. stock accounts should contact: Marilyn B. Buhyoff Secretary and Counsel (540)552-2011 or (800)552-4123 The National Bank of Blacksburg serves as transfer agent for National Bankshares, Inc. stock. Written requests and requests for stock transfers may be directed to: National Bankshares, Inc., P.O. Box 90002, Blacksburg, VA 24062-9002. A copy of National Bankshares, Inc.'s annual report to the Securities and Exchange Commission on Form 10-K will be furnished without charge to any stockholder upon written request. Corporate Office National Bankshares, Inc. 100 South Main Street Blacksburg, VA 24060 P.O. Box 90002 Blacksburg, VA 24062-9002 50 EX-27 3 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE YEAR-END 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-K. 1,000 12-MOS DEC-31-1997 DEC-31-1997 12,435 9,728 4,300 0 65,582 84,392 85,005 216,990 2,438 402,907 344,867 485 3,526 0 0 0 9,482 44,547 402,907 19,553 9,563 681 29,797 13,089 13,106 16,691 435 37 10,031 9,059 9,059 0 0 6,560 1.73 1.73 4.75 87 672 0 177 2,575 679 107 2,438 2,438 0 1,742
EX-99 4 INDEPENDENT AUDITOR'S REPORT BTC COOK ASSOCIATES, LLP CERTIFIED PUBLIC ACCOUNTANTS MEMBERS: DIVISION FOR CPA FIRMS AICPA AND THE VIRGINIA SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS ORIGINATING OFFICE P.O. BOX 580 RICHLANDS, VIRGINIA INDEPENDENT AUDITOR'S REPORT To the Board of Directors Bank of Tazewell County Tazewell, Virginia We have audited the accompanying balance sheets of Bank of Tazewell County as of December 31, 1995 and 1994, and the related statements of income, changes in stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Bank of Tazewell County as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles. As discussed in Note 1 and 11 to the financial statements, Bank of Tazewell County adopted the provisions of Statement of Financial Accounting Standards No.'s 114 and 118, "Accounting by Creditors for Impairment of a Loan," as of January 1, 1995. Cook Associates, LLP February 27, 1996 -----END PRIVACY-ENHANCED MESSAGE-----