-----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, QSqi4XwYZ6kk22BbguQhQZbDjos7I9+J9Xq3i2reYHFLfwQELieC3LU+OrP5bblo c3eJavIqvYXSZ04Ws3qxjw== 0000796534-00-000004.txt : 20000331 0000796534-00-000004.hdr.sgml : 20000331 ACCESSION NUMBER: 0000796534-00-000004 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 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: 585261 BUSINESS ADDRESS: STREET 1: 100 SOUTH MAIN ST CITY: BLACKSBURG STATE: VA ZIP: 24062-9002 BUSINESS PHONE: 5405522011 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 1999 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, 1999 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) 101 Hubbard 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 15, 2000 was $65,666,075. (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 15, 2000 - ------------------------------ ------------------------------- Common Stock, $2.50 Par Value 3,516,977 DOCUMENTS INCORPORATED BY REFERENCE Selected information from the Registrants' Annual Report to Stockholders for the year ended December 31, 1999, 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 11, 2000 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 42 pages.) -- (The Index of Exhibits are on pages 41-42.) National Bankshares, Incorporated Annual Report For 1999 on Form 10-K Table of Contents Page ---- Part I Item 1. Business 4 Item 2. Properties 30 Item 3. Legal Proceedings 30 Item 4. Submission of Matters to a Vote of Security Holders 30 Executive Officers of the Registrant 31 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 32 Item 6. Selected Financial Data 32 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 32 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 32 Item 8. Financial Statements and Supplementary Data 36 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 36 Part III Item 10. Directors and Executive Officers of the Registrant 36 Item 11. Executive Compensation 36 Item 12. Security Ownership of Certain Beneficial Owners and Management 36 Item 13. Certain Relationships and Related Transactions 37 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 37 Signatures 40 Index to Exhibits 41 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). Except for a separate investment portfolio, Bankshares conducts all of its business 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 nine 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. At December 31, 1999, NBB had total assets of $278,016. Total deposits at this date were $233,245. NBB's net income for 1999 was $4,873 which produced a return on average assets of 1.79% and a return on average stockholders' equity of 17.32%. Refer to footnote 11 of the Company's 1999 Annual Report to Stockholders for NBB's risk-based capital ratios. -3- 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 new institution became Farmers Bank of Clinch Valley. Bank of 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. At December 31, 1999 BTC had total assets of $198,735. Total deposits at this same date were $173,963. BTC's net income for 1999 was $2,215 which produced a return on average assets of 1.21% and a return on average stockholders' equity of 8.67%. Refer to footnote 11 of the Company's 1999 Annual Report to Stockholders for BTC's risk-based capital ratios. 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. 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. Some loans originated by BTC are held in the bank's loan portfolio and others are sold in the secondary market. In their secondary market operations, NBB and BTC 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. -4- 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. 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. 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. 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. -5- The following table sets forth, for the three fiscal years ended December 31, 1999, 1998 and 1997 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. Percentage of Period Class of Service Total Revenues ------ ---------------- -------------- December 31, 1999 Interest and Fees on Loans 64.95% Interest on Investments 24.41% December 31, 1998 Interest and Fees on Loans 61.97% Interest on Investments 25.99% December 31, 1997 Interest and Fees on Loans 59.92% Interest on Investments 29.31% Market Area The National Bank of Blacksburg Market Area NBB's primary market area consists of the northern portion of Montgomery County, all of Giles County, the City of Galax and adjacent portions of Carroll and Grayson Counties, 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 1999 and 1998 the unemployment rate in Montgomery County was 1.9% and 2.6% in 1997, and the rate in Giles County during those years was 6.2% in 1999, 5.8% in 1998 and 6.7% in 1997. The City of Galax had an unemployment rate of 4.3% in 1999, 3.9% in 1998 and 2.6% in 1997. 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 Celanese Corp. plant, a manufacturer of 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 a small number of these temporary layoffs have become permanent. The City of Galax is located in the Virginia-North Carolina furniture- manufacturing region. Three furniture companies, Vaughan Bassett Furniture Company, Vaughan Furniture Company, Inc. and Webb Furniture Company together employ the largest percentage of the area's work force. The Galax economy is stable. Several other small manufacturing concerns are located in Montgomery and Giles Counties and in the City of Galax. These concerns manufacture diverse products and are not dependent on one sector of the economy. Agriculture and tourism are also important to the region, especially in Giles County and in the area near Galax. -6- 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, with an approximate population of 77,000, has experienced moderate population growth and this trend is predicted to continue. Neighboring Giles County is more rural, with a total population of approximately 16,500. The population of Giles County is expected to slowly decline over the next few years. It is not anticipated that this decline will materially impact NBB's business in Giles County. The City of Galax has a population of approximately 7,000, and the neighboring, mostly rural, counties of Carroll and Grayson have a total of approximately 50,000 in habitants. The area's population is stable, and no dramatic changes are predicted. 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 1999 and 1998 the unemployment rate for Tazewell County was 7.0% and in 1997 9.5%. In the same years, Mercer County, West Virginia's unemployment rate was 4.7%, 4.2% and 5.3%, 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 new competition from non- traditional financial services provides 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 -7- 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 officers, and conducts substantially all of its operations through its subsidiaries. All 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, 1999, NBB employed 117 full time equivalent employees at its main office, operations center and branch offices. BTC at December 31, 1999 employed 68 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 Gramm-Leach-Bliley Act of 1999. 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 any additional information the Federal Reserve Board may require under 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 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 the acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of the 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 -8- 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 Board, by order or regulation, has found those activities to be so closely related to banking or managing or controlling banks as to be incident to banking. Under recent amendments to the BHCA, included in the Gramm-Leach- Bliley Act of 1999 (see below), any bank holding company, all the depository institution subsidiaries of which are well-capitalized, well managed (as those terms are defined in the BHCA) and have a satisfactory or better rating under the Community Reinvestment Act as of their last examination, may file an election with the Federal Reserve Board to become a Financial Holding Company. A Financial Holding Company may engage in any activity that is (i) financial in nature (ii) incidental to a financial activity or (iii) complementary to a financial activity. The BHCA provides a long list of "financial activities", including: insurance underwriting; securities dealing and underwriting; providing financial, investment or economic arising services; and merchant banking activities. Financial Holding Companies may also engage in other activities that the Federal Reserve Board has determined are permissible under the BHCA, by regulation or order. 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 these 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 Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act (the GLBA), enacted on November 12, 1999, was a broad rewrite of financial services legislation. The GLBA permits significant combinations among different sectors of the financial services industry; allows for significant expansion of financial service activities by Bank holding companies and provides for a regulatory framework by various governmental authorities responsible for different financial activities; and offers certain financial privacy protections to consumers. The GLBA repealed affiliation and management interlock prohibitions of the Depression-era Glass-Steagall Act and, by amending the Bank Holding Companies, the GLBA added new substantive provisions to the non-banking activities permitted under the BHCA with the creation of the financial holding company. The GLBA preempts most state laws that prohibit financial holding companies from engaging in insurance activities. The GLBA permits affiliations between banks and securities firms within the same holding company structure, and the Act permits financial holding companies to directly engage in a broad range securities and merchant banking activities. -9- The Gramm-Leach-Bliley Act will lead to important changes in the manner in which financial services are delivered in the United States. Bank holding companies and their subsidiary banks will be able to offer a much broader array of financial services; however, there will be greater competition in all sectors of the financial services market. 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 under Virginia law by the Commission have been complied with, and may make examinations of any bank holding company and its subsidiaries. The Virginia Banking Act allows 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. The Virginia Banking Act permits bank holding companies from throughout the United States to enter the Virginia market, subject to federal and state approval. 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 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, these 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. -10- 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 locations. The 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, this 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". Federal Deposit Insurance Corporation Improvement Act of 1991. 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. 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. 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 -11- 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. 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. 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. 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. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the Interstate Act) 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 also permits banks to acquire out-of-state branches through -12- interstate mergers, if the state has not opted out of interstate branching. 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. 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 these branches are 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. 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 has increased 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. Beginning in 1997, all banks, including NBB and BTC, were subject to an additional 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. Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act of 1999 (the GLBA) allows national banks, with OCC approval, to acquire financial subsidiaries to engage in any activity that is financial in nature or incidental to a financial activity, as defined in the Bank Holding Act, except (i) insurance underwriting, (ii) merchant or insurance portfolio investments, and (iii) real estate development or investment. Well-capitalized national banks are also given the authority to engage in municipal bond underwriting. -13- To establish or acquire a financial subsidiary, a national bank must be well- managed, and the consolidated assets of its financial subsidiary must not exceed the lesser of 45% of the consolidated total assets of the bank or $50 billion. Relationship between a national bank and a financial subsidiary are subject to a variety of supervisory enhancements from regulators. The GLBA also provides that state banks that establish or acquire financial subsidiaries are required to comply with the same safeguards imposed on the financial subsidiaries of national banks. 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. 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 -14- 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 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 CAMELS 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 -15- 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. 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 or 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 (The Company) 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 1999 1998 1997 ---- ---- ---- Cash and due from banks $ 12,820 10,281 9,954 Interest bearing deposits 5,263 12,889 4,165 Federal funds sold 2,926 6,389 8,181 Securities available for sale: Taxable 95,979 94,247 54,213 Nontaxable 29,286 29,284 6,312 Securities held to maturity: Taxable 8,940 9,972 67,046 Nontaxable 17,219 18,929 29,608 Mortgage loans held for sale 709 1,017 413 Loans, net 266,431 225,613 204,540 Other assets 14,616 12,367 11,500 -------- ------- ------- Total assets $454,189 420,988 395,932 ======== ======= ======= Liabilities and Stockholders' Equity Noninterest-bearing demand deposits $ 55,700 49,552 44,193 Interest-bearing demand deposits 85,284 77,842 75,519 Savings deposits 46,792 47,475 47,781 Time deposits 203,807 185,101 171,946 -------- ------- ------- Total deposits 391,583 359,970 339,439 Short-term borrowings 4,228 216 319 Other liabilities 2,182 2,520 2,462 -------- ------- ------- Total liabilities 397,993 362,706 342,220 Stockholders' equity 56,196 58,282 53,712 ------- ------- ------- Total liabilities and stockholders' equity $454,189 420,988 395,932 ======== ======= ======= -17- B. Analysis of Net Interest Earnings The following table shows the major categories of interest-earning assets and interest-bearing liabilities, the interest earned or paid, the average yield or rate on the daily average balance outstanding, net interest income and net yield on average interest-earning assets for the years indicated.
December 31, 1999 December 31, 1998 December 31, 1997 Average Average Average Average Yield/ Average Yield/ Average Yield/ ($ in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate ------- -------- ------- ------- -------- ------- ------- -------- ------- Interest-earning assets: Loans, net (1)(2)(3) $267,140 24,244 9.08% 226,630 21,726 9.59% $204,953 19,667 9.60% Taxable securities 104,919 6,820 6.50% 104,219 7,201 6.91% 121,259 7,776 6.41% Nontaxable securities (1) 46,505 3,414 7.34% 48,213 2,899 6.01% 35,920 2,708 7.54% Federal funds sold 2,926 170 5.81% 6,389 345 5.40% 8,181 470 5.75% Interest bearing deposits 5,263 269 5.11% 12,889 696 5.40% 4,165 230 5.52% -------- ------- ------- ------- -------- ------- Total interest-earning assets $426,753 34,917 8.18% 398,340 32,867 8.25% $374,478 30,851 8.24% ======== ======= ======= ======= ======== ======= Interest-bearing liabilities: Interest-bearing demand deposits $ 85,284 2,129 2.50% 77,842 2,203 2.83% $ 75,519 2,161 2.86% Savings deposits 46,792 1,212 2.59% 47,475 1,511 3.18% 47,781 1,571 3.29% Time deposits 203,807 10,630 5.22% 185,101 10,203 5.51% 171,946 9,357 5.44% Short-term borrowings 4,228 232 5.49% 216 11 5.09% 319 17 5.33% Long-term debt --- --- --- --- --- --- --- --- --- -------- ------- ------- ------- -------- ------- Total interest- bearing liabilities $340,111 14,203 4.18% 310,634 13,928 4.48% 295,565 13,106 4.43% ======== ======= ======= ======= ======== ======= Net interest income and interest rate spread 20,714 4.00% 18,939 3.77% 17,745 3.81% Net yield on average interest-earning assets 4.85% 4.75% 4.74% (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 $680 in 1999, $414 in 1998 and $339 in 1997 are included in total interest income. (3) Nonaccrual loans are included in average balances for yield computations.
-18- C. Analysis of Changes in Interest Income and Interest Expense The Company's primary source of revenue is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other funds. The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities and by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities. The following table sets forth, for the years indicated, a summary of the changes in interest income and interest expense resulting from changes in average asset and liability balances (volume) and changes in average interest rates (rate).
1999 Over 1998 1998 Over 1997 ------------------------------ ------------------------------- Changes Due To Changes Due To -------------- -------------- Net Dollar Net Dollar ($ in thousands) Rates(2) Volume(2) Change Rates(2) Volume(2) Change -------- --------- ---------- -------- --------- ---------- Interest income:(1) Loans $(1,206) 3,724 2,518 (19) 2,078 2,059 Taxable securities (429) 48 (381) 572 (1,147) (575) Nontaxable securities 621 (106) 515 (618) 809 191 Federal funds sold 24 (199) (175) (98) (27) (125) Interest bearing deposits (35) (392) (427) 471 (5) 466 ------- ------ ------ ------ ------ ------ Increase(decrease) in income on interest-earning assets $(1,025) 3,075 2,050 308 1,708 2,016 ------- ------ ------ ------ ------ ------ Interest expense: Interest-bearing demand deposits $ (273) 199 (74) 66 (24) 42 Savings deposits (278) (21) (299) (50) (10) (60) Time deposits (568) 995 427 724 122 846 Short-term borrowings 1 220 221 (1) (5) (6) ------- ------ ------ ------ ------ ------ Increase(decrease) in expense of interest-bearing liabilities $(1,118) 1,393 275 739 83 822 -------- ------ ------ ------ ------ ------ Increase (decrease) in net interest income $ 93 1,682 1,775 (431) 1,625 1,194 ======= ====== ====== ====== ====== ====== (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, 1999, 1998 and 1997 were as follows:
December 31, 1999 1998 1997 ---- ---- ---- Amortized Fair Amortized Fair Amortized Fair ($ in thousands) Costs Values Costs Values Costs Values --------- ------ --------- ------ --------- ------ Available for sale: U.S. Treasury $ 6,244 6,164 9,253 9,671 6,742 6,862 U.S. Government agencies and corporations 50,373 47,498 59,365 59,595 36,252 36,276 States and political subdivisions 32,903 31,617 32,183 32,865 9,540 9,639 Mortgage-backed securities (1) 13,464 13,176 17,282 17,200 4,172 4,119 Corporate debt securities 14,349 13,646 14,528 14,824 7,780 7,824 Federal Home Loan Bank stock 1,329 1,329 1,214 1,214 537 537 Federal Reserve Bank stock 247 247 247 247 247 247 Other securities 168 168 462 462 18 78 -------- ------- ------- ------- ------- ------- Total securities available for sale $119,077 113,845 134,534 136,078 65,288 65,582 ======== ======= ======= ======= ======= ======= The amortized costs of securities held to maturity as of December 31, 1999, 1998 and 1997 were as follows: December 31, ($ in thousands) 1999 1998 1997 ---- ---- ---- Held to maturity: U.S. Treasury $ 500 1,006 7,527 U.S. Government agencies and corporations 5,500 7,497 36,853 States and political subdivisions 17,283 21,160 32,949 Mortgage-backed securities (1) 364 513 630 Corporate --- 500 6,433 ------- ------- ------- Total securities held to maturity $23,647 30,676 84,392 ======= ======= ======= (1) The majority of mortgage-backed securities and collateralized mortgage obligations held at December 31, 1999 were backed by U.S. agencies. Certain holdings are required to be periodically subjected to the Financial Institution Examination Council's (FFIEC) high risk mortgage security test. These tests address possible fluctuations in the average life and price sensitivity which are the primary risks associated with this type of security. Such tests are usually subject to regulatory review. Except for U.S. Government securities, the Company has no securities with any issuer that exceeds 10% of stockholders' equity.
-20- B. Maturities and Associated Yields The following table presents the maturities for those securities available for sale and held to maturity as of December 31, 1999 and weighted average yield for each range of maturities.
Maturities and Yields December 31, 1999 ($ in thousands except for % data) < 1 Year 1-5 Years 5-10 Years > 10 Years None Total -------- --------- ---------- ---------- ---- ------- Available for Sale ------------------ U.S. Treasury $ --- 5,203 961 --- --- $ 6,164 ---% 6.03% 5.67% ---% ---% 5.97% U.S. Government agencies 4,001 5,854 23,188 14,455 --- 47,498 5.95% 6.20% 6.53% 6.67% ---% 6.48% Mortgage-backed securities --- --- 2,142 11,035 --- 13,177 ---% ---% 5.97% 7.16% ---% 6.95% States and Political --- 1,701 494 1,287 --- 3,482 Subdivision - taxable ---% 7.24% 7.40% 7.77% ---% 6.73% States and Political Subdivision --- 5,710 8,436 13,990 --- 28,136 - nontaxable(1) ---% 7.20% 7.36% 7.03% ---% 7.16% Corporate --- 992 6,299 6,354 --- 13,645 ---% 6.23% 6.75% 6.79% ---% 6.73% Federal Home Loan Bank stock --- --- --- --- 1,329 1,329 ---% ---% ---% ---% 7.75% 7.75% Federal Reserve Bank stock --- --- --- --- 247 247 ---% ---% ---% ---% 6.00% 6.00% Other securities 167 --- --- --- --- 167 5.67% ---% ---% ---% ---% 5.67% ----- ------ ------ ------ ------ ------- Total 4,168 19,460 41,520 47,121 1,576 113,845 5.94% 6.54% 6.69% 6.94% 7.52% 6.75% Held to Maturity ---------------- U.S. Treasury 500 --- --- --- --- 500 5.09% ---% ---% ---% ---% 5.09% U.S. Government agencies --- 4,500 1,000 --- --- 5,500 ---% 5.66% 3.96% ---% ---% 5.35% Mortgage-backed securities --- 14 102 247 --- 363 ---% 9.00% 7.67% 7.26% ---% 7.44% States and Political 400 1,072 358 200 --- 2,030 Subdivision - taxable 6.40% 6.98% 7.03% 9.00% ---% 7.07% States and Political 1,701 10,283 2,416 854 --- 15,254 Subdivision - nontaxable 6.86% 7.32% 7.62% 7.09% ---% 7.30% Corporate --- --- --- --- --- --- ---% ---% ---% ---% ---% ---% Other securities --- --- --- --- --- --- ---% ---% ---% ---% ---% ---% ----- ------ ------ ------ ------ ------ Total 2,601 15,869 3,876 1,301 --- 23,647 6.45% 6.83% 6.62% 7.42% ---% 6.78% (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, 1999. A. Types of Loans December 31, ($ in thousands) 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Commercial and industrial loans $149,386 110,509 101,379 87,519 59,609 Real estate mortgage loans 58,829 48,724 42,969 43,917 45,589 Real estate construction loans 14,669 12,827 8,510 6,295 6,007 Loans to individuals 73,825 69,493 66,635 60,991 56,920 -------- ------- ------- ------- ------- Total loans 296,709 241,553 219,493 198,722 168,125 Less unearned income and deferred fees (1,916) (2,296) (2,503) (2,549) (2,307) -------- ------- ------- ------- ------- Total loans, net of unearned income 294,793 239,257 216,990 196,173 165,818 Less allowance for loans losses (3,231) (2,679) (2,438) (2,575) (2,625) -------- ------- ------- ------- ------- Total loans, net $291,562 236,578 214,552 193,598 163,193 ======== ======= ======= ======= ======= B. Maturities and Interest Rate Sensitivities December 31, 1999 After ($ in thousands) <1 Year 1-5 Years 5 Years Total ------- --------- ------- ----- Commercial and industrial $52,277 61,749 35,360 149,386 Real estate construction 14,669 --- --- 14,669 Less loans with predetermined interest rates 31,052 26,567 34,878 92,497 ------- ------ ------ ------- Loans with adjustable rates $35,894 35,182 482 71,558 ======= ====== ====== ======= -22- C. Risk Elements 1. Nonaccrual, Past Due and Restructured Loans The following table presents aggregate amounts for nonaccrual loans, restructured loans, other real estate owned, net and accruing loans which are contractually past due ninety days or more as to interest or principal payments. December 31, ($ in thousands) 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Nonaccrual loans: Commercial and industrial $ 65 --- 55 121 270 Real estate mortgage 33 28 32 495 418 Real estate construction --- --- --- --- --- Loans to individuals 53 --- --- --- 30 ------ ----- ----- ------ ----- $ 151 28 87 616 718 Restructured loans: Commercial and industrial 40 --- --- --- --- ------ ----- ----- ------ ----- Total nonperforming loans $ 191 28 87 616 718 Other real estate owned, net 447 628 421 474 762 ------ ----- ----- ------ ----- Total nonperforming assets $ 638 656 508 1,090 1,480 ====== ===== ===== ====== ===== Accruing loans past due 90 days or more: Commercial and industrial $ 99 186 82 14 11 Real estate mortgage 704 160 358 252 250 Real estate construction --- --- --- --- --- Loans to individuals 274 204 232 192 313 ------ ----- ----- ------ ----- $1,077 550 672 458 574 ====== ===== ===== ====== ===== The effect of nonaccrual and restructured loans on interest income is presented below: ($ in thousands) 1999 1998 1997 ---- ---- ---- Scheduled interest: Nonaccrual loans $ 13 4 8 Restructured loans --- --- --- ----- ----- ----- Total scheduled interest $ 13 4 8 ===== ===== ===== Recorded interest: Nonaccrual loans $ --- --- 1 Restructured loans --- --- --- ----- ----- ----- Total recorded interest $ --- --- 1 ===== ===== ===== -23- 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. 2. Potential Problem Loans At December 31, 1999, the recorded investment in loans which have been identified as impaired loans totaled $317,000. Of this amount, $95,000 related to loans with no valuation allowance and $222,000 related to loans with a corresponding valuation allowance of $154,000. For the year-ended December 31, 1999, the average recorded investment in impaired loans was approximately $292,000 and the total interest income recognized on impaired loans was $13,000 of which $0 was recognized on a cash basis. At December 31, 1998, the recorded investment in loans which have been identified as impaired loans totaled $373,000. Of this amount, $228,000 related to loans with no valuation allowance and $145,000 related to loans with a corresponding valuation allowance of $145,000. For the year ended December 31, 1998, the average recorded investment in impaired loans was approximately $387,000, and the total interest income recognized on impaired loans was $32,000 of which $0 was recognized on a cash basis. 3. Foreign Outstandings At December 31, 1999, 1998 and 1997, 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, consists of Montgomery and Giles Counties, and the City of Galax, 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. -24- At December 31, 1999 and 1998, approximately $130 million and $94 million, respectively, of the loan portfolio were concentrated in commercial real estate. This represents approximately 44% and 39% of the loan portfolio at December 31, 1999 and 1998, respectively. Included in commercial real estate at December 31, 1999 and 1998 was approximately $85 million and $64 million, respectively, in loans for college housing and professional office buildings. Loans secured by residential real estate were approximately $74 million and $67 million at December 31, 1999 and 1998, respectively. This represents approximately 25% and 28% of the loan portfolio at December 31, 1999 and 1998, respectively. Loans secured by automobiles were approximately $33 million and $32 million at December 31, 1999 and 1998, respectively. This represents approximately 11% of the loan portfolio at December 31, 1999 and 13% at December 31, 1998. The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property and with loan amounts established based on certain percentage limitations of the property's total stated or appraised value. Credit approval is primarily a function of collateral and the evaluation of the creditworthiness of the individual borrower or project based on available financial information. -25- IV. Summary of Loan Loss Experience ------------------------------- A. Analysis of the Allowance for Loan Losses The following tabulation shows average loan balances at the end of each period; changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category; and additions to the allowance which have been charged to operating expense:
December 31, ($ in thousands) 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Average loans outstanding $266,431 225,613 204,540 177,419 160,643 ======== ======= ======= ======= ======= Balance at beginning of year 2,679 2,438 2,575 2,625 2,551 Charge-offs: Commercial and industrial loans 185 32 257 95 23 Real estate mortgage loans 33 80 --- 11 9 Real estate construction loans --- --- --- --- --- Loans to individuals 760 526 422 400 259 -------- ------- ------- ------- ------- Total loans charged off 978 638 679 506 291 -------- ------- ------- ------- ------- Recoveries: Commercial and industrial loans 51 --- 70 4 10 Real estate mortgage loans 1 2 --- 64 16 Real estate construction loans --- 190 --- --- --- Loans to individuals 78 63 37 57 57 -------- ------- ------- ------- ------- Total recoveries 130 255 107 125 83 -------- ------- ------- ------- ------- Net loans charged off 848 383 572 381 208 Additions charged to operations 1,400 624 435 331 282 -------- ------- ------- ------- ------- Balance at end of year $ 3,231 2,679 2,438 2,575 2,625 ======== ======= ======= ======= ======= Net charge-offs to average net loans outstanding 0.32% 0.17% 0.28% 0.21% 0.13% 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, 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- 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 $ 555 50.35% 222 45.75% 213 46.18% 403 44.04% 411 35.46% Real estate mortgage loans 119 19.83% 73 20.17% 67 19.58% 305 22.10% 363 27.12% Real estate construction loans --- 4.94% --- 5.31% --- 3.88% 51 3.17% 100 3.57% Loans to individuals 978 24.88% 497 28.77% 416 30.36% 504 30.69% 271 33.85% Unallocated 1,579 1,887 1,742 1,312 1,480 ------ ------ ------ ------ ------ $3,231 100.00% 2,679 100.00% 2,438 100.00% 2,575 100.00% 2,625 100.00% ====== ====== ====== ====== ====== ====== ====== ====== ====== ======
-27- Loan Loss Allowance - ------------------- 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 as well as other internal and external factors such as general economic conditions. The evaluation of the allowance for loan losses is performed by the internal credit review department. Guidance for the evaluations performed are established by the regulatory authorities who periodically review the results for compliance. As a part of this process, loans are grouped into principally two classes. The first involves loans that are individually reviewed and direct allocations made based on collateral values, financial statements of the borrower and other documentation. In addition, an estimate is made for losses inherent to this portfolio. The second class includes pools of loans. Allocations from this analysis are derived and based on historical loss averages. The unallocated portion of the allowance for loan losses is the residual amount after allocation to the above classes. As previously stated, adequacy of the allowance for loan losses is subject to periodic regulatory review. These reviews cover the allocation process and overall adequacy of the allowance for loan losses. Regulatory authorities at their discretion may set minimum levels for the allowance and/or require the charge-off of loans as a result of their examination. This independent grading process by regulators serves as a standard to gage the effectiveness of the internal credit review. -28- 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, 1999 1998 1997 ---- ---- ---- Average Average Average Average Rates Average Rates Average Rates ($ in thousands) Amounts Paid Amounts Paid Amounts Paid ------- ------- ------- ------- ------- ------- Noninterest-bearing demand deposits $ 55,700 --- 49,552 --- 44,193 --- Interest-bearing demand deposits 85,284 2.50% 77,842 2.83% 75,519 2.86% Savings deposits 46,792 2.59% 47,475 3.18% 47,781 3.29% Time deposits 203,807 5.22% 185,101 5.51% 171,946 5.44% -------- ------- ------- Average total deposits $391,583 4.16% 359,970 4.48% 339,439 4.43% ======== ======= ======= B. Time Deposits of $100,000 or More The following table sets forth time certificates of deposit and other time deposits of $100,000 or more: December 31, 1999 Over 3 Over 6 3 Months Months Months Through 6 Through 12 Over 12 ($ in thousands) or Less Months Months Months Total ------- --------- ---------- ------- ----- Certificates of deposit $46,801 34,200 71,164 67,055 219,220 Other time deposits 35,590 27,526 54,381 55,551 173,048 ------- ------ ------ ------ ------- Total time deposits of $100,000 or more $11,211 6,674 16,783 11,504 46,172 ======= ====== ====== ====== ======= -29- 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, 1999 1998 1997 ---- ---- ---- Return on average assets 1.56% 1.61% 1.66% Return on average equity(1) 12.61% 11.66% 12.21% Dividend payout ratio 39.70% 41.29% 39.31% Average equity to average assets(1) 12.37% 13.84% 13.57% (1) Includes amount related to common stock subject to ESOP put option excluded from stockholders' equity on the Consolidated Balance Sheets for 1998 and 1997. Item 2. Properties - ------------------- Bankshares' headquarters, including the Main Office of NBB, are located at 100 South Main Street, Blacksburg, Virginia. In addition to the Bank's Main Office location, NBB owns nine branch offices: three in the Town of Blacksburg; one in the Town of Christiansburg; one in Montgomery County; and three in the County of Giles and one in the City of Galax. An additional tract of land has been acquired for the construction of a tenth branch. 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 utilizes this same system for data processing. 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 - ------------------------------------------------------------ None -30- 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 11, 2000. 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 55 Chairman, President and 1986 Chief Executive Officer, National Bankshares, Inc.; and President and Chief Executive Officer of The National Bank of Blacksburg since 1983. J. Robert Buchanan 48 Treasurer, National 1998 Bankshares, Inc.; Senior Vice President/Chief Financial Officer of The National Bank of Blacksburg, since January 1, 1998; prior thereto Senior Vice President, Treasurer and Chief Financial Officer, Premier Bankshares Corporate since 1991. Marilyn B. Buhyoff 51 Secretary & Counsel, 1989 National Bankshares, Inc.; and Senior Vice President/ Administration since 1992, of The National Bank of Blacksburg. F. Brad Denardo 47 Corporate Officer, National 1989 Bankshares, Inc.; and Executive Vice President/ Loans since 1989 of The National Bank of Blacksburg. Except for J. Robert Buchanan, each of the executive officers listed above have served Bankshares and/or its subsidiaries in the aforementioned executive capacity for the past five years. -31- Part II ------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters - ------------------------------------------------------------------------------ Effective December 1, 1999, National Bankshares, Inc.'s common stock began trading on the Nasdaq SmallCap Market under the symbol "NKSH". Prior to December 1, 1999, National Bankshares, Inc.'s common stock was traded on a limited basis in the over-the-counter market and was not listed on any exchange or quoted on Nasdaq. As of March 15, 2000, there were 1,103 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 1999 and 1998. Prices prior to December 1, 1999 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. Information concerning Market Price and Dividend Data is set forth under "Common Stock Information and Dividends" on page 11 of Bankshares' 1999 Annual Report to Stockholders and is incorporated herein by reference. Item 6. Selected Financial Data - -------------------------------- The table entitled "Selected Consolidated Financial Data" on page 4 of Bankshares' 1999 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 5 through 11 of Bankshares' 1999 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 Sensitivity" on page 5 and the section "Derivatives and Market Risk Exposure" on page 9 of Bankshares' 1999 Annual Report to Stockholders and is incorporated herein by reference. -32- Analysis of Interest Rate Sensitivity The following discussion of interest rate sensitivity contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results could differ materially from those set forth in the forward-looking statements. The table below sets forth, as of December 31, 1999, 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), 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. 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 in 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 five years. 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. In prior years, the Company has used its securities available for sale as a primary means to counter movements in interest rates. At December 31, 1999, this portfolio contained a substantial amount of longer term securities with call features. Due to overall increase in interest rate levels these securities have not been called as originally anticipated. The rising interest rate levels also resulted in a substantial increase in net unrealized losses making the sale of these securities impractical. At present and for an indeterminate amount of time in the future, the Company will not be able to use the securities available for sale portfolio to respond to interest rate movements to the extent possible in recent years. This risk can be mitigated, however, by funds management, specifically through use of credit instruments offered by the Federal Home Loan Bank. Accordingly, the Company's vulnerability to upward movements of interest rates has increased. -33- 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, 1999 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 $ 31,713 6,345 7,416 64,641 39,206 149,321 Real estate mortgage loans 8,953 1,030 2,546 29,562 16,705 58,796 Real estate construction loans 11,484 655 2,530 --- --- 14,669 Loans to individuals 11,556 5,251 8,689 37,144 9,216 71,856 --------- -------- -------- ------- ------- ------- Total loans, net of unearned income (2) $ 63,706 13,281 21,181 131,347 65,127 294,642 --------- -------- -------- ------- ------- ------- Federal funds sold 2,800 --- --- --- --- 2,800 Interest bearing deposits 9,219 --- --- --- --- 9,219 Securities available for sale (3) 2,407 407 1,318 28,263 81,450 113,845 Securities held to maturity (3) 1,818 710 1,399 16,375 3,345 23,647 Mortgage loans held for sale 229 --- --- --- --- 229 --------- -------- -------- ------- ------- ------- Total interest-earning assets $ 80,179 14,398 23,898 175,985 149,922 444,382 ========= ======== ======== ======= ======= ======= Interest-bearing liabilities: Interest-bearing demand deposits $ 88,385 --- --- --- --- 88,385 Savings deposits 44,834 --- --- --- --- 44,834 Time deposits 46,801 34,200 71,164 67,055 --- 219,220 Other borrowings 10,460 --- --- --- --- 10,460 --------- -------- -------- ------- ------- ------- Total interest-bearing liabilities $ 190,480 34,200 71,164 67,055 --- 362,899 ========= ======== ======== ======= ======= ======= Cumulative ratio of interest- sensitive assets to interest- sensitive liabilities .42 .42 .40 .81 1.22 1.22 Cumulative interest-sensitivity gap $(110,301) (130,103) (177,369) (68,439) 81,483 81,483 ========= ======== ======== ======= ======= ======= (1) The Company is sensitive to interest rate changes, as liabilities generally reprice or mature before interest-earning assets. The above gap table reflects the Company's rate-sensitive position at December 31, 1999, and is not necessarily reflective of its position throughout the year. The carrying amounts of interest-rate sensitive assets and liabilities are presented in the periods in which they reprice to market rates or mature and are summed to show the interest-rate sensitivity gap. (2) Excludes nonaccrual loans. (3) Call features on certain securities, if exercised, could have the effect of materially shortening the average life of the investment portfolio. The exercise of a call feature is dependent upon the rate environment. The call decision is at the issuers discretion and ultimate benefit.
-34- The Company also uses simulation analysis to forecast its balance sheet and monitor interest rate sensitivity. One test used by NBI is shock analysis which measures the effect of a hypothetical, immediate and parallel shift in interest rates. The following table shows the results of a rate shock of 100, 200, and 300 basis points and the effects on net income and return on average assets and return on average equity at December 31, 1999. ($ in thousands, except for percent data) Rate Net Return on Return on Shift Income Average Equity Average Assets ----- ------ -------------- -------------- 300 $ 5,773 10.40% 1.24% 200 6,614 11.83% 1.42% 100 7,449 13.23% 1.60% (-)100 9,103 15.94% 1.95% (-)200 9,921 17.26% 2.12% (-)300 10,331 17.91% 2.21% Simulation analysis allows the Company to test asset and liability management strategies under rising and falling rate conditions. As a part of simulation process, certain estimates and assumptions must be made dealing with but, not limited to, asset growth, the mix of assets and liabilities, rate environment, local and national economic conditions. Asset growth and the mix of assets can to a degree be influenced by management. Other areas such as the rate environment and economic factors cannot be controlled. For this reason actual results may vary materially from any particular forecast or shock analysis. This shortcoming is offset to a degree by the periodic re-forecasting of the balance sheet to reflect current trends and economic conditions. Shock analysis must also be updated periodically as a part of the asset and liability management process. -35- Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The following consolidated financial statements of the Registrant and the Independent Auditors' Report set forth on pages 12 through 35 of Bankshares' 1999 Annual Report to Stockholders are incorporated herein by reference: 1. Independent Auditors' Report 2. Consolidated Balance Sheets - December 31, 1999 and 1998 3. Consolidated Statements of Income and Comprehensive Income - Years ended December 31, 1999, 1998 and 1997 4. Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 1999, 1998 and 1997 5. Consolidated Statements of Cash Flows - Years ended December 31, 1999, 1998 and 1997 6. Notes to Consolidated Financial Statements - December 31, 1999, 1998 and 1997 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, 1999 are listed on page 32 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 15, 2000, which information is incorporated herein by reference. Item 11. Executive Compensation - -------------------------------- The information set forth under "Executive Compensation" on pages 5 through 6 of Bankshares' Proxy Statement dated March 15, 2000 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 "Stock Ownership of Certain Beneficial Owners" and "Stock Ownership of Directors and Executive Officers" on pages 1 and 2 of Bankshares' Proxy Statement dated March 15, 2000 is incorporated herein by reference. -36- 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 15, 2000 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: 1999 Annual Report To Stockholders Page(s)* ------------------------ 1. Financial Statements: -------------------- Independent Auditors' Report 12 Consolidated Balance Sheets - December 31, 1999 and 1998 13 Consolidated Statements of Income and Comprehensive Income - Years ended December 31, 1999, 1998 and 1997 14 Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 1999, 1998 and 1997 15 Consolidated Statements of Cash Flows - Years ended December 31, 1999, 1998 and 1997 16 Notes to Consolidated Financial Statements - December 31, 1999, 1998 and 1997 17-35 2. Financial Statement Schedules: ----------------------------- None * Incorporated by reference from the indicated pages of the 1999 Annual Report to Stockholders. -37- 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) 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 (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 herein by between National Bankshares, reference to Inc. and 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. herein by 10(a)) reference to Exhibit 10(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) -38- 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 Exhibit 10(c) of Blacksburg the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) National Bankshares, Inc. (incorporated herein 1999 Stock Option Plan by reference to Exhibit 4.3 of the Form S-8, filed as Registration No. 333-79979 with the Commission on June 4, 1999) 13(i) 1999 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. 23 Consent of KPMG LLP to incorporation by reference of independent auditors' report incorporated by reference in this Form 10-K, into registrant's registration statement on Form S-8. 27 Financial Data Schedule * 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. -39- 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, Chairman, President and Chief Executive Officer DATE: March 29, 2000 ------------------------------------- BY: /s/J. Robert Buchanan ------------------------------------- J. Robert Buchanan Treasurer (Principal Financial Officer) DATE: March 29, 2000 ------------------------------------- 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 ---- ---- ----- Director and Vice ------------------------- -------------- Chairman of the Board C. L. Boatwright /s/L. A. Bowman March 29, 2000 Director ------------------------- -------------- L. A. Bowman /s/A. A. Crouse March 29, 2000 Director ------------------------- -------------- A. A. Crouse /s/J. A. Deskins, Sr. March 29, 2000 Director ------------------------- -------------- J. A. Deskins, Sr. /s/P. A. Duncan March 29, 2000 Director ------------------------- -------------- P. A. Duncan /s/C. L. Forrester March 29, 2000 Director ------------------------- -------------- C. L. Forrester /s/W. T. Peery March 29, 2000 Director ------------------------- -------------- W. T. Peery /s/J. G. Rakes March 29, 2000 Chairman of the Board ------------------------- -------------- President and Chief J. G. Rakes Executive Officer - National Bankshares, Inc. /s/J. R. Stewart March 29, 2000 Director ------------------------- -------------- J. R. Stewart -40- 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) 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) -41- 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) *10(iii)(A) National Bankshares, Inc. 1999 (incorporated herein Stock Option Plan by reference to Exhibit 4.3 of the Form S-8, filed as Registration No. 333-79979 with the Commission on June 4, 1999) 13(i) 1999 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. 23 Consent of KPMG LLP to incorporation by reference of independent auditors' report incorporated by reference in this Form 10-K, into registrant's registration statement on Form S-8. 27 Financial Data Schedule * Indicates a management contract or compensatory plan required to be filed herein. -42- EX-13 2 ANNUAL REPORT 1999 National Bankshares 1999 Annual Report 1999 Annual Report Financial Highlights $ In thousands, except per share data 1999 1998 1997 ---- ---- ---- Net income $ 7,088 6,798 6,560 Basic net income per share 1.96 1.79 1.73 Cash dividends declared per share 0.80 0.74 0.68 Book value per share 14.99 16.00 14.73 Loans, net $291,562 236,578 214,552 Total securities 137,492 166,754 149,974 Total assets 472,134 445,166 402,907 Total deposits 407,187 382,696 344,867 Stockholders' equity 52,723 58,503 54,029 Contents To Our Stockholders 2 Selected Consolidated Financial Data 4 Management's Discussion and Analysis 5 Independent Auditors' Report 12 Consolidated Financial Statements 13 Notes to Consolidated Financial Statements 17 Selected Quarterly Data 36 Board of Directors 38 Corporate Information 40 To Our Stockholders We are pleased to report another year of higher earnings and solid asset growth. National Bankshares, Inc. achieved net income in 1999 of nearly $7.09 million, an increase of 4.3% over 1998. Based National Bankshares upon a weighted average of shares outstanding during 1999 and also reflecting the effects of the common stock repurchase plan that was completed in the second quarter of the year, basic net income per share rose to $1.96 from $1.79 in 1998. The total assets of National Bankshares increased to $472.13 million at December 31, 1999, as compared to $445.17 million for the same period in 1998. A major factor contributing to asset growth during Picture of the year was a 23.2% increase in net "New Hubbard Street Office" loans, to $291.56 million at year- end. Adding sound loans to our subsidiary banks' portfolios serves our communities, our customers and our stockholders. Funds on deposit at The National Bank and at Bank of Tazewell County are used to make loans in our local region. The loans in turn support business expansion and the construction of new homes. They also allow our customers to purchase new cars, to pay for medical expenses and to educate their children. National Picture of Bankshares' stockholders benefit "Newly renovated BTC Bluefield from loan growth because making good Branch Lobby" loans is the most profitable use of the banks' capital and assets. As I mentioned above, when you review this year's Annual Report you will see that net income for 1999 totaled nearly $7.09 million, a 4.3% increase over last year. You will also see an item listed as "comprehensive income", which is less than the net income figure. Since this difference can be confusing, I want to explain about comprehensive income, an accounting presentation that in our case is Picture of used to reflect the annual "NBB Customer Service Representative fluctuations in the market value of demonstrating Online Banking" our "available for sale" investment portfolio. 2 In 1999, because of increases Picture of in interest rates in the bond market "James G. Rakes" and the structure of our available for sale investment portfolio, National Bankshares experienced an unrealized net loss in the work by employees, neither The portfolio. This year's National Bank nor Bank of Tazewell comprehensive income resulted from Country experienced any disruption subtracting the unrealized net loss in work flow. On the first business figure from our net income total. day of 2000, it was business as This unrealized net loss is usual for bank customers and significant only if we actually sell employees. the investments and recognize the We believe that the future of loss into net income. When our progressive community banks investments are fundamentally sound, depends upon offering a full as we believe ours are, there is no spectrum of financial service need to recognize any loss into net options, from high touch to high income unless the investments are tech. As the world becomes more sold before maturity. We do not impersonal, trusted relationships plan to liquidate any significant become more valuable. Because of portion of our available for sale our historic community ties, The investment portfolio before National Bank and Bank of Tazewell maturity, and we do not foresee any County are important present and events in the near future that would future sources of quality financial cause us to change these plans. services with a personal touch. It This past year was a busy and would be impossible for us to move productive one for The National Bank forward and carry out our corporate and for Bank of Tazewell County. On mission without the support of our February 1, NBB introduced an stockholders, directors and Internet Banking product that has employees. I thank you for your proven to be quite popular. With contributions to the continued Internet Banking, our customers can success of National Bankshares. access account balances, apply for loans, open new accounts and pay bills when it is most convenient for James G. Rakes them. In August, The National Bank Chairman of the Board opened the new Hubbard Street Office President and Building in Blacksburg. In addition Chief Executive Officer to housing the bank's tenth branch location, Hubbard Street serves as the corporate headquarters and as the home to NBB's Trust, Bank Card, Marketing, Human Resources, Audit, Compliance and Loan Review departments. Also during 1999, Bank of Tazewell County completed needed renovations at the Bluefield, Virginia office. BTC highlighted the importance of tradition by incorporating several items of antique furniture from its 110-year past into the office renovation plan. The year ended with the publicized millennium celebration and the associated Y2K computer century date change. Fortunately, because of years of advance preparation and a great deal of hard 3 National Bankshares, Inc. and Subsidiaries Selected Consolidated Financial Data $ In thousands, except per share data. Years ended December 31, 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- Selected Interest income $ 33,603 31,828 29,797 28,647 28,094 Income Interest expense 14,203 13,928 13,106 13,036 12,703 Statement Net interest income 19,400 17,900 16,691 15,611 15,391 Data: Provision for loan losses 1,400 624 435 331 282 Noninterest income 3,512 3,174 2,834 2,693 2,382 Noninterest expense 11,868 11,061 10,031 9,515 10,033 Income taxes 2,556 2,591 2,499 2,341 1,933 Net income 7,088 6,798 6,560 6,117 5,525 Per Share Basic net income $ 1.96 1.79 1.73 1.61 1.46 Data: Cash dividends declared 0.80 0.74 0.68 0.62 0.57 Book value per share(1) 14.99 16.00 14.73 13.56 12.70 Selected Loans, net $291,562 236,578 214,552 193,598 163,193 Balance Total securities 137,492 166,754 149,974 171,244 187,635 Sheet Total assets 472,134 445,166 402,907 388,850 380,915 Data at Total deposits 407,187 382,696 344,867 334,584 330,313 End Stockholders' of Year: equity 52,723 58,503 54,029 49,801 48,154 Selected Loans, net $266,431 225,613 204,540 177,419 160,643 Balance Total securities 151,424 152,432 157,179 177,403 183,994 Sheet Total assets 454,189 420,988 395,932 388,045 378,406 Daily Total deposits 391,583 359,970 339,439 335,938 330,261 Averages: Stockholders' equity(1) 56,196 58,282 53,712 49,459 45,726 Selected Return on average Ratios: assets 1.56 1.61 1.66 1.58 1.46 Return on average equity(1) 12.61 11.66 12.21 12.37 12.08 Dividend payout ratio 39.70 41.29 39.31 37.55 37.32 Average equity to average assets(1) 12.37 13.84 13.57 12.75 12.08 (1) Includes amount related to common stock subject to ESOP put option excluded from stockholders' equity on the Consolidated Balance Sheets in 1998, 1997 and 1996. "Cash Dividends Per Share" Graph (In Dollars) 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- .80 .74 .68 .62 .57 4 Management's Discussion and Analysis ($ In thousands, except per share data.) PERFORMANCE SUMMARY Net income in 1999 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 $7,088, an increase of $290 or 4.27% over the previous year. This produced a return on average assets and a return on average equity of 1.56% and 12.61%, respectively. Net income for the Company for 1998 was $6,798, an increase of $238 or 3.63% over 1997. The return on average assets and return on average equity for 1998 were 1.61% and 11.66%, respectively. The Company's net income for 1997 was $6,560 which produced a return on average assets of 1.66% and a return on average equity of 12.21%. Basic net income per share increased steadily over the three-year period rising from $1.73 per share in 1997 to $1.79 in 1998 and $1.96 in 1999. Net income for 1999 increased 4.27% as previously stated; however, total asset growth increased at a rate of approximately 6%, resulting in a slight decline in the return on average assets. The increase in the return on average equity for 1999 was the result of increased earnings and a decline in stockholders' equity. This decline in stockholders' equity was due to a combination of a stock repurchase that occurred in the second quarter of 1999, cash dividends and a substantial decline in accumulated other comprehensive income. The dividend payout ratio for 1999 was 39.70%, which compares to 41.29% in 1998 and 39.31% in 1997. "Net Income" Graph (In Millions) 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- 7.1 6.8 6.6 6.1 5.5 NET INTEREST INCOME Net interest income for 1999 was $19,400, an increase of $1,500 or 8.38% over 1998. In 1998, net interest income was $17,900, up $1,209 or 7.24% from 1997 net interest income of $16,691. The net yield on earning assets for 1999 was 4.82%. In 1998 and 1997, the net yield on earning assets was 4.77% and 4.75%, respectively. During 1999, the Company continued to experience substantial loan growth, which in turn contributed significantly to the increase in net interest income. The improvement in the net interest margin of 5 basis points was the result of a 14 basis point decline in the yield on earning assets combined with a 19 basis point decline in the cost to fund earning assets. In the fourth quarter of 1999, the Company changed its method of accounting for loan late fees from cash to accrual basis. As a result of this change, net interest income increased by $266. This change was not deemed to be material. The Company experienced a higher level of deposit growth in 1998 relative to the preceding year. This allowed loan growth to be funded by deposits. The investment portfolio grew as well. In 1997, management's strategy was to fund increases in the loan portfolio through liquidity generated principally from the securities portfolio. In 1997, overall loan growth was strong, particularly in commercial loans and loans to individuals. 5 Management's Discussion and Analysis 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. In prior years, the Company has used its securities available for sale as a primary means to counter movements in interest rates. At December 31, 1999, this portfolio contained a substantial amount of longer term securities with call features. Due to an overall increase in interest rate levels these securities have not been called as originally anticipated. The rising interest rate levels also resulted in a substantial increase in net unrealized losses making the sale of these securities impractical. At present and for an indeterminate amount of time in the future, the Company will not be able to use the securities available for sale portfolio to respond to interest rate movements to the extent possible in recent years. This risk can be mitigated, however, by funds management, specifically through use of credit instruments offered by the Federal Home Loan Bank. Accordingly, the Company's vulnerability to upward movements of interest rates has increased. 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. 6 National Bankshares, Inc. and Subsidiaries Loan Loss Data ($ In thousands) 1999 1998 1997 ---- ---- ---- Provision for loan losses $ 1,400 624 435 Net charge-offs to average net loans 0.31% 0.17% 0.28% Allowance for loan losses to loans, net of unearned income and deferred fees 1.10% 1.12% 1.12% Allowance for loan losses to nonperforming loans 1,691.62% 9,567.86% 2,802.30% Allowance for loan losses to nonperforming assets 506.43% 408.38% 479.92% Nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned 0.22% 0.27% 0.23% Nonaccrual loans $ 151 28 87 Restructured loans 40 --- --- Other real estate owned, net 447 628 421 --------- --------- --------- Total nonperforming assets $ 638 656 508 ========= ========= ========= Accruing loans past due 90 days or more $ 1,077 550 672 ========= ========= ========= Nonperforming loans include nonaccrual loans and restructured loans, but do not include accruing loans past due 90 days or more. Nonperforming assets for 1999 have decreased $18 or 2.74% from 1998. Nonperforming assets for 1998 increased by $148 or 29.13% from the 1997 total of $508. Net charge-offs to average net loans for 1999 were 0.31%, up from 0.17% in 1998. In 1999, overall asset quality continued to be satisfactory and general economic conditions favorable. The provision for loan loss increased by $776 or 124.36%. This increased level of bad debt expense was primarily in response to the growth in the loan portfolio, but also provided for additional losses. Charge-offs in the commercial loan category increased by $153, while charge- offs on loans to individuals increased by $234. A majority of the charge-offs in the commercial loan area was due to a single credit, while charge-offs on loans to individuals consisted of numerous smaller credits. Net charge-offs to average net loans for 1998 were 0.17%, down from 1997 when that ratio was 0.28%. The provision for loan losses, which increased $189 in 1998 or 43.45% over 1997's provision of $435, was increased to cover 1998's net charge-offs and loan growth. 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. While past efforts directed at improving asset quality have been largely successful, management is unable to estimate when and under what exact terms problem assets will be resolved. 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. In addition, precise loss predictions may be difficult to determine because of the complex circumstances that surround troubled debts. NONINTEREST INCOME Noninterest income for 1999 was $3,512, an increase of $338 or 10.65% over 1998. Noninterest income for 1998 was $3,174, up $340 or 12.00% from 1997. 7 Management's Discussion and Analysis Service charges on deposits for 1999 totaled $1,395, an increase of $230 or 19.74% from 1998. This increase was due in part to volume and improved collection efforts. Service charges on deposit accounts in 1998 were up $34 or 3.01% 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 increase for 1998 was largely attributable to the overall increase in demand deposit volume. The decrease for 1997 was 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 1999, these charges were $279, an increase of $48 or 20.78% from 1998. For 1998, these charges totaled $231, a decrease of $19 or 7.60% from 1997. Trust income for 1999 was $927 which represents an increase of $153 or 19.77% over 1998. In 1998, trust income was $774, an increase of $36 or 4.88% over 1997. 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 1999, credit card income totaled $802, an increase of $149 or 22.82% over 1998. The increase in 1999 was attributable to increases in merchant income and debit card processing fees. Credit card income for 1998 was $653, up $47 or 7.76% over 1997. Credit card income increased in 1998 largely because of a higher volume of interchange transactions, created in part by the Company's debit card product. The Company's debit card product was introduced late in the first quarter of 1997. Accordingly, 1998 reflects the first full year of income derived from this product. Given the highly competitive market which limits the amount of set charges, 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 realized securities gains were $24 in 1999, down $164 or 87.23% from 1998. In 1998, net securities gains were $188, up 408.11% from 1997. Gains and losses can occur as a result of portfolio restructuring, securities called before maturity and certain market adjustments. NONINTEREST EXPENSE Noninterest expense in 1999 totaled $11,868, up $807 or 7.30% from 1998. In 1998, noninterest expense was $11,061, an increase of $1,030 or 10.27% from 1997. Salaries and benefits in 1999 increased $224 or 3.85% from 1998. In 1998, salaries and benefits expense totaled $5,824, up $426 or 7.89% from 1997. The increase in salaries was due in part to the acquisition of the Galax office by NBB at the beginning of the second quarter, salary adjustments and from increases in other normal compensation related items. In early 2000, the Company's NBB subsidiary purchased a tract of land with the intent to establish a new branch facility. The exact timing of the branch application and construction processes has not been precisely determined. When completed, it is expected that this planned addition will increase salaries expense as well as certain other noninterest expenses. Occupancy and furniture and fixtures expense increased $154 or 15.43% for 1999 when compared to 1998. This increase was due to higher costs associated with the Galax office acquired by NBB in the second quarter of 1998 and also to regular planned maintenance of facilities. Management anticipates occupancy 8 National Bankshares, Inc. and Subsidiaries and furniture and fixtures expense will continue to increase due to the addition of its Hubbard Street office placed in service in the third quarter of 1999 and the previously mentioned planned new facility. The expected increase in occupancy and furniture and fixtures expense will be somewhat offset by a future reduction in expenses for leased premises. Occupancy and furniture and fixtures expense experienced an increase in 1998 of 4.18% over 1997. Data processing and ATM expense was $889 for 1999, an increase over 1998 of $118 or 15.30%. This increase was due to costs associated with the upgrade of information system hardware and software and costs related to an expanded microcomputer network. In 1998, data processing and ATM expense was $771, an increase of $193 or 33.39% over 1997. The cost of Federal Deposit Insurance was $47 in 1999, an increase of $10 from 1998. 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 1998, the Company's affiliates paid a premium of $37, a decrease of $6 over 1997. Credit card processing expense for 1999 was $712, an increase of $113 or 18.86% over 1998. In 1998, credit card processing expense was $599, an increase of 8.71%. 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. Net costs of other real estate owned for 1999 were $26, a decrease of $11 or 29.73% from 1998. In 1998, net costs of other real estate owned were $37, increasing $29 from 1997. Other operating expenses were $2,956 in 1999, up $197 or 7.14% from 1998, which was primarily the result of increases in stationery and supplies, telephone and state franchise tax expense at BTC. The other operating expense category in 1998 was $2,759, increasing 11.93% from 1997. INCOME TAXES Despite higher pre-tax income in 1999, a $35 decrease in income tax expense resulted when compared to 1998. Tax exempt interest income continues to be the primary difference between the "expected" and reported income tax expense. The Company's effective tax rates for 1999, 1998 and 1997 were 26.50%, 27.60% and 27.59%, respectively. See note 10 of Notes to Consolidated Financial Statements for additional information relating to income taxes. EFFECTS OF INFLATION The Company's consolidated statements of income and comprehensive income generally reflect the effects of inflation. Since interest rates, loan demand and deposit levels are related to inflation, the resulting changes are included in net income. The most significant item which does not reflect the effects of inflation is depreciation expense, because historical dollar values used to determine this expense do not reflect the effect of inflation on the market value of depreciable assets after their acquisition. "Total Assets" Graph ($ In Millions) 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- $472.1 445.2 402.9 388.9 380.9 9 Management's Discussion and Analysis "Net Loans" Graph ($ In Millions) 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- $291.6 236.6 214.6 193.6 163.2 BALANCE SHEET Total assets at year-end 1999 were $472,134 which represents an increase of $26,968 or 6.06% over the previous year. The Company's primary methods of achieving growth are to seek increases in deposits at its bank subsidiaries and to grow through corporate acquisitions and mergers. While deposit growth was strong in 1999, it was not sufficient to fund all of the Company's investing and financing activities. Deposit growth was supplemented in the fourth quarter by borrowing approximately $10,000 from the Federal Home Loan Bank. See the Liquidity section for further comments. In 1998, deposit growth was sufficient to fund loan growth as well as some expansion of the securities portfolio. Profitable growth continues to be a management objective. In 1999 and 1998, total average deposits grew by $31,613 and $20,531, respectively, which represents growth rates of 8.78% and 6.05%, respectively. LOANS Loans, net of unearned income and deferred fees, grew by $55,536 or 23.21% in 1999. Commercial loans grew by $38,877 or 35.18% with loans to individuals increasing by $4,332 or 6.23%. Loan growth for the year 2000 is not expected to reach 1999 levels. In 1998, loans, net of unearned income and deferred fees, grew by $22,267 or 10.26%. Commercial loans, which grew by $9,130 or 9.01%, accounted for the largest portion of the increase. The Company engages in the origination and sale of mortgage loans in the secondary market. In 1999 and 1998, the Company originated $31,538 and $41,472, respectively, and sold $33,489 and $39,697 in 1999 and 1998, respectively, of mortgage loans. SECURITIES In 1999, total bank-owned securities decreased by $29,262 or 17.55% compared to 1998. Securities available for sale declined by $22,233 or 16.34%, while securities held to maturity declined by $7,029 or 22.91%. (See comments in the Interest Rate Sensitivity section.) In 1998, total bank-owned securities increased by $16,780 or 11.19% from 1997. 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. At December 31, 1999 and 1998, the Company had no investment concentrations in any single issues (excluding U.S. Government) that exceeded ten percent of capital. DEPOSITS At year-end 1999, total deposits were $407,187 which represents a $24,491 or 6.4% increase over 1998. At December 31, 1998, total deposits were $382,696, an increase of 10.97% over 1997. In the third quarter of 1999, the 10 National Bankshares, Inc. and Subsidiaries Office of the Comptroller of Currency announced the closure of a banking institution in Keystone, West Virginia. As a result of the closure, depositors in that area were forced to seek banking relationships with other institutions in the general area. The Company's BTC affiliate benefitted from the event, acquiring new deposits in excess of $20,000. This event accounted for the majority of the Company's deposit growth for 1999. Average noninterest-bearing deposits were $55,700 in 1999, an increase of $6,148 or 12.41% over 1998. In 1998, average noninterest- bearing deposits increased by $5,359 or 12.13% over 1997. Average interest-bearing deposits were $335,883 in 1999, an increase of $25,465 over 1998. In 1998, average interest-bearing deposits of $310,418 increased $15,172 from 1997. 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 14 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, principally GNMA's, with a fair value of approximately $13,547, which includes $2,142 of structured notes. In addition, the Company has investments in nonmortgage-backed structured notes with a fair value of approximately $4,297. 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 15 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 changes in the overall rate environment. The Company's profitability in the near term may be temporarily affected either positively by a falling interest rate scenario or negatively by a period of rising rates. See note 16 of Notes to Consolidated Financial Statements for information relating to fair value of financial instruments and comments concerning interest rate sensitivity. 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 1999 and 1998. In 1999, the Company's liquidity was materially affected by several events. As previously discussed, the Company's available for sale securities 11 Management's Discussion and Analysis portfolio experienced a significant level of net unrealized losses through much of 1999 and at December 31, 1999, which limited, in the near term, its use as a source of liquidity. Deposit growth, however, during 1999 was strong, reducing the effect of the lack of liquidity found in the securities portfolio. (See comments in the deposit section related to the Keystone matter.) Loan growth and other cash needs did however remain strong and resulted in the Company borrowing $10,000 from the Federal Home Loan Bank on a short term basis at its NBB subsidiary. Liquidity was also affected by a stock repurchase that used cash totaling $7,762 and the building of a new corporate headquarters. Management does not anticipate that 1999 loan growth levels will be repeated in 2000 and accordingly, believes that liquidity needs can be met by extensions of credit by the Federal Home Loan Bank, as well as federal funds purchased. Other needs for cash include the planned building of a new branch by the Company's NBB subsidiary. The Company had approximately $43,000 in available credit at the Federal Home Loan Bank at December 31, 1999. Overall, based on available information, management does not expect demands for cash in 2000 to reach 1999 levels. Management is not aware of any other commitments or events that will result in or are reasonably likely to result in a material and adverse decrease in liquidity. Net cash from operating activities of $11,448 in 1999 increased by $6,201 from 1998 primarily due to the increase in the provision for loan losses and the decrease in mortgage loans held for sale. Net cash flows provided by operating activities and financing activities for 1999 of $11,448 and $24,161, respectively, were used primarily to fund loan growth. Net cash from operating activities of $5,247 in 1998 decreased $2,326 from 1997 due primarily to the increase in mortgage loans held for sale offset by the increase in net income. Net cash flows provided by operating activities and financing activities for 1998 of $5,247 and $34,751, respectively, were used to fund the net increases in federal funds sold, securities, loans made to customers and purchases of loan participations of $790, $15,429, $18,675 and $4,635, respectively. CAPITAL RESOURCES Total stockholders' equity decreased $7,986 from 1998 to 1999 and increased $4,474 from 1997 to 1998. Cash dividends on common stock of $2,814 and the repurchase of common stock of $7,762, offset by net income, contributed to the decrease in 1999. In addition, net unrealized gains (losses) on securities available for sale, net of deferred income taxes, were ($3,453) at December 31, 1999, $1,019 at December 31, 1998 and $194 at December 31, 1997. These unrealized net gains and losses are recorded as accumulated other comprehensive income (loss), 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. In the second quarter of 1999, the Company repurchased 275,856 of its common shares at $28.00 per share. This reduced stockholders' equity by $7,762. The Company has operated from a consistently strong capital position. The ratio of total stockholders' equity to total assets was 11.17% at year end 1999 compared to 13.14% at year end 1998 and 13.41% at year end 1997. 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 banks' risk-based capital ratios. No regulatory authorities have advised National Bankshares, Inc., The National Bank of Blacksburg or Bank of Tazewell County of any specific leverage ratios applicable to them. National Bankshares, Inc., The National Bank of Blacksburg 12 National Bankshares, Inc. and Subsidiaries 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 11 of Notes to Consolidated Financial Statements for additional information. RECENT ACCOUNTING PRONOUNCEMENTS See notes 1 and 19 of Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements. BUSINESS COMBINATIONS 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. Settlement of this purchase agreement occurred on April 3, 1998 and did not have a material impact on the Company's results of operations or liquidity. YEAR 2000 The Company was cognizant of the risks posed by the Year 2000 issue for Bank operations and borrowers. Subsequent to December 31, 1999, the Company was not aware of any information that indicates a significant vendor or service provider may be unable to sell goods or provide services to the Company because of Year 2000 issues. Further, the Company has not received any notifications from borrowers or regulatory agencies to which it is subject, nor is it aware of any such information which indicates that (1) a borrower has experienced significant issues which may impact its ability to service its loan or which may impact its borrowing agreement terms or covenants or (2) significant regulatory action is being or may be taken against the Company, as a result of Year 2000 issues. The Company has not experienced any significant disruptions to financial or operating activities caused by failure in computerized systems resulting from Year 2000 issues. Management does not expect Year 2000 issues to have a material adverse effect on the Company's operations or financial results in 2000. The Company was prepared for the millennium change and continues to successfully operate and handle the transactions of customers subsequent to December 31, 1999. COMMON STOCK INFORMATION AND DIVIDENDS Effective December 1, 1999, National Bankshares, Inc.'s common stock began trading on the Nasdaq SmallCap Market under the symbol "NKSH". Prior to December 1, 1999, National Bankshares, Inc.'s common stock was traded on a limited basis in the over-the-counter market and was not listed on any exchange or quoted on Nasdaq. As of December 31, 1999, there were 1,109 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 1999 and 1998. Prices prior to December 1, 1999 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. 13 Common Stock Market Prices Dividends 1999 1998 Per Share High Low High Low 1999 1998 ---- --- ---- --- ---- ---- First Quarter $26.00 22.00 $27.75 24.75 --- --- Second Quarter 27.50 24.00 28.00 26.50 0.39 0.36 Third Quarter 25.00 22.00 27.50 23.25 --- --- Fourth Quarter 23.50 19.75 24.25 21.25 0.41 0.38 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 11 of Notes to Consolidated Financial Statements. 14 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, 1999 and 1998, and the related consolidated statements of income and comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999. 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 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 provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Bankshares, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999 in conformity with generally accepted accounting principles. As discussed in note 1(S) to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities," as of October 1, 1998. /S/KPMG LLP Roanoke, Virginia February 11, 2000 15 National Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets
$ In thousands, except share and per share data. December 31, 1999 and 1998 1999 1998 ---- ---- Assets Cash and due from banks (notes 2 and 16) $ 13,311 14,421 Interest-bearing deposits (note 16) 9,219 7,027 Federal funds sold (note 16) 2,800 5,090 Securities available for sale (notes 3 and 16) 113,845 136,078 Securities held to maturity (fair value $23,496 in 1999 and $31,151 in 1998) (notes 3 and 16) 23,647 30,676 Mortgage loans held for sale (notes 14, 15 and 16) 229 2,180 Loans (notes 4, 5, 15 and 16): Real estate construction loans 14,669 12,827 Real estate mortgage loans 58,829 48,724 Commercial and industrial loans 149,386 110,509 Loans to individuals 73,825 69,493 -------- ------- Total loans 296,709 241,553 Less unearned income and deferred fees (1,916) (2,296) -------- ------- Loans, net of unearned income and deferred fees 294,793 239,257 Less allowance for loan losses (note 5) (3,231) (2,679) -------- ------- Loans, net 291,562 236,578 -------- ------- Bank premises and equipment, net (note 6) 8,506 6,657 Accrued interest receivable 4,014 3,777 Other real estate owned, net (note 5) 447 628 Other assets (note 10) 4,554 2,054 -------- ------- Total assets $472,134 445,166 ======== ======= Liabilities Noninterest-bearing demand deposits $ 54,748 55,479 and Interest-bearing demand deposits 88,385 84,319 Stockholders'Savings deposits 44,834 46,387 Equity Time deposits (note 7) 219,220 196,511 -------- ------- Total deposits (note 16) 407,187 382,696 -------- ------- Other borrowed funds (notes 3 and 16) 10,460 214 Accrued interest payable 651 647 Other liabilities (note 8) 1,113 926 -------- ------- Total liabilities 419,411 384,483 -------- ------- 16 Common stock subject to ESOP put option (note 8) --- 2,180 -------- ------- Stockholders' equity (notes 9, 10, 11 and 17): 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 3,516,977 shares in 1999 and 3,792,833 in 1998 8,792 9,482 Retained earnings 47,384 50,182 Accumulated other comprehensive income (loss) (3,453) 1,019 Common stock subject to ESOP put option (77,301 shares at $28.20 per share in 1998)(note 8) --- (2,180) -------- ------- Total stockholders' equity 52,723 58,503 Commitments and contingent liabilities (notes 6, 8, and 14) -------- ------- Total liabilities and stockholders' equity $472,134 445,166 ======== ======= See accompanying notes to consolidated financial statements.
17 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income and Comprehensive Income $ In thousands, except per share data. Years ended December 31, 1999, 1998 and 1997 1999 1998 1997 ---- ---- ---- Interest Interest and fees on loans $ 24,105 21,691 19,553 Income Interest on federal funds sold 170 345 451 Interest on interest-bearing deposits 269 696 230 Interest on securities - taxable 6,820 7,201 7,776 Interest on securities - nontaxable 2,239 1,895 1,787 -------- -------- ------- Total interest income 33,603 31,828 29,797 -------- -------- ------- Interest Interest on time deposits of $100,000 or Expense more 2,487 2,457 2,335 Interest on other deposits 11,484 11,460 10,754 Interest on borrowed funds 232 11 17 -------- -------- ------- Total interest expense 14,203 13,928 13,106 -------- -------- ------- Net interest income 19,400 17,900 16,691 Provision for loan losses (note 5) 1,400 624 435 -------- -------- ------- Net interest income after provision for loan losses 18,000 17,276 16,256 -------- -------- ------- Noninterest Service charges on deposit accounts 1,395 1,165 1,131 Income Other service charges and fees 279 231 250 Credit card fees 802 653 606 Trust income 927 774 738 Other income 85 163 72 Realized securities gains, net (note 3) 24 188 37 -------- -------- ------- Total noninterest income 3,512 3,174 2,834 -------- -------- ------- Noninterest Salaries and employee benefits (note 8) 6,048 5,824 5,398 Expense Occupancy and furniture and fixtures 1,152 998 958 Data processing and ATM 889 771 578 FDIC assessment 47 37 43 Credit card processing 712 599 551 Goodwill amortization 38 36 30 Net costs of other real estate owned 26 37 8 Other operating expenses 2,956 2,759 2,465 -------- -------- ------- Total noninterest expense 11,868 11,061 10,031 -------- -------- ------- 18 Income before income tax expense 9,644 9,389 9,059 Income tax expense (note 10) 2,556 2,591 2,499 -------- -------- ------- Net income 7,088 6,798 6,560 -------- -------- ------- Other comprehensive income (loss), net of income taxes: Net unrealized gains (losses) on securities available for sale (notes 1(R), 1(S) and 18): Arising during the year (4,472) 356 442 Cumulative accounting change --- 469 --- -------- -------- ------- Total other comprehensive income (loss) (4,472) 825 442 -------- -------- ------- Comprehensive income $ 2,616 7,623 7,002 ======== ======== ======= Basic net income per share (note 1(N)) $ 1.96 1.79 1.73 ======== ======== ======= See accompanying notes to consolidated financial statements. 19 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity
Common Stock Accumulated Subject $ In thousands, except per share Other to ESOP data. Years ended December 31, 1999, Common Retained Comprehensive Put 1998 and 1997. Stock Earnings Income (Loss) Option Total ------ -------- ------------- ------- ----- Balances, December 31, 1996 $ 9,482 42,210 (248) (1,643) 49,801 Net income --- 6,560 --- --- 6,560 Cash dividends ($0.68 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 Net income --- 6,798 --- --- 6,798 Cash dividends ($0.74 per share) --- (2,807) --- --- (2,807) Change in net unrealized gains (losses) on securities available for sale, net of income tax expense of $425: Arising during the year, net of income tax expense of $183 --- --- 356 --- 356 Cumulative accounting change, net of income tax expense of $242 (note 1(S)) --- --- 469 --- 469 ------- ------ ------ ------ ------ Total --- --- 825 --- 825 ------- ------ ------ ------ ------ Change in common stock subject to ESOP put option --- --- --- (342) (342) ------- ------ ------ ------ ------ Balances December 31, 1998 9,482 50,182 1,019 (2,180) 58,503 Net income --- 7,088 --- --- 7,088 Cash dividends ($0.80 per share) --- (2,814) --- --- (2,814) Change in net unrealized gains (losses) on securities available for sale, net of income tax benefit of $2,304 --- --- (4,472) --- (4,472) Common stock repurchase (690) (7,072) --- --- (7,762) Change in common stock subject to ESOP put option (note 8) --- --- --- 2,180 2,180 ------- ------ ------ ------ ------ Balances, December 31, 1999 $ 8,792 47,384 (3,453) --- 52,723 ======= ====== ====== ====== ====== See accompanying notes to consolidated financial statements.
20 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows
$ In thousands. Years ended December 31, 1999, 1998 and 1997 1999 1998 1997 ---- ---- ---- Cash Flows Net income $ 7,088 6,798 6,560 from Adjustments to reconcile net income to net cash Operating provided by operating activities: Activities Provision for loan losses 1,400 624 435 (Note 13) Recovery of bond losses --- --- (10) Provision for deferred income taxes (214) (135) 300 Depreciation of bank premises and equipment 903 811 586 Amortization of intangibles 152 144 121 Amortization of premiums and accretion of discounts, net 350 87 11 Gains on sales and calls of securities available for sale, net (20) (145) (5) Gains on calls of securities held to maturity, net (4) --- --- Other 22 (135) (18) (Increase) decrease in: Mortgage loans held for sale 1,951 (1,775) 111 Accrued interest receivable (237) (332) 65 Other assets (134) (580) (76) Increase (decrease) in: Accrued interest payable 4 (75) 22 Other liabilities 187 (40) (529) -------- -------- ------- Net cash provided by operating activities 11,448 5,247 7,573 -------- -------- ------- Cash Flows Net (increase) decrease in federal funds sold 2,290 (790) (2,390) from Net (increase) decrease in interest-bearing Investing deposits (2,192) 2,701 (9,637) Activities Proceeds from repayments of mortgage-backed (Note 13) securities available for sale 4,558 1,065 396 Proceeds from sales of other securities available for sale 1,300 2,999 --- Proceeds from calls and maturities of other securities available for sale 21,495 35,180 9,443 Proceeds from calls and maturities of securities held to maturity 6,997 34,187 35,673 Purchases of mortgage-backed securities available for sale --- (14,175) --- Purchases of other securities available for sale (12,190) (73,685) (12,201) Purchases of securities held to maturity --- (1,000) (11,345) Purchases of loan participations (5,643) (4,635) (6,189) Collections of loan participations 3,408 4,074 1,934 Loans purchased, including premium --- (4,051) --- Net increase in loans made to customers (54,456) (18,675) (17,400) Proceeds from disposal of other real estate owned 336 194 216 21 Recoveries on loans charged off 130 255 107 Bank premises and equipment expenditures (2,757) (1,770) (1,304) Proceeds from sale of bank premises and equipment 5 114 8 -------- -------- ------- Net cash used in investing activities (36,719) (38,012) (12,689) -------- -------- ------- Cash Flows Deposits acquired, net of premium --- 7,016 --- from Net increase in time deposits 22,709 14,357 6,618 Financing Net increase in other deposits 1,782 16,456 3,665 Activities Net increase (decrease) in other borrowed funds 10,246 (271) (142) (Note 13) Cash dividends paid (2,814) (2,807) (2,579) Common stock repurchase (7,762) --- --- -------- -------- ------- Net cash provided by financing activities 24,161 34,751 7,562 -------- -------- ------- Net increase (decrease) in cash and due from banks (1,110) 1,986 2,446 Cash and due from banks at beginning of year 14,421 12,435 9,989 -------- -------- ------- Cash and due from banks at end of year $ 13,311 14,421 12,435 ======== ======== ======= See accompanying notes to consolidated financial statements.
22 National Bankshares, Inc. and Subsidiaries $ In thousands, except share and per share data. December 31, 1999, 1998 and 1997 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. 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. 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. All interest accrued but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash basis until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Impaired loans are presented in the consolidated 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. This requirement 23 Notes to Consolidated Financial Statements 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. 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. 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. Subsequent decreases in the net realizable value of such properties are 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 $592 and $706 at December 31, 1999 and 1998, respectively, and goodwill of $382 and $420 at December 31, 1999 and 1998, 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. (I) Stock Option Plan Effective March 10, 1999, the Company adopted the National Bankshares, Inc. 1999 Stock Option Plan. The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, in accounting for its fixed plan stock options. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by Statement 123, 24 National Bankshares, Inc. and Subsidiaries the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of Statement 123. (J) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of Long-lived assets and certain identifiable intangibles are 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 undiscounted 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. (K) Pension Plans On January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosure about Pension and Other Post-retirement Benefits." Statement 132 revises the Company's disclosure about pension and other post-retirement benefit plans. Statement 132 does not change the method of accounting for such 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. (L) 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. (M) 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. (N) Net Income Per Share Basic net income per share is based upon the weighted average number of common shares outstanding (3,607,669 shares in 1999, and 3,792,833 in 1998 and 1997). Stock options that could potentially dilute basic net income per share in the future that were not included in the computation of diluted net income per share because to do so would have been antidilutive totaled 5,500 at December 31, 1999 (see note 9). 25 Notes to Consolidated Financial Statements In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings per Share." Statement 128 established new standards for computing and presenting earnings per share (EPS) and applies to entities with publicly-held common stock or potential common stock. 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. (O) 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. (P) 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. 26 National Bankshares, Inc. and Subsidiaries 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. (5) Other Borrowed Funds Other borrowed funds represents treasury tax and loan deposits, and short-term borrowings from the Federal Home Loan Bank. 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, 1999 and 1998, and as such, the related fair values have not been estimated. (Q) 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, 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. 27 Notes to Consolidated Financial Statements (R) Comprehensive Income On January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income." Statement 130 establishes standards for reporting and presentation of comprehensive income and its components 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. The Company is required to classify items of "Other Comprehensive Income" [such as net unrealized gains (losses) on securities available for sale] by their nature in a financial statement and present 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. In accordance with the provisions of the Statement, the Company has included Consolidated Statements of Income and Comprehensive Income in the accompanying consolidated financial statements. Comprehensive income consists of net income and net unrealized gains (losses) on securities available for sale. Also, accumulated other comprehensive income (loss) is included as a separate disclosure within the Consolidated Statements of Changes in Stockholders' Equity in the accompanying consolidated financial statements. The adoption of Statement 130 did not have any effect on the Company's consolidated financial position, results of operation or liquidity. (S) Derivatives In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Company adopted Statement 133 as of October 1, 1998. In connection with the adoption of Statement 133, the Company transferred securities with a carrying value of approximately $20,516 from held to maturity to available for sale. This transfer of securities resulted in an increase in unrealized gains on securities available for sale, comprehensive income, accumulated other comprehensive income and stockholders' equity of approximately $469, net of income taxes of $242, as of October 1, 1998, which is reported as a cumulative effect of an accounting change. Except as discussed above, the adoption of Statement 133 did not have a material effect on the consolidated financial position, results of operations or liquidity of the Company. (T) 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. 28 National Bankshares, Inc. and Subsidiaries 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 $5,285 and $4,813 for the weeks including December 31, 1999 and 1998, respectively. Note 3: Securities The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities available for sale by major security type as of December 31, 1999 and 1998 are as follows: December 31, 1999 Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- ------ Available for sale: U.S. Treasury $ 6,244 7 87 6,164 U.S. Government agencies and corporations 50,373 7 2,882 47,498 States and political subdivisions 32,903 112 1,398 31,617 Mortgage-backed securities 13,464 8 296 13,176 Corporate debt securities 14,349 --- 703 13,646 Federal Home Loan Bank stock 1,329 --- --- 1,329 Federal Reserve Bank stock 247 --- --- 247 Other securities 168 --- --- 168 -------- ------ ----- ------- Total securities available for sale $119,077 134 5,366 113,845 ======== ====== ===== ======= December 31, 1998 Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- ------ Available for sale: U.S. Treasury $ 9,253 418 --- 9,671 U.S. Government agencies and corporations 59,365 369 (139) 59,595 States and political subdivisions 32,183 786 (104) 32,865 Mortgage-backed securities 17,282 12 (94) 17,200 Corporate debt securities 14,528 331 (35) 14,824 Federal Home Loan Bank stock 1,214 --- --- 1,214 Federal Reserve Bank stock 247 --- --- 247 Other securities 462 --- --- 462 -------- ------ ----- ------- Total securities available for sale $134,534 1,916 (372) 136,078 ======== ====== ===== ======= 29 Notes to Consolidated Financial Statements The amortized costs and fair values of single maturity securities available for sale at December 31, 1999, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities included in these totals are allocated based upon estimated cash flows at December 31, 1999. December 31, 1999 Amortized Fair ($ In thousands) Costs Values --------- ------ Due in one year or less $ 4,170 4,168 Due after one year through five years 21,629 21,423 Due after five years through ten years 40,667 38,984 Due after ten years 51,037 47,695 No maturity 1,574 1,575 -------- ------- $119,077 113,845 ======== ======= The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities held to maturity by major security type as of December 31, 1999 and 1998 are as follows: December 31, 1999 Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- ------ Held to maturity: U.S. Treasury $ 500 --- --- 500 U.S. Government agencies and corporations 5,500 --- 230 5,270 States and political subdivisions 17,283 117 45 17,355 Mortgage-backed securities 364 7 --- 371 ------- ------- ----- ------- Total securities held to maturity $23,647 124 275 23,496 ======= ======= ===== ======= 30 National Bankshares, Inc. and Subsidiaries December 31, 1998 Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- ------ Held to maturity: U.S. Treasury $ 1,006 3 --- 1,009 U.S. Government agencies and corporations 7,497 55 (121) 7,431 States and political subdivisions 21,160 537 (18) 21,679 Mortgage-backed securities 513 17 --- 530 Corporate debt securities 500 2 --- 502 ------- ------- ----- ------- Total securities held to maturity $30,676 614 (139) 31,151 ======= ======= ===== ======= The amortized costs and fair values of single maturity securities held to maturity at December 31, 1999, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities included in these totals are allocated based upon estimated cash flows at December 31, 1999. December 31, 1999 Amortized Fair ($ In thousands) Costs Values --------- ------ Due in one year or less $ 2,602 2,606 Due after one year through five years 15,868 15,817 Due after five years through ten years 3,877 3,779 Due after ten years 1,300 1,294 ------- ------- $23,647 23,496 ======= ======= There were no sales of securities held to maturity during 1999, 1998 or 1997. The carrying value of securities pledged to secure public and trust deposits, and for other purposes as required or permitted by law, was $46,937 at December 31, 1999 and $21,629 at December 31, 1998. As members of the Federal Reserve and the Federal Home Loan Bank (FHLB) of Atlanta, NBB and BTC are required to maintain certain minimum investments in the common stock of those entities. Required levels of investment are based upon NBB and BTC's capital and a percentage of qualifying assets. In addition, NBB and BTC are eligible to borrow from the FHLB with borrowings collateralized by qualifying assets, primarily residential mortgage loans, and NBB and BTC's capital stock investment in the FHLB. At December 31, 1999, the available borrowing limit was approximately $53,000, of which NBB had $10,000 in borrowings outstanding at December 31, 1999. The note is due in February 2000 and bears interest at a fixed rate of 5.93 percent. 31 Notes to Consolidated Financial Statements 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, 1999 and 1998, there were direct loans to executive officers and directors of $1,566 and $1,782, respectively. In addition, there were loans of $357 and $1,844 at December 31, 1999 and 1998, respectively, which were endorsed by directors and/or executive officers or had been made to companies in which directors and/or executive officers had an equity interest. The following schedule summarizes amounts receivable from executive officers and directors of Bankshares and its subsidiaries, and their immediate families or associates: Year ended December 31, ($ In thousands) 1999 ------------ Aggregate balance, beginning of year $ 3,626 Additions 2,601 Collections (4,304) ------- Aggregate balance, end of year $ 1,923 ======= Note 5: Nonperforming Assets, Past Due Loans, Impaired Loans and Allowance for Loan Losses Nonperforming assets consist of the following: December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Nonaccrual loans $ 151 28 87 Restructured loans 40 --- --- Other real estate owned, net 447 628 421 ------- ------- ------ Total nonperforming assets $ 638 656 508 ======= ======= ====== Accruing loans past due 90 days or more $ 1,077 550 672 ======= ======= ====== There were no material commitments to lend additional funds to customers whose loans were classified as nonperforming at December 31, 1999. 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: 32 National Bankshares, Inc. and Subsidiaries Years ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Scheduled interest: Nonaccrual loans $ 13 4 8 ======= ====== ====== Recorded interest: Nonaccrual loans $ --- --- 1 ======= ====== ====== Changes in the valuation allowance for other real estate owned are as follows: Years ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Balances, beginning of year $ 93 68 96 Provision for other real estate owned 8 25 --- Write-offs --- --- (28 ------- ------- ----- Balances, end of year $ 101 93 68 ======= ======= ===== At December 31, 1999, the recorded investment in loans which have been identified as impaired loans, totaled $317. Of this amount, $95 related to loans with no valuation allowance and $222 related to loans with a corresponding valuation allowance of $154. At December 31, 1998, the recorded investment in loans which have been identified as impaired loans totaled $373. Of this amount, $228 related to loans with no valuation allowance and $145 related to loans with a corresponding valuation allowance of $145. For the year ended December 31, 1999, the average recorded investment in impaired loans was approximately $292, and the total interest income recognized on impaired loans was $13 of which $0 was recognized on a cash basis. For the year ended December 31, 1998, the average recorded investment in impaired loans was approximately $387, and the total interest income recognized on impaired loans was $32 of which $0 was recognized on a cash basis. 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 $12 was recognized on a cash basis. Changes in the allowance for loan losses are as follows: Years ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Balances, beginning of year $ 2,679 2,438 2,575 Provision for loan losses 1,400 624 435 Recoveries 130 255 107 Loans charged off (978) (638) (679) ------- ------- ------ Balances, end of year $ 3,231 2,679 2,438 ======= ======= ====== 33 Notes to Consolidated Financial Statements Note 6: Bank Premises and Equipment Bank premises and equipment stated at cost, less accumulated depreciation, are as follows: December 31, ($ In thousands) 1999 1998 ---- ---- Premises $ 8,818 6,321 Furniture and equipment 6,140 5,343 Construction-in-progress 21 632 -------- -------- 14,979 12,296 Less accumulated depreciation (6,473) (5,639) -------- -------- Bank premises and equipment, net $ 8,506 6,657 ======== ======== The Company leases a branch facility as well as certain other office space under noncancellable operating leases that expire over the next five years. The future minimum lease payments under these leases (with initial or remaining lease terms in excess of one year) as of December 31, 1999 are as follows: $51 in 2000, $50 in 2001, $43 in 2002 and $33 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 $46,172 at December 31, 1999 and $46,257 at December 31, 1998. At December 31, 1999, the scheduled maturities of time deposits are as follows: $152,147 in 2000, $43,490 in 2001, $9,692 in 2002, $8,297 in 2003 and $5,594 in 2004. 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, 1999, 1998 and 1997, NBB contributed $102, $91 and $87, 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 $162, $0 and $219 for the years ended December 31, 1999, 1998 and 1997, respectively. Dividends on ESOP shares are charged to retained earnings. As of December 31, 1999, the number of allocated shares held by the ESOP was 76,680 and the number of unallocated shares was 1,951. All shares held by the ESOP are treated as outstanding in computing the Company's basic 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 34 National Bankshares, Inc. and Subsidiaries not readily tradeable on an established market at the time of its distribution. Since the shares were not readily tradeable at December 31, 1998, 77,301 shares of stock held by the ESOP, at their estimated fair value, which was based on the most recent available independent valuation, is recorded outside of stockholders' equity as of December 31, 1998. Effective December 1, 1999, Bankshares' common stock began trading on the Nasdaq SmallCap Market. As a result of being listed on an established national exchange, presentation of the fair value of the shares of common stock held by the ESOP outside of stockholders' equity is no longer required at December 31, 1999. 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 (30%), mutual funds (32%), corporate bonds (5%) and equity securities (33%). BTC's pension plan's assets are invested principally in BTC certificates of deposit (4%), U.S. Government agency obligations (81%) and equity securities (15%). Pension Benefits ---------------- December 31, ------------ ($ In thousands) 1999 1998 ---- ---- Change in benefit obligation Benefit obligation at beginning of year $ 5,995 4,967 Service cost 398 331 Interest cost 415 367 Actuarial gain (749) 491 Benefits paid (365) (161) -------- -------- Benefit obligation at end of year 5,694 5,995 -------- -------- Change in plan assets Fair value of plan assets at beginning of year 4,971 4,337 Actual return on plan assets 85 430 Employer contribution 186 365 Benefits paid (365) (161) -------- -------- Fair value of plan assets at end of year 4,877 4,971 -------- -------- Funded status (817) (1,024) Unrecognized net actuarial loss 522 917 Unrecognized prior service cost 201 216 Unrecognized transition asset (160) (183) -------- -------- Net accrued pension cost (includes accrued pension cost of $414 in 1999 and $363 in 1998 included in other liabilities, and prepaid pension cost of $160 in 1999 and $289 in 1998 included in other assets) $ (254) (74) ======== ======== 35 Notes to Consolidated Financial Statements Pension Benefits ------------------------------------------------ NBB BTC ($ In thousands) 1999 1998 1997 1999 1998 1997 ---- ---- ---- ---- ---- ---- Weighted average assumptions as of December 31 Weighted average discount rate 7.50% 7.00% 7.50% 7.50% 7.00% 7.50% Expected return on plan assets 9.00% 9.00% 9.00% 9.00% 9.00% 9.00% Rate of compensation increase 5.00% 5.00% 5.00% 5.00% 5.00% 5.00% Pension Benefits ---------------- Years Ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Components of net periodic benefit cost Service cost $ 398 331 281 Interest cost 415 367 367 Expected return on plan assets (457) (400) (364) Amortization of prior service cost 15 15 15 Recognized net actuarial loss 18 3 8 Amortization of transition asset (23) (22) (23) ------ ----- ----- Net periodic benefit cost $ 366 294 284 ====== ===== ===== Note 9: Stock Option Plan Effective March 10, 1999, the Company adopted the National Bankshares, Inc. 1999 Stock Option Plan to give key employees of Bankshares and its subsidiaries an opportunity to acquire shares of National Bankshares, Inc. common stock. The purpose of the 1999 Stock Option Plan is to promote the success of Bankshares and its subsidiaries by providing an incentive to key employees that enhances the identification of their personal interest with the long term financial success of the Company and with growth in stockholder value. Under the 1999 Stock Option Plan, up to 250,000 shares of Bankshares common stock may be granted. The 1999 Stock Option Plan is administered by the Stock Option Committee, which is made up of all of the non-employee, outside directors of National Bankshares, Inc. The Stock Option Committee may determine whether options are incentive stock options or nonqualified stock options and may determine the other terms of grants, such as number of shares, term, a vesting schedule and the exercise price. The 1999 Stock Option Plan limits the maximum term of any option granted to ten years, states that options may be granted at not less than fair market value on the date of the grant and contains certain other limitations on the exercisability of incentive stock options. The options vest 25% after one year, 50% after two years, 75% after 36 National Bankshares, Inc. and Subsidiaries three years and 100% after four years. At the discretion of the Stock Option Committee, options may be awarded with the provision that they may be accelerated upon a change of control, merger, consolidation, sale or dissolution of National Bankshares, Inc. At December 31, 1999, there were 244,500 additional shares available for grant under the Plan. The per share weighted-average estimated fair value of stock options granted during 1999 was $2.38 on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 1999 - expected cash dividend yield of 3.41% percent, risk-free interest rate of 6.38% percent, expected volatility of 18.60% percent and an expected life of ten years. The Company applies APB Opinion No. 25 in accounting for its Plan and, accordingly, no compensation cost has been recognized for its stock options in the consolidated financial statements. Proforma compensation cost determined in accordance with Statement 123 was not material and had no impact on net income per share presented. Stock option activity during the periods indicated is as follows: Weighted Number of Average Shares Exercise Price --------- -------------- Granted in 1999 5,500 $22.00 Exercised --- --- Forfeited --- --- Expired --- --- ------ ------ Balance at December 31, 1999 5,500 $22.00 ====== ====== At December 31, 1999, the exercise price and remaining contractual life of outstanding options was $22.00 and 9.83 years. Note 10: Income Taxes Total income taxes were allocated as follows: Years ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Income $ 2,556 2,591 2,499 Stockholders' equity, for net unrealized gains (losses) on securities available for sale recognized for financial reporting purposes (2,304) 425 228 ------- ------- ------ Total income taxes $ 252 3,016 2,727 ======= ======= ====== 37 Notes to Consolidated Financial Statements The components of federal income tax expense attributable to income before income tax expense are as follows: Years ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Current $ 2,770 2,726 2,199 Deferred (214) (135) 300 ------- ------- ------ Total income tax expense $ 2,556 2,591 2,499 ======= ======= ====== Taxes resulting from securities transactions amounted to a tax expense of $8 for the year ended December 31, 1999, $64 for the year ended December 31, 1998 and $13 for the year ended December 31, 1997. The following is a reconciliation of the "expected" income tax expense, computed by applying the U.S. Federal income tax rate of 34% to income before income tax expense, with the reported income tax expense: Years ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Expected income tax expense (34%) $ 3,279 3,192 3,080 Tax-exempt interest income (866) (742) (700) Nondeductible interest expense 109 97 90 Other, net 34 44 29 ------- ------- ------ Reported income tax expense $ 2,556 2,591 2,499 ======= ======= ====== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1999 and 1998 are presented below: 38 National Bankshares, Inc. and Subsidiaries December 31, ($ In thousands) 1999 1998 ---- ---- Deferred tax assets: Loans, principally due to allowance for loan losses and unearned fee income $ 786 545 Other real estate owned, principally due to valuation allowance 32 32 Deferred compensation and other liabilities, due to accrual for financial reporting purposes 124 96 Deposit intangibles and goodwill 59 51 Community development corporation related tax credit 19 22 Other 36 --- Net unrealized losses on securities available for sale 1,779 --- ------- ------- Total gross deferred tax assets 2,835 746 Less valuation allowance --- --- ------- ------- Net deferred tax assets 2,835 746 Deferred tax liabilities: Bank premises and equipment, principally due to differences in depreciation (121) (102) Securities, due to differences in discount accretion (58) (52) Accrued late fee income (72) --- Other assets (62) (63) Net unrealized gains on securities available for sale --- (525) ------- ------- Total gross deferred tax liabilities (313) (742) ------- ------- Net deferred tax asset included in other assets $ 2,522 4 ======= ======= The Company has determined that a valuation allowance for the gross deferred tax assets is not necessary at December 31, 1999 and 1998 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. 39 Notes to Consolidated Financial Statements Note 11: 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, 1999, 1998 and 1997, dividends received from subsidiary banks were $10,538, $5,341 and $2,712, respectively. Additional funds dividended to the parent in 1999 were used primarily for a common stock repurchase. 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, 1999, retained net income which was free of such restriction at NBB amounted to approximately $198. There was no retained income free of this restriction at BTC at December 31, 1999. Bankshares and its subsidiaries are subject to various regulatory capital requirements administered by the bank regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bankshares and its subsidiaries must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Bankshares' and its subsidiaries' capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require Bankshares and its subsidiaries to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1999, that Bankshares and its subsidiaries meet all capital adequacy requirements to which they are subject. Bankshares' and its subsidiaries' actual regulatory capital amounts and ratios are also presented in the following tables. 40 National Bankshares, Inc. and Subsidiaries To Be Well Capitalized Under Prompt For Capital Corrective Adequacy Action Actual Purposes Provisions ------ ----------- ------------ ($ In thousands) Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- December 31, 1999 Total capital (to risk weighted assets) Bankshares consolidated $58,433 18.3% 25,552 8.0% N/A N/A NBB 29,320 14.1% 16,682 8.0% 20,853 10.0% BTC 26,630 23.7% 8,998 8.0% 11,247 10.0% Tier I capital (to risk weighted assets) Bankshares consolidated $55,202 17.3% 12,776 4.0% N/A N/A NBB 27,222 13.1% 8,341 4.0% 12,512 6.0% BTC 25,497 22.7% 4,499 4.0% 6,748 6.0% Tier I capital (to average assets) Bankshares consolidated $55,202 11.7% 18,957 4.0% N/A N/A NBB 27,222 9.8% 11,135 4.0% 13,919 5.0% BTC 25,497 12.7% 8,019 4.0% 10,023 5.0% To Be Well Capitalized Under Prompt Corrective For Capital Action Adequacy Provisions Actual Purposes ------------ ------ ----------- ($ In thousands) Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- December 31, 1998 Total capital (to risk weighted assets) Bankshares consolidated $61,216 22.4% 21,819 8.0% N/A N/A NBB 30,411 16.5% 14,747 8.0% 18,433 10.0% BTC 28,284 31.8% 7,112 8.0% 8,890 10.0% Tier I capital (to risk weighted assets) Bankshares consolidated $58,537 21.5% 10,910 4.0% N/A N/A NBB 28,511 15.5% 7,373 4.0% 11,060 6.0% BTC 27,505 30.9% 3,536 4.0% 5,334 6.0% Tier I capital (to average assets) Bankshares consolidated $58,537 13.4% 17,457 4.0% N/A N/A NBB 28,511 11.1% 10,292 4.0% 12,865 5.0% BTC 27,505 15.6% 7,068 4.0% 8,835 5.0% 41 Notes to Consolidated Financial Statements As of December 31, 1999, the most recent notifications from the appropriate regulatory authorities categorized Bankshares and its subsidiaries as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized, Bankshares and its subsidiaries must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since those notifications that management believes have changed Bankshares' and its subsidiaries' category. 42 National Bankshares, Inc. and Subsidiaries Note 12: Parent Company Financial Information Condensed financial information of Bankshares (Parent) is presented below: Condensed Balance Sheets December 31, ($ In thousands, except share and per share data.) 1999 1998 ---- ---- Assets Cash due from subsidiaries $ 5 28 Securities available for sale (note 3) 2,292 2,521 Investment in subsidiaries, at equity 50,302 58,139 Refundable income taxes due from subsidiaries 59 30 Other assets 85 30 -------- -------- Total assets $ 52,743 60,748 ======== ======== Liabilities Other liabilities $ 20 65 and -------- -------- Stockholders' Common stock subject to ESOP Equity put option (note 8) --- 2,180 -------- -------- Stockholders' equity (notes 9, 10, 11 and 17): 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 3,516,977 shares in 1999 and 3,792,833 in 1998 8,792 9,482 Retained earnings 47,384 50,182 Accumulated other comprehensive income (loss) (3,453) 1,019 Common stock subject to ESOP put option (77,301 shares at $28.20 per share in 1998) (note 8) --- (2,180) ------- -------- Total stockholders' equity 52,723 58,503 Commitments and contingent liabilities (notes 6, 8, and 14) ------- -------- Total liabilities and stockholders' equity $52,743 60,748 ======= ======== 43 Notes to Consolidated Financial Statements Condensed Statements of Income and Comprehensive Income Years ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Income Dividends from subsidiaries (note 11) $10,538 5,341 2,712 Interest on securities - taxable 17 29 --- Interest on securities - nontaxable 118 24 --- ------- ------ ------ 10,673 5,394 2,712 Expenses Other expenses 194 173 125 ------- ------ ------ Income before income tax benefit and equity in undistributed net income (distributions in excess of equity in net income) of subsidiaries 10,479 5,221 2,587 Applicable income tax benefit 59 47 42 ------- ------ ------ Income before equity in undistributed net income (distributions in excess of equity in net income) of subsidiaries 10,538 5,268 2,629 Equity in undistributed net income (distributions in excess of equity in net income) of subsidiaries (3,450) 1,530 3,931 ------- ------ ------ Net income 7,088 6,798 6,560 ------- ------ ------ Other comprehensive income (loss), net of income taxes: Net unrealized gains (losses) on securities available for sale (notes 1(R), 1(S) and 18): Arising during the year (4,472) 356 442 Cumulative accounting change --- 469 --- ------- ------ ------ Total other comprehensive income (loss) (4,472) 825 442 ======= ------ ------ Comprehensive income $ 2,616 7,623 7,002 ======= ====== ====== 44 National Bankshares, Inc. and Subsidiaries Condensed Statements of Cash Flows Years ended December 31, ($ In thousands) 1999 1998 1997 ---- ---- ---- Cash Flows Net income $ 7,088 6,798 6,560 from Adjustments to reconcile net Operating income to net cash provided Activities by operating activities: (Equity in undistributed net income) distributions in excess of equity in net income of subsidiaries 3,450 (1,530) (3,931) Amortization of premiums and accretion of discounts, net 7 4 --- (Increase) decrease in refundable income taxes due from subsidiaries (29) (8) 3 Increase in other assets (10) (30) --- Increase (decrease) in other liabilities (45) 22 (4) ------- ------- ------ Net cash provided by operating activities 10,461 5,256 2,628 ------- ------- ------ Cash Flows Purchases of securities from available for sale (207) (4,534) --- Investing Maturities of securities Activities available for sale 299 2,044 --- ------- ------- ------ Net cash provided by (used in) investing activities 92 (2,490) --- ------- ------- ------ Cash Flows Cash dividends paid (2,814) (2,807) (2,579) from Common stock repurchase (7,762) --- --- Financing ------- ------- ------ Activities Net cash used in financing activities (10,576) (2,807) (2,579) ------- ------- ------ Net increase (decrease) in cash (23) (41) 49 Cash due from subsidiary at beginning of year 28 69 20 ------- ------- ------ Cash due from subsidiary at end of year $ 5 28 69 ======= ======= ====== 45 Notes to Consolidated Financial Statements Note 13: Supplemental Cash Flow Information The Company paid $14,199, $14,003 and $13,084 for interest and $2,941, $2,631 and $2,719 for income taxes, net of refunds, in 1999, 1998 and 1997, respectively. Noncash investing activities consisted of $978, $638 and $679 of loans charged against the allowance for loan losses in 1999, 1998 and 1997, respectively. Noncash investing activities also included $177 in 1999, $382 in 1998 and $159 in 1997 of loans transferred to other real estate owned. In addition, for the years ended December 31, 1999, 1998 and 1997, noncash investing activities included changes in net unrealized gains (losses) on securities available for sale of ($6,776), $1,250 and $670, respectively, changes in deferred tax assets included in other assets of $2,304, ($425) and ($228), respectively, and changes in net unrealized gains (losses) on securities available for sale included in stockholders' equity of ($4,472), $825 and $442, respectively. Securities, classified as held to maturity, totaling approximately $20,516, were transferred to securities available for sale in 1998. This was in accordance with the reassessment of the classification of securities allowed by Statement No. 133 "Accounting for Derivative Instruments and Hedging Activities," which was adopted by the Company on October 1, 1998. Note 14: Financial Instruments with Off-Balance Sheet Risk The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company may require collateral or other security to support the following financial instruments with credit risk: December 31, ($ In thousands) 1999 1998 ---- ---- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $52,932 53,498 ======= ======= Standby letters of credit $ 5,109 3,320 ======= ======= Mortgage loans sold with potential recourse $33,489 39,697 ======= ======= 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 46 National Bankshares, Inc. and Subsidiaries 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 approximately equally divided between fixed and variable rate in nature, except for 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 1999, the Company originated $31,538 and sold $33,489 to investors, compared to $41,472 originated and $39,697 sold in 1998. 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 15: 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 and the City of Galax, 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, 1999 and 1998, approximately $130,000 and $94,000, respectively, of the loan portfolio was concentrated in commercial real estate. This represents approximately 44% and 39% of the loan portfolio at December 31, 1999 and 1998, respectively. Included in commercial real estate at December 31, 1999 and 1998 was approximately $85,000 and $64,000, respectively, in loans 47 Notes to Consolidated Financial Statements for college housing and professional office buildings. Loans secured by residential real estate were approximately $74,000 and $67,000 at December 31, 1999 and 1998, respectively. This represents approximately 25% and 28% of the loan portfolio at December 31, 1999 and 1998, respectively. Loans secured by automobiles were approximately $33,000 and $32,000 at December 31, 1999 and 1998, respectively. This represents approximately 11% of the loan portfolio at December 31, 1999 and 13% at December 31, 1998 The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property and with loan amounts established based on certain percentage limitations of the property's total stated or appraised value. Credit approval is primarily a function of collateral and the evaluation of the creditworthiness of the individual borrower or project based on available financial information. Interest-bearing deposits with banks represent deposits with the Federal Home Loan Bank of Atlanta. Management considers the concentration of credit risk to be minimal. Note 16: Fair Value of Financial Instruments The estimated fair values of the Company's financial instruments at December 31, 1999 and 1998 are as follows: December 31, 1999 1998 ---- ---- Carrying Estimated Carrying Estimated ($ In thousands) Amount Fair Value Amount Fair Value -------- ---------- -------- ---------- Financial assets: Cash and due from banks $ 13,311 13,311 14,421 14,421 Interest-bearing deposits 9,219 9,219 7,027 7,027 Federal funds sold 2,800 2,800 5,090 5,090 Securities 137,492 137,341 166,754 167,229 Mortgage loans held for sale 229 229 2,180 2,180 Loans, net 291,562 287,504 236,578 241,064 -------- -------- ------- -------- Total financial assets $454,613 450,404 432,050 437,011 ======== ======== ======= ======== Financial liabilities: Deposits $407,187 407,328 382,696 384,080 Other borrowed funds 10,460 10,460 214 214 -------- -------- ------- -------- Total financial liabilities $417,647 417,788 382,910 384,294 ======== ======== ======= ======== 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 48 National Bankshares, Inc. and Subsidiaries 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 17: Business Combinations 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 was subject to regulatory approval, closed in the second quarter of 1998. It did not have a material impact on the Company's results of operations or liquidity. Note 18: Other Comprehensive Income (Loss) Other comprehensive income (loss) net of income taxes and net of reclassification adjustments between net income and other comprehensive income (loss) relating to securities available for sale are reported in the Consolidated Statements of Income and Comprehensive Income. The information that follows discloses the reclassification adjustments and the income taxes related to securities available for sale that are included in other comprehensive income, net of income taxes. ($ In thousands) 1999 1998 ---- ---- Net unrealized gains (losses) on securities available for sale: Net unrealized holding gains (losses) during the year $(6,756) 1,282 Less reclassification adjustments for gains included in net income (20) (32) Income tax (expense) benefit 2,304 (425) ------- ------ Total other comprehensive income (loss) $(4,472) 825 ======= ====== Note 19: Future Accounting Considerations There have been no recent accounting pronouncements issued that would have a material effect on the consolidated financial position, results of operations or liquidity of the Company or require additional disclosures. 49 Selected Quarterly Data (Unaudited) The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 1999 and 1998: 1999 ($ In thousands, except First Second Third Fourth per share data) Quarter Quarter Quarter Quarter ------- ------- ------- ------- Income Statement Data: Interest income $ 8,089 8,170 8,416 8,928 Interest expense 3,436 3,392 3,506 3,869 ------- ------ ------ ------ Net interest income 4,653 4,778 4,910 5,059 Provision for loan losses 232 237 371 560 Noninterest income 766 856 956 934 Noninterest expense 2,926 2,946 3,025 2,971 Income taxes 582 651 666 657 ------- ------ ------ ------ Net income $ 1,679 1,800 1,804 1,805 ======= ====== ====== ====== Per Share Data: Basic net income per share $ 0.44 0.50 0.51 0.51 Cash dividends per share --- 0.39 --- 0.41 Book value per share $ 16.21 14.80 15.16 14.99 Selected Ratios: Return on average assets 1.54% 1.61% 1.60% 1.53% Return on average equity 11.12% 12.55% 13.64% 13.50% Average equity to average assets 13.82% 12.81% 11.70% 11.37% 50 1998 ($ In thousands, except First Second Third Fourth per share data) Quarter Quarter Quarter Quarter ------- ------- ------- ------- Income Statement Data: Interest income $ 7,571 7,923 8,150 8,184 Interest expense 3,296 3,458 3,590 3,584 ------- ------ ------ ------ Net interest income 4,275 4,465 4,560 4,600 Provision for loan losses 21 73 225 305 Noninterest income 666 826 754 928 Noninterest expense 2,696 2,850 2,780 2,735 Income taxes 616 666 638 671 ------- ------ ------ ------ Net income $ 1,608 1,702 1,671 1,817 ======= ====== ====== ====== Per Share Data: Basic net income per share $ 0.42 0.45 0.44 0.48 Cash dividends per share --- 0.36 --- 0.38 Book value per share $ 15.18 15.26 15.88 16.00 Selected Ratios: Return on average assets 1.63% 1.63% 1.56% 1.65% Return on average equity 11.49% 11.92% 11.37% 11.80% Average equity to average assets 14.16% 13.71% 13.74% 14.02% 51 National Bankshares Mission Statement National Bankshares, Inc. strives to be an exceptional community bank holding company dedicated to providing shareholder value by offering financial services to customers through subsidiary financial instituions and affiliated companies in an efficient, friendly, personalized and cost-effective manner. We recognize that to do this, our financial institutions must retain the ability to make decisions locally and must actively participate in the 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. 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 County Advisory Board Paul B. Collins, John H. Givens, Jr., Ross E. Martin, Kenneth L. Rakes, Scarlet B. Ratcliffe, H. M. Scanland, Jr., Buford Steele Galax Advisory Board Charles L. Cox, Willie T. Greene, Sr., Jerry R. Mink, Judy C. Wherry, James A. Williams, Jr. 52 National Bankshares Board of Directors Picture of Picture of "William T. Peery, Charles L. "Cameron L. Forrester, James A. Boatwright and James G. Rakes" Deskins, Sr. and L. Allen Bowman" William T. Peery Cameron L. Forrester Cargo Oil Co., Inc. President Bank of Tazewell County, President Charles L. Boatwright and Chief Executive Officer Vice Chairman of the Board, James A. Deskins, Sr. Physician Deskins Super Market, Inc., Retired James G. Rakes President Chairman of the Board, National L. Allen Bowman Bankshares, Inc., President and Litton Poly-Scientific, Retired Chief Executive Officer, The President National Bank, President and Chief Executive Officer Picture of Alonzo A. Crouse "Alonzo A. Crouse, Paul A. Bank of Tazewell County, Executive Duncan and Jeffrey R. Stewart" Vice President, Secretary and Cashier Paul A. Duncan Holiday Motor Corp., President Jeffrey R. Stewart Educational Consultant 53 NBB The National Bank Board of Directors Picture of "NBB Board of Directors" Seated, from left: J. Lewis Webb, Jr., Dentist; Jeffrey R. Stewart, Chairman of the Board, Educational Consultant; Paul A. Duncan, Holiday Motor Corp., President. Standing, from left: Charles L. Boatwright, Physician; James G. Rakes, National Bankshares, Inc., Chairman, The National Bank, President and Chief Executive Officer; L. Allen Bowman, Vice Chairman of the Board, Litton Poly-Scientific, Retired President; James M. Shuler, Virginia House of Delegates, Delegate; Paul P. Wisman, Grundy National Bank, Vice President of Investments, Nicewonder Investments, Manager of Assets. BTC Bank of Tazewell County Board of Directors Picture of "BTC Board of Directors" Charles E. Green, III, Registered Representative, The Equitqble Life Assurance Society of the United States; E.P. Greever, Retired; William T. Peery, Chairman of the Board, Cargo Oil Co., Inc. President; William H. VanDyke, Candlewax Smokeless Fuel Co., Vice President; Alonzo A. Crouse, Bank of Tazewell County, Executive Vice President, Secretary and Cashier; James S. Gillespie, Jr., Jim Sam Gillespie Farm, President; Carl C. Gillespie, Honorary Chairman of the Board, Attorney; James A. Deskins, Sr., Deskins Super Market, Inc., Retired President; Jack Harry, Harry's Enterprises, Inc., President; J. M. Pope, Retired; Cameron L. Forrester, Bank of Tazewell County, President and Chief Executive Officer; James G. Rakes, National Bankshares, Inc., Chairman, The National Bank, President and Chief Executive Officer. 54 Corporate Information National Bankshares, Inc. Officers James G. Rakes, Chairman F. Brad Denardo 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 Annual Meeting The Annual Meeting of Stockholders will be held on Tuesday, April 11, 2000 at 3:00 p.m. at the Best Western Red Lion Inn, 900 Plantation Road, Blacksburg, Virginia. Corporate Stock National Bankshares, Inc. common stock trades on the Nasdaq Stock Market under the symbol "NKSH". Financial Information Investors and analysts seeking financial information about National Bankshares, Inc. should contact: James G. Rakes, Chairman or J. Robert Buchanan President and Chief Executive Officer Treasurer (540)951-6300 or (800)552-4123 (540)951-6300 or (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)951-6300 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. 101 Hubbard Street Blacksburg, VA 24060 P.O. Box 90002 Blacksburg, VA 24062-9002 55 EX-21 3 Exhibit 21(i) National Bankshares, Inc. Subsidiaries of Registrant The National Bank of Blacksburg, Blacksburg, Virginia. A wholly-owned subsidiary of the Registrant is a national banking association, organized under the laws of the United States of America. Bank of Tazewell County, Tazewell, Virginia. A wholly-owned subsidiary of the Registrant is incorporated under the laws of the Commonwealth of Virginia. EX-23 4 Exhibit 23 Accountants' Consent The Board of Directors National Bankshares, Inc. We consent to incorporation by reference in Registration Statement No. 333- 79979 on Form S-8 of National Bankshares, Inc. of our report dated February 11, 2000, relating to the consolidated balance sheets of National Bankshares, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income and comprehensive income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1999, which report is incorporated by reference in the December 31, 1999 Annual Report on Form 10-K of National Bankshares, Inc. KPMG LLP Roanoke, Virginia March 28, 2000 EX-27 5
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE YEAR END 10-K AND QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-K 1,000 12-MOS DEC-31-1999 DEC-31-1999 13,311 9,219 2,800 0 113,845 23,647 23,496 294,793 3,231 472,134 407,187 10,460 1,764 0 0 0 8,792 43,931 472,134 24,105 9,059 439 33,603 13,971 14,203 19,400 1,400 24 11,868 9,644 9,644 0 0 7,088 1.96 1.96 4.85 151 1,077 40 317 2,679 978 130 3,231 3,231 0 1,579
-----END PRIVACY-ENHANCED MESSAGE-----