-----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, QDJKBdU31w98lDTkK7BCULMnTWYSMGJgbfE/TZRbYCQzGH1SKU054oa07gUpo0ES QDta8aMITd8hNstsyxvWhQ== 0000796534-02-000003.txt : 20020415 0000796534-02-000003.hdr.sgml : 20020415 ACCESSION NUMBER: 0000796534-02-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020329 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: 1934 Act SEC FILE NUMBER: 000-15204 FILM NUMBER: 02593384 BUSINESS ADDRESS: STREET 1: PO BOX 90002 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 form10k.txt FORM 10-K 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, 2001 O-15204 National Bankshares, Inc. - -------------------------------------------------------------------------------- (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) 951-6300 -------------------- 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 5, 2002 was $74,094,317. (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 5, 2002 - ------------------------------ ------------------------------ Common Stock, $2.50 Par Value 3,511,377 DOCUMENTS INCORPORATED BY REFERENCE Selected information from the Registrants' Annual Report to Stockholders for the year ended December 31, 2001, is incorporated by reference into Parts I and II of this report. Selected information from the Registrant's Proxy Statement for the Annual Meeting to be held April 9, 2002 and filed with the Securities and Exchange Commission pursuant to Regulation 14A, is incorporated by reference into Part III of this report. (This report contains 43 pages.) (The Index of Exhibits are on pages 42 & 43.) 1 Table of Contents Page Part I ---- Item 1. Business 3 Item 2. Properties 31 Item 3. Legal Proceedings 31 Item 4. Submission of Matters to a Vote of Security Holders 31 Executive Officers of the Registrant 32 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 34 Item 6. Selected Financial Data 34 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 34 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 34 Item 8. Financial Statements and Supplementary Data 36 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 37 Part III Item 10. Directors and Executive Officers of the Registrant 37 Item 11. Executive Compensation 37 Item 12. Security Ownership of Certain Beneficial Owners and Management 37 Item 13. Certain Relationships and Related Transactions 37 Part IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 38 Signatures 41 Index to Exhibits 42-43 2 Part I ($ In Thousands Except Per Share Data) Item 1. Business. - ----------------- History and Business National Bankshares, Inc. (Bankshares) is a bank holding company organized under the laws of Virginia in 1986 and registered under the Bank Holding Company Act (BHCA). Bankshares conducts a good deal of its business operations through its wholly-owned bank subsidiaries, The National Bank of Blacksburg (NBB), Bank of Tazewell County (BTC) and through National Bankshares Financial Services, Inc. (NBFS) doing business as National Bankshares Investment Services and National Bankshares Financial Services, collectively referred to as "The Company". 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 thirteen 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. 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, 2001, NBB had total assets of $358,009. Total deposits at this date were $322,711. NBB's net income for 2001 was $4,765 which produced a return on average assets of 1.36% and a return on average stockholders' equity of 14.62%. Refer to footnote 11 of the Company's 2001 Annual Report to Stockholders for NBB's risk-based capital ratios. 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 3 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 services normally offered by commercial banks. BTC also conducts a general trust business. At December 31, 2001 BTC had total assets of $283,425. Total deposits at this same date were $254,060. BTC's net income for 2001 was $2,550 which produced a return on average assets of 0.90% and a return on average stockholders' equity of 9.21%. Refer to footnote 11 of the Company's 2001 Annual Report to Stockholders for BTC's risk-based capital ratios. National Bankshares Financial Services On April 9, 2001 National Bankshares Financial Services Inc., a wholly-owned subsidiary began offering non-deposit investment products and insurance products for sale to the public. NBFS is working with Bankers Insurance, LLC, a joint effort of Virginia banks originally sponsored by the Virginia Bankers Association. In another cooperative effort, NBFS is working with UVEST Financial Services Group, Inc. to offer investment services. 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. Collateralized business loans may be secured by a security interest in marketable equipment, accounts receivable, business equipment and/or general intangibles of the business. In addition, or as an 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 residential 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 participate in insured loan programs sponsored by the Department of Housing and 4 Urban Development, the Veterans Administration and the Virginia Housing Development Authority. Residential real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. Construction Loans NBB makes loans for the purpose of financing the construction of business and residential structures to financially responsibly business entities and individuals. These loans are subject to the same credit criteria as commercial and residential real estate loans. Although BTC offers construction loans, its involvement in this area of lending is more limited than NBB's due to the nature of its market area. 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. 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 residential mortgage loans regularly sold by NBB. 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. 5 The banks will consider purchasing a loan, or a participation in a loan, from another financial institution (including from another subsidiary of the Company) if the loan meets all applicable credit quality standards and (i) the bank's loan to deposit ratio is at a level where additional loans would be desirable; and/or (ii) a common customer requests the purchase. The following table sets forth, for the three fiscal years ended December 31, 2001, 2000 and 1999 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, 2001 Interest and Fees on Loans 55.84% Interest on Investments 21.37% December 31, 2000 Interest and Fees on Loans 66.74% Interest on Investments 21.22% December 31, 1999 Interest and Fees on Loans 64.95% Interest on Investments 24.41% 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, all of Pulaski County, the City of Radford, 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, the towns of Pearisburg, Pembroke and Rich Creek, in Giles County, and the towns of Dublin and Pulaski in Pulaski County. The local economy is diverse and is oriented toward higher education, retail and service, light manufacturing and agriculture. 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 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. Employment at this plant has remained relatively stable over the past several years. Pulaski County's major employer is the Volvo Heavy Trucks production facility. During 2000, the Volvo company laid off a significant number of workers, and the trend is likely to continue in the near term as the demand for heavy trucks nationwide is very low. The county also has several large furniture plants, most notably Pulaski Furniture and Ethan Allen. Pulaski Furniture recently announced a small work force reduction. 6 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, but furniture manufacturing has been negatively affected in the recent economic downturn. Several other small manufacturing concerns are located in Montgomery, Giles and Pulaski 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. Since 1988, Montgomery County has developed into a regional retail center, with the construction of several large shopping areas. Two area hospitals, each of which are affiliated with different large health care systems, have constructed additional facilities attracting health care providers to Montgomery County, making it a center for basic health care services. VPI & SU's Corporate Research Center has brought small high tech companies to Blacksburg, and further expansion is planned. 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, Richlands and Bluefield, Virginia and Bluefield, West Virginia. BTC has also recently added offices located in the Towns of Wytheville, Marion and Abingdon located in Wythe, Smyth and Washington Counties, Virginia, respectively. 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 reducing the number of individuals required for the production of coal. However, 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 emerged as a regional medical center. Real estate values remain stable and comparable to other areas in southwest Virginia. BTC's expanded market areas in Wythe, Smyth and Washington Counties have a diverse economic base, with manufacturing, agriculture, education and service industries all represented. 7 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. 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, NBB and BTC rely upon service-based business philosophies, personal relationships with customers, specialized services tailored to meet customers' needs and the convenience of office locations. In addition, the banks are generally competitive with other financial institutions in their market areas with respect to interest rates paid on deposit accounts, interest rates charged on loans and other service charges on loans and deposit accounts. Registrant's Organization and Employment Bankshares, NBB, BTC and NBFS are organized in a holding company/subsidiary structure. Until January 1, 2002, Bankshares had no employees, except for officers, and it conducted substantially all of its operations through its subsidiaries. Until January 1, 2002, all compensation paid to Bankshares officers was paid by the subsidiary banks, except for fees paid to Chairman, President and Chief Executive Officer James G. Rakes and to Corporate Officer Cameron L. Forrester for their service as directors of the Company. On January 1, 2002, several administrative functions that serve multiple subsidiaries were moved to the holding company level. These functions include audit, compliance, loan review and human resources. Employees performing these functions who were formerly employed at the bank level will now be employed at the holding company level. At December 31, 2001, NBB employed 140 full time equivalent employees at its main office, operations center and branch offices. BTC at December 31, 2001 employed 102 full time equivalent employees 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. 8 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 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. 9 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, broadly rewrote 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 of securities and merchant banking activities. The Gramm-Leach-Bliley Act has and 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 are able to offer a much broader array of financial services; however, there is 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. 10 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. 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 11 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 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 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. 12 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 the OCC, NBB can acquire existing banking operations in Virginia. As a state bank, BTC is subject to Virginia state branching laws. With BFI and Federal Reserve Bank approval, BTC is able to acquire existing banking operations in the state. 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 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. 13 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 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. 14 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. The 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 15 greater than its undivided profits then on hand after deducting its losses and bad debts. For this purpose, bad debts are generally defined to include the principal amount of loans which are in arrears with respect to interest by six months or more, unless such loans are fully secured and in the process of collection. Moreover, for purposes of this limitation, a state member bank is not permitted to add the balance in its allowance for loan losses account to its undivided profits then on hand; however, it may net the sum of its bad debts as so defined against the balance in its allowance for loan losses account and deduct from undivided profits only bad debts as so defined in excess of that account. In addition, the Federal Reserve Board is authorized to determine, under certain circumstances relating to the financial condition of a state member bank, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The payment of dividends that depletes a bank's capital base could be deemed to constitute such an unsafe or unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings. Virginia law also imposes restrictions on the ability of BTC to pay dividends. A Virginia state bank is permitted to declare a dividend out of its "net undivided profits", after providing for all expenses, losses, interest and taxes accrued or due by the bank. In addition, a deficit in capital originally paid in must be restored to its initial level, and no dividend can be paid which could impair the bank's paid in capital. The Bureau of Financial Institutions further has authority to limit the payment of dividends by a Virginia bank if it determines the limitation is in the public interest and is necessary to ensure the bank's financial soundness. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) provides that no insured depository institution may make any capital distribution (which would include a cash dividend) if, after making the distribution, the institution would not satisfy one or more of its minimum capital requirements. Capital Requirements. The Federal Reserve Board has adopted risk-based capital guidelines 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 average 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 16 their particular circumstances and risk profiles. The guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Bank regulators from time to time have indicated a desire to raise capital requirements applicable to banking organizations beyond current levels. In addition, the number of risks which may be included in risk-based capital restrictions, as well as the measurement of these risks, is likely to change, resulting in increased capital requirements for banks. Bankshares, NBB and BTC are unable to predict whether higher capital ratios would be imposed and, if so, at what levels and on what schedule. 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. 17 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 2001 2000 1999 =============================================================================================== Cash and due from banks $10,221 $11,355 $12,820 Interest - bearing deposits 10,986 10,683 5,263 Federal funds sold 18,419 6,149 2,926 Securities available for sale: Taxable 69,486 87,813 95,979 Nontaxable 40,196 31,302 29,286 Securities held to maturity: Taxable 46,043 9,029 8,940 Nontaxable 33,084 14,542 17,219 Mortgage loans held for sale 808 519 709 Loans, net 376,958 310,624 266,431 Other assets 29,491 18,365 14,616 -------------------------------------------- Total assets $635,692 $500,381 $454,189 =============================================================================================== Liabilities and Stockholders' Equity =============================================================================================== Noninterest-bearing demand Deposits $66,793 $56,709 $55,700 Interest-bearing demand deposits 116,529 85,713 85,284 Savings deposits 47,175 43,138 46,792 Time deposits 338,642 248,113 203,807 -------------------------------------------- Total deposits $569,139 $433,673 $391,583 Short-term borrowings 295 9,011 4,228 Other liabilities 2,798 2,015 2,182 -------------------------------------------- Total liabilities $572,232 $444,699 $397,993 Stockholders' equity 63,460 55,682 56,196 -------------------------------------------- Total liabilities and Stockholders' equity $635,692 $500,381 $454,189 ===============================================================================================
18 B. Analysis of Net Interest Earnings The following table shows the major categories of interest-earning assets and interest-bearing liabilities, the interest earned or paid, the average yield or rate on the daily average balance outstanding, net interest income and net yield on average interest-earning assets for the years indicated.
------------------------------- ----------------------------- ------------------------------- December 31, 2001 December 31, 2000 December 31, 1999 ------------------------------- ----------------------------- ------------------------------- Average Average Average Average Yield/ Average Yield/ Average Yield/ ($ in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate ------------------------------- ------------------------------ ------------------------------- Interest-earning Assets: Loans, net (1)(2)(3) $381,778 $33,584 8.80% $314,685 $28,454 9.04% $267,140 $24,244 9.08% Taxable securities 115,529 7,501 6.56% 96,842 6,760 6.98% 104,919 6,820 6.50% Nontaxable Securities (1) 73,280 5,091 6.49% 45,844 3,420 7.46% 46,505 3,414 7.34% Federal funds sold 18,419 652 3.54% 6,149 338 5.50% 2,926 170 5.81% Interest bearing Deposits 10,986 577 5.25% 10,683 689 6.45% 5,263 269 5.11% ------------------------------- ------------------------------ ------------------------------- Total interest- Earning assets $599,992 $47,405 7.90% $474,203 $39,661 8.36% $426,753 $34,917 8.18% =============================== ============================== =============================== Interest-bearing Liabilities: Interest-bearing Demand deposits $116,529 $2,518 2.16% $85,713 $2,243 2.62% $85,284 $2,129 2.50% Savings deposits 47,175 919 1.95% 43,138 1,135 2.63% 46,792 1,212 2.59% Time deposits 338,642 19,326 5.71% 248,113 14,157 5.71% 203,807 10,630 5.22% Short-term Borrowings 295 8 2.71% 1,727 118 6.83% 4,228 232 5.49% Long-term debt --- --- --- 7,284 510 7.00% --- --- --- ------------------------------- ------------------------------ ------------------------------- Total interest- Bearing liabilities $502,641 $22,771 4.53% $385,975 $18,163 4.71% $340,111 $14,203 4.18% =============================== ============================== =============================== Net interest income and interest rate spread $24,634 3.37% $21,498 3.66% $20,714 4.00% ================================================================ =============================== Net yield on average Interest-earning Assets 4.11% 4.53% 4.85% ==================================================================================================
(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 $608 in 2001, $381 in 2000 and $680 in 1999 are included in total interest income. (3) Nonaccrual loans are included in average balances for yield computations. 19 C. Analysis of Changes in Interest Income and Interest Expense The Company's primary source of revenue is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other funds. The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities and by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities. The following table sets forth, for the years indicated, a summary of the changes in interest income and interest expense resulting from changes in average asset and liability balances (volume) and changes in average interest rates (rate).
============================================================================================== 2001 Over 2000 2000 Over 1999 ---------------------------------------------------------------------------------------------- Changes Due To Changes Due To ----------------------------- ----------------------------- Net Dollar Net Dollar ($ in thousands) Rates(2) Volume(2) Change Rates(2) Volume(2) Change =================================================================================================================================== - ----------------------------------------------------------------------------------------------------------------------------------- Interest income:(1) Loans $(791) $5,921 $5,130 $(89) $4,299 $4,210 Taxable securities (430) 1,171 741 485 (545) (60) Nontaxable securities (249) 1,920 1,671 55 (49) 6 Federal funds sold (157) 471 314 (10) 178 168 Interest bearing deposits (131) 19 (112) 85 335 420 - ----------------------------------------------------------------------------------------------------------------------------------- Increase(decrease) in income on interest- earning assets $(1,758) $9,502 $7,744 $526 $4,218 $4,744 - ----------------------------------------------------------------------------------------------------------------------------------- Interest expense: Interest-bearing demand deposits $(437) $712 $275 $103 $11 $114 Savings deposits (315) 99 (216) 19 (96) (77) Time deposits 3 5,166 5,169 1,065 2,462 3,527 Short-term borrowings (46) (64) (110) 47 (161) (114) Long-Term Borrowings --- (510) (510) --- 510 510 - ----------------------------------------------------------------------------------------------------------------------------------- Increase(decrease) in expense of interest- bearing liabilities $(795) $5,403 $4,608 $1,234 $2,726 $3,960 - ----------------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in net interest income $(963) $4,099 $3,136 $(708) $1,492 $784 ===================================================================================================================================
(1) Taxable equivalent basis using a Federal income tax rate of 34%. (2) Variances caused by the change in rate times the change in volume have been allocated to rate and volume changes proportional to the relationship of the absolute dollar amounts of the change in each. 20 II. Investment Portfolio A. Book Value of Investments The amortized costs and fair values of securities available for sale as of December 31, 2001, 2000 and 1999 were as follows:
============================================================= December 31, -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2001 2000 1999 -------------------------------------------------------------------------------- Amortized Fair Amortized Fair Amortized Fair ($ in thousands) Costs Values Costs Values Costs Values ================================================================================================================================== - ---------------------------------------------------------------------------------------------------------------------------------- Available for sale: U.S. Treasury $6,248 $ 6,490 $6,246 $ 6,331 $ 6,244 $ 6,164 U.S. Government agencies and corporations 5,340 5,375 54,815 54,034 50,373 47,498 States and political subdivisions 51,030 51,189 35,456 35,606 32,903 31,617 Mortgage-backed securities (1) 13,178 13,415 11,818 11,776 13,464 13,176 Corporate debt securities 9,066 9,093 14,341 14,058 14,349 13,646 Federal Home Loan Bank stock 1,411 1,411 1,329 1,329 1,329 1,329 Federal Reserve Bank stock 209 209 209 209 247 247 Other securities 1,328 1,485 442 442 168 168 ----------------------------------------------------------------------------- Total securities available for sale $87,810 $88,667 $124,656 $123,785 $119,077 $113,845 ==================================================================================================================================
The amortized costs of securities held to maturity as of December 31, 2001, 2000 and 1999 were as follows:
================================================ December 31, ------------------------------------------------ ------------------------------------------------ ($ in thousands) 2001 2000 1999 ===================================================================================================== - ----------------------------------------------------------------------------------------------------- Held to maturity: U.S. Treasury $ --- $ --- $ 500 U.S. Government agencies and corporations 17,025 8,500 5,500 States and political subdivisions 49,230 17,288 17,283 Mortgage-backed securities (1) 13,723 288 364 Corporate 22,831 6,483 --- ------------------------------------------------ Total securities held to maturity $ 102,809 $ 32,559 $ 3,647 =====================================================================================================
(1) The majority of mortgage-backed securities and collateralized mortgage obligations held at December 31, 2001 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. 21 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, 2001 and weighted average yield for each range of maturities.
==================================================================================== Maturities and Yields December 31, 2001 ------------------------------------------------------------------------------------ ($ in thousands except for % data) < 1 Year 1-5 Years 5-10 Years > 10 Years None Total ================================================================================================================================ Available for Sale - ------------------ U.S. Treasury $2,553 $3,937 --- --- --- $6,490 6.23% 5.73% --- --- --- 5.93% - -------------------------------------------------------------------------------------------------------------------------------- U.S. Government agencies --- 1,534 2,949 892 --- 5,375 --- 7.43% 7.01% 6.52% --- 7.05% - -------------------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities --- --- 2,133 11,282 --- 13,415 --- --- 3.92% 6.68% --- 6.24% - -------------------------------------------------------------------------------------------------------------------------------- States and Political --- 1,684 --- 1,285 --- 2,969 Subdivision - taxable --- 7.15% --- 7.77% --- 7.42% - -------------------------------------------------------------------------------------------------------------------------------- States and Political Subdivision 921 8,706 17,981 20,612 --- 48,220 - nontaxable(1) 7.12% 6.82% 6.32% 6.50% --- 6.50% - -------------------------------------------------------------------------------------------------------------------------------- Corporate --- 4,168 2,931 1,994 --- 9,093 --- 6.74% 6.55% 6.59% --- 6.65% - -------------------------------------------------------------------------------------------------------------------------------- Federal Home Loan Bank stock --- --- --- --- 1,411 1,411 --- --- --- --- 5.75% 5.75% - -------------------------------------------------------------------------------------------------------------------------------- Federal Reserve Bank stock --- --- --- --- 209 209 --- --- --- --- 6.00% 6.00% - -------------------------------------------------------------------------------------------------------------------------------- Other securities 18 --- --- --- 1,467 1,485 2.03% --- --- --- 6.00% 5.95% - -------------------------------------------------------------------------------------------------------------------------------- Total 3,492 20,029 25,994 36,065 3,087 88,667 6.44% 6.66% 6.23% 6.61% 3.04% 6.38% - -------------------------------------------------------------------------------------------------------------------------------- Held to Maturity - ---------------- U.S. Treasury --- --- --- --- --- --- --- --- --- --- --- --- - -------------------------------------------------------------------------------------------------------------------------------- U.S. Government agencies --- 3,000 10,030 3,995 --- 17,025 --- 5.84% 5.17% 6.90% --- 5.69% - -------------------------------------------------------------------------------------------------------------------------------- Mortgage-backed securities 1 28 52 13,642 --- 13,723 9.00% 7.80% 7.98% 6.00% --- 6.01% - -------------------------------------------------------------------------------------------------------------------------------- States and Political 165 1,057 690 --- --- 1,912 Subdivision - taxable 6.88% 7.05% 5.99% --- --- 6.65% - -------------------------------------------------------------------------------------------------------------------------------- States and Political 2,426 5,308 18,625 20,959 --- 47,318 Subdivision - nontaxable 6.78% 7.08% 6.17% 6.34% --- 6.38% - -------------------------------------------------------------------------------------------------------------------------------- Corporate --- 11,488 11,343 --- --- 22,831 --- 6.83% 6.80% --- --- 6.82% - -------------------------------------------------------------------------------------------------------------------------------- Other securities --- --- --- --- --- --- --- --- --- --- --- --- - -------------------------------------------------------------------------------------------------------------------------------- Total $2,592 $20,881 $40,740 $38,596 --- $102,809 6.78% 6.77% 6.10% 6.28% --- 6.32% ================================================================================================================================
(1) Rates shown represent weighted average yield on a fully taxable basis. 22 III. Loan Portfolio The Company concentrates its lending activities in commercial and industrial loans, real estate mortgage loans, both residential and business, and loans to individuals. The following tables set forth (i) a comparison of the Company's loan portfolio by major category of loans as of the dates indicated and (ii) the maturities and interest rate sensitivity of the loan portfolio at December 31, 2001. A. Types of Loans
============================================================== December 31, -------------------------------------------------------------- ($ in thousands) 2001 2000 1999 1998 1997 =================================================================================================== Commercial and industrial loans $189,764 $163,929 $149,386 $110,509 $101,379 Real estate mortgage loans 77,339 71,163 58,829 48,724 42,969 Real estate construction loans 19,573 16,726 14,669 12,827 8,510 Loans to individuals 113,413 110,176 73,825 69,493 66,635 -------------------------------------------------------------- Total loans $400,089 $361,994 $296,709 $241,553 $219,493 Less unearned income and deferred fees (1,775) (2,313) (1,916) (2,296) (2,503) -------------------------------------------------------------- Total loans, net of unearned income $398,314 $359,681 $294,793 $239,257 $216,990 Less allowance for loans losses (4,272) (3,886) (3,231) (2,679) (2,438) -------------------------------------------------------------- Total loans, net $394,042 $355,795 $291,562 $236,578 $214,552 ===================================================================================================
B. Maturities and Interest Rate Sensitivities
============================================================= December 31, 2001 -------------- --------------- -------------- --------------- After ($ in thousands) <1 Year 1-5 Years 5 Years Total ======================================= ============== =============== ============== =============== Commercial and industrial $50,286 $83,466 $56,012 $189,764 Real estate construction 19,573 --- --- 19,573 Less loans with predetermined interest 28,219 39,407 55,544 123,170 rates -------------- --------------- -------------- --------------- Loans with adjustable rates $41,640 $44,059 $468 $86,167 ======================================= ============== =============== ============== ===============
23 C. Risk Elements 1. Nonaccrual, Past Due and Restructured Loans The following table presents aggregate amounts for nonaccrual loans, restructured loans, other real estate owned, net and accruing loans which are contractually past due ninety days or more as to interest or principal payments.
====================================================== December 31, ------------------------------------------------------ ($ in thousands) 2001 2000 1999 1998 1997 - ----------------------------------------------------------------------------------------------------- Nonaccrual loans: Commercial and industrial $ 175 $ 65 $ 65 $ --- $ 55 Real estate mortgage 11 5 33 28 32 Real estate construction --- --- --- --- --- Loans to individuals 168 18 53 --- --- - ----------------------------------------------------------------------------------------------------- $ 354 $ 88 $ 151 $ 28 $ 87 - ----------------------------------------------------------------------------------------------------- Restructured loans: Commercial and industrial --- --- 40 --- --- - ----------------------------------------------------------------------------------------------------- Total nonperforming loans $ 354 $ 88 $ 191 $ 28 $ 87 Other real estate owned, net 211 540 447 628 421 - ----------------------------------------------------------------------------------------------------- Total nonperforming assets $ 565 $ 628 $ 638 $ 656 $ 508 ====================================================== - ----------------------------------------------------------------------------------------------------- Accruing loans past due 90 days or more: Commercial and industrial Real estate mortgage $ 303 $ 242 $ 99 $ 186 $ 82 Real estate construction 277 664 704 160 358 Loans to individuals --- --- --- --- --- 400 415 274 204 232 - ----------------------------------------------------------------------------------------------------- $ 980 $1,321 $1,077 $ 550 $ 672 =====================================================================================================
The effect of nonaccrual and restructured loans on interest income is presented below: ===================================== ($ in thousands) 2001 2000 1999 ===================================================================== Scheduled interest: Nonaccrual loans $ 37 $ 11 $ 13 Restructured loans --- --- --- ------------------------------------- Total scheduled interest $ 37 $ 11 $ 13 ------------------------------------- Recorded interest: Nonaccrual loans $ 7 $ --- $ --- Restructured loans --- --- --- ------------------------------------- Total recorded interest $ 7 $ --- $ --- ===================================================================== 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. 24 2. Potential Problem Loans At December 31, 2001, management was unaware of any potential problem loans other than those presented in the table above. 3. Foreign Outstandings At December 31, 2001, 2000 and 1999, 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 the northern portion of Montgomery County, all of Giles County, all of Pulaski County, the City of Radford, the City of Galax and adjacent portions of Carroll and Grayson Counties, Virginia. 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. Much 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 also serves the counties of Wythe, Smyth and Washington in Virginia. BTC's primary 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 emerged 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, 2001 and 2000, approximately $177 million and $151 million, respectively, of the loan portfolio were concentrated in commercial real estate. This represents approximately 44% and 42% of the loan portfolio at December 31, 2001 and 2000, respectively. Included in commercial real estate at December 31, 2001 and 2000 was approximately $101 million and $84 million, respectively, in loans for college housing and professional office 25 buildings. Loans secured by residential real estate were approximately $119 million and $110 million at December 31, 2001 and 2000, respectively. This represents approximately 30% and 31% of the loan portfolio at December 31, 2001 and 2000, respectively. Loans secured by automobiles were approximately $32 million and $36 million at December 31, 2001 and 2000, respectively. This represents approximately 8% of the loan portfolio at December 31, 2001 and 10% at December 31, 2000. The Company has established operating policies relating to the credit process and collateral requirements in loan originations. Loans to purchase real and personal property are generally collateralized by the related property and with loan amounts established based on certain percentage limitations of the property's total stated or appraised value. Credit approval is primarily a function of collateral and the evaluation of the creditworthiness of the individual borrower or project based on available financial information. 26 IV. Summary of Loan Loss Experience A. Analysis of the Allowance for Loan Losses The following tabulation shows average loan balances at the end of each period; changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category; and additions to the allowance which have been charged to operating expense:
============================================================================ December 31, ---------------------------------------------------------------------------- ($ in thousands) 2001 2000 1999 1998 1997 ======================================================================================================================== Average net loans outstanding $ 376,958 $ 310,624 $ 266,431 $ 225,613 $ 204,540 ============================================================================ - ------------------------------------------------------------------------------------------------------------------------ Balance at beginning of year $ 3,886 $ 3,231 $ 2,679 $ 438 $ 2,575 Charge-offs: Commercial and industrial loans 141 55 185 32 257 Real estate mortgage loans 32 --- 33 80 --- Real estate construction loans --- --- --- --- --- Loans to individuals 955 715 760 526 422 ---------------------------------------------------------------------------- Total loans charged off $ 1,128 $ 770 $ 978 $ 638 $ 679 ---------------------------------------------------------------------------- Recoveries: Commercial and industrial loans 8 3 51 --- 70 Real estate mortgage loans --- --- 1 2 --- Real estate construction loans --- --- --- 190 --- Loans to individuals 98 93 78 63 37 ---------------------------------------------------------------------------- Total recoveries $ 106 $ 96 $ 130 $ 255 $ 107 ---------------------------------------------------------------------------- Net loans charged off 1,022 674 848 383 572 ---------------------------------------------------------------------------- Additions charged to operations 1,408 1,329 1,400 624 435 ---------------------------------------------------------------------------- Balance at end of year $ 4,272 $ 3,886 $ 3,231 $ 2,679 $ 2,438 ============================================================================ - ------------------------------------------------------------------------------------------------------------------------ Net charge-offs to average net loans Outstanding 0.27% 0.21% 0.32% 0.17% 0.28% =========================================================================================================================
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. 27 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, ------------------------------------------------------------------------------------------------------------------------ 2001 2000 1999 1998 1997 ------------------------------------------------------------------------------------------------------------------------ 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 ($ in Allowance Category to Allowance Category to Allowance Category to Allowance Category to Allowance Category to thousands) Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans Amount Total Loans ==================================================================================================================================== Commercial and industrial loans $557 47.43% $ 255 45.29% $ 555 50.35% $ 222 45.75% $ 213 46.18% - ------------------------------------------------------------------------------------------------------------------------------------ Real estate mortgage loans 50 19.33% 120 19.66% 119 19.83% 73 20.17% 67 19.58% - ------------------------------------------------------------------------------------------------------------------------------------ Real estate construction loans --- 4.89% --- 4.62% --- 4.94% --- 5.31% --- 3.88% - ------------------------------------------------------------------------------------------------------------------------------------ Loans to individuals 2,909 28.35% 1,709 30.43% 978 24.88% 497 28.77% 416 30.36% - ------------------------------------------------------------------------------------------------------------------------------------ Unallocated 756 1,802 1,579 1,887 1,742 - ------------------------------------------------------------------------------------------------------------------------------------ $4,272 100.00% $ 3,886 100.00% $ 3,231 100.00% $ 2,679 100.00% $ 2,438 100.00% ========================================================================================================================
28 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, their cash flow capabilities to repay, 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 gauge the effectiveness of the internal credit review. 29 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, ----------------------------------------------------------------------- 2001 2000 1999 ----------------------------------------------------------------------- Average Average Average Average Rates Average Rates Average Rates ($ in thousands) Amounts Paid Amounts Paid Amounts Paid - -------------------------------------------------------------------------------------------- Noninterest-bearing demand deposits $ 66,793 --- $ 56,709 --- $55,700 --- Interest-bearing demand deposits 116,529 2.16% 85,713 2.62% 85,284 2.50% Savings deposits 47,175 1.95% 43,138 2.63% 46,792 2.59% Time deposits 338,642 5.71% 248,113 5.71% 203,807 5.22% - -------------------------------------------------------------------------------------------- Average total deposits $569,139 4.53% $433,673 4.64% $391,583 4.16% ============================================================================================
B. Time Deposits of $100,000 or More The following table sets forth time certificates of deposit and other time deposits of $100,000 or more:
===================================================================== December 31, 2001 ===================================================================== Over 3 Months Over 6 Months 3 Months Through 6 Through 12 Over 12 ($ in thousands) or Less Months Months Months Total ===================================================================================================== Certificates of deposit $65,246 $81,198 $90,281 $85,085 $321,810 - ----------------------------------------------------------------------------------------------------- Other time deposits 49,764 59,665 69,060 66,107 244,596 - ----------------------------------------------------------------------------------------------------- Total time deposits of $100,000 or more $15,482 $21,533 $21,221 $18,978 $77,214 =====================================================================================================
30 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, ---------------------------------------- 2001 2000 1999 ============================================================================ Return on average assets 1.15% 1.46% 1.56% - ---------------------------------------------------------------------------- Return on average equity(1) 11.53% 13.13% 12.61% - ---------------------------------------------------------------------------- Dividend payout ratio 41.29% 40.87% 39.70% - ---------------------------------------------------------------------------- Average equity to average assets(1) 9.98% 11.13% 12.37% ============================================================================ (1) Includes amount related to common stock subject to ESOP put option excluded from stockholders' equity on the Consolidated Balance Sheet for 1999. Item 2. Properties - ------------------- Bankshares' headquarters and one branch office of NBB is located at 101 Hubbard Street, Blacksburg, Virginia. NBB's Main Office is at 100 South Main Street, Blacksburg, Virginia. In addition to the Bank's Main Office location and the Hubbard Street branch office, NBB owns eleven branch offices in Virginia: four in the Town of Blacksburg; one in the Town of Christiansburg; and three in the County of Giles, two in Pulaski County, one in the City of Radford and one in the City of Galax. An additional tract of land has been acquired for the construction of a fourteenth branch. Bank of Tazewell County owns the land and building of nine of its eleven offices. The bank leases the land and building for two offices. The Main Office is located at 309 East Main Street, Tazewell, Virginia. Three additional branches are located in Tazewell, one in Richlands and three are located in Bluefield, Virginia. The bank also has one branch in Wytheville, Virginia, one branch in Abingdon, Virginia and one branch in Marion, 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, BTC, and NBFS 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 31 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 9, 2002. 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 57 Chairman, President and Chief 1986 Executive Officer, National Bankshares, Inc.; and President and Chief Executive Officer of The National Bank of Blacksburg since 1983. President and Treasurer of National Bankshares Financial Services, Inc. since 2001. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- J. Robert Buchanan 50 Treasurer, National Bankshares, Inc.; 1998 Cashier and 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 Corporation. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Marilyn B. Buhyoff 53 Secretary & Counsel, National 1989 Bankshares, Inc.; and Secretary & Counsel since 1989 and Senior Vice President/ Administration, since 1992, of The National Bank of Blacksburg. Secretary of National Bankshares Financial Services, Inc. since 2001. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- F. Brad Denardo 49 Corporate Officer, National 1989 Bankshares, Inc.; and Executive Vice President/ Loans since 1989 of The National Bank of Blacksburg. - -------------------------------------------------------------------------------- 32 - -------------------------------------------------------------------------------- Cameron L. Forrester 53 Corporate Officer, National 2001 Bankshares, Inc.; and President and Chief Executive Officer of Bank of Tazewell County since 1998; prior thereto Vice President of First Virginia Bank, Clinch Valley (formerly Premier Bank, N. A.) ================================================================================ Except for J. Robert Buchanan and Cameron Forrester, each of the executive officers above have served Bankshares and/or its subsidiaries in the listed executive capacity for the past five years. 33 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 December 31, 2001 there were 1,045 stockholders of Bankshares common stock. Information concerning Market Price and Dividend Data is set forth under "Common Stock Information and Dividends" on page 11 of Bankshares' 2001 Annual Report to Stockholders and is incorporated herein by reference. 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. Item 6. Selected Financial Data - -------------------------------- The table entitled "Selected Consolidated Financial Data" on page 4 of Bankshares' 2001 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' 2001 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 pages 5 through 6 and the section "Derivatives and Market Risk Exposures" on page 10 of Bankshares' 2001 Annual Report to Stockholders and is incorporated herein by reference. 34 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. 35 The Company uses simulation analysis to forecast its balance sheet and monitor interest rate sensitivity. One test used by Bankshares is shock analysis which measures the effect of a hypothetical, immediate and parallel shifts 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, 2001.
($ in thousands, except for percent data) - ---------------------------- ------------------------ -------------------------- -------------------------------- Rate Shift Net Income Return on Average Equity Return on Average Assets - ---------------------------- ------------------------ -------------------------- -------------------------------- - ---------------------------- ------------------------ -------------------------- -------------------------------- 300 $8,501 12.24% 1.24% - ---------------------------- ------------------------ -------------------------- -------------------------------- - ---------------------------- ------------------------ -------------------------- -------------------------------- 200 9,766 13.95% 1.42% - ---------------------------- ------------------------ -------------------------- -------------------------------- - ---------------------------- ------------------------ -------------------------- -------------------------------- 100 10,904 15.47% 1.58% - ---------------------------- ------------------------ -------------------------- -------------------------------- - ---------------------------- ------------------------ -------------------------- -------------------------------- (-) 100 13,263 18.55% 1.93% - ---------------------------- ------------------------ -------------------------- -------------------------------- - ---------------------------- ------------------------ -------------------------- -------------------------------- (-) 200 13,616 19.01% 1.98% - ---------------------------- ------------------------ -------------------------- --------------------------------
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. Assets 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 reforecasting 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. Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The following consolidated financial statements of the Registrant and the Independent Auditor's Report set forth on pages 12 through 36 of Bankshares' 2001 Annual Report to Stockholders are incorporated herein by reference: 36 1. Independent Auditor's Report 2. Consolidated Balance Sheets - December 31, 2001 and 2000 3. Consolidated Statements of Income - Years ended December 31, 2001, 2000 and 1999 4. Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 2001, 2000 and 1999 5. Consolidated Statements of Cash Flows - Years ended December 31, 2001, 2000 and 1999 6. Notes to Consolidated Financial Statements - December 31, 2001, 2000 and 1999 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, 2001 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 14, 2002 which information is incorporated herein by reference. Item 11. Executive Compensation - -------------------------------- The information set forth under "Executive Compensation" on pages 4 through 6 of Bankshares' Proxy Statement dated March 14, 2002 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 14, 2002 is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------- The information contained under "Certain Transactions With Officers and Directors" on page 13 of Bankshares' Proxy Statement dated March 14, 2002 is incorporated herein by reference. 37 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: 2001 Annual Report 1. Financial Statements: To Stockholders Page(s)* -------------------- ------------------------ Independent Auditor's Report 12 Consolidated Balance Sheets - 13 December 31, 2001 and 2000 Consolidated Statements of 14 Income - Years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Changes 15 in Stockholders' Equity - Years ended December 31, 2001, 2000 and 1999 Consolidated Statements of Cash 16 Flows - Years ended December 31, 2001, 2000 and 1999 Notes to Consolidated 17-35 Financial Statements - December 31, 2001, 2000 and 1999 2. Financial Statement Schedules: ----------------------------- None *Incorporated by reference from the indicated pages of the 2001 Annual Report to Stockholders. 3. Exhibits: -------- Page No. in Exhibit No. Description Sequential System - ----------- ----------- ----------------- 3(i) Articles of Incorporation, as amended, of (incorporated National Bankshares, Inc. herein by reference to Exhibit 3(a) of the Annual Report on Form 10-K for Fiscal year ended December 31, 1993) 38 Page No. in Exhibit No. Description Sequential System - ----------- ----------- ----------------- 4(i) Specimen copy of certificate for National (incorporated Bankshares, Inc. common stock, $2.50 par herein by value reference to Exhibit 4(a) of the Annual Report on Form 10-K for Fiscal year ended December 31, 1993) 4(i) Article Four of the Articles of (incorporated Incorporation of National Bankshares, Inc. herein by included in Exhibit No. 3(a)) reference to Exhibit 4(b) of the Annual Report on Form 10-K for Fiscal year ended December 31, 1993) 10(ii)(B) Computer software license agreement dated (incorporated June 18, 1990, by and between Information herein by Technology, Inc. and The National Bank of reference to Blacksburg Exhibit 10(e) of the Annual Report on Form 10-K for Fiscal year ended December 31, 1992) *10(iii)(A) Employment Agreement dated January 1, 1992, (incorporated by and between National Bankshares, Inc. and herein by James G. Rakes reference to Exhibit 10(a) of the Annual Report on Form 10-K for Fiscal year ended December 31, 1992) *10(iii)(A) Capital Accumulation Plan (included in (incorporated Exhibit No. 10(a)) herein by reference to Exhibit 10(b) of the Annual Report on Form 10-K for Fiscal year ended December 31, 1992) *10(iii)(A) Employee Lease Agreement dated May 7, 1992, (incorporated by and between National Bankshares, Inc. herein by and The National Bank of Blacksburg reference to Exhibit 10(c) of the Annual Report on Form 10-K for Fiscal year ended December 31, 1992) 39 Page No. in Exhibit No. Description Sequential System - ----------- ----------- ----------------- *10(iii)(A) National Bankshares, Inc. 1999 Stock Option (incorporated Plan herein 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) 2001 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. 23.1 Consent of Yount, Hyde & Barbour, P.C. to incorporation by reference of independent auditor's report included in this Form 10-K, into registrant's registration statement on Form S-8. 23.2 Consent of KPMG LLP to incorporation by reference of independent auditors' report included in this Form 10-K, into registrant's registration statement on Form S-8. 99 Independent Auditors' Report of KPMG LLP on consolidated financial statements of National Bankshares, Inc. and subsidiaries for the year ended December 31, 1999. *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. 40 (d) Financial Statement Schedules required by Regulation S-X: -------------------------------------------------------- See Item 14(a)2 above. 41 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 28, 2002 ------------------------------------- BY: /s/ J. Robert Buchanan ------------------------------------- J. Robert Buchanan Treasurer (Principal Financial Officer) DATE: March 28, 2002 ------------------------------------- Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the date indicated. Name Date Title - ---- ---- ----- /s/ L.A. Bowman March 13, 2002 Director - ------------------------ -------------- L. A. Bowman /s/ A. A. Crouse March 13, 2002 Director - ------------------------ -------------- A. A. Crouse /s/ J. A. Deskins, Sr. March 13, 2002 Director - ------------------------ -------------- J. A. Deskins, Sr. /s/ P. A. Duncan March 13, 2002 Director - ------------------------ -------------- P. A. Duncan /s/ C. L. Forrester March 13, 2002 Director - ------------------------ -------------- C. L. Forrester /s/ W. T. Peery March 13, 2002 Director - ------------------------ -------------- W. T. Peery /s/ J. G. Rakes March 13, 2002 Chairman of the Board - ------------------------ -------------- President and Chief J. G. Rakes Executive Officer - National Bankshares, Inc. /s/ J. M. Shuler March 13, 2002 Director - ------------------------ -------------- J. M. Shuler /s/ J. R. Stewart March 13, 2002 Director - ------------------------ -------------- J. R. Stewart 43 Index to Exhibits ----------------- Page No. in Exhibit No. Description Sequential System - ----------- ----------- ----------------- 3(i) Articles of Incorporation, as amended, of (incorporated National Bankshares, Inc. herein by reference to Exhibit 3(a) of the Annual Report on Form 10-K for fiscal year ended December 31, 1993) 4(i) Specimen copy of certificate for National (incorporated Bankshares, Inc. common stock, $2.50 par herein by value reference to Exhibit 4(a) of the Annual Report on Form 10-K for fiscal year ended December 31, 1993) 4(i) Article Fourth of the Articles of (incorporated Incorporation of National Bankshares, Inc. herein by included in Exhibit No. 3(a)) reference to Exhibit 4(b) of the Annual Report on Form 10-K for fiscal year ended December 31, 1993) 10(ii)(B) Computer software license agreement dated (incorporated June 18, 1990, by and between Information herein by Technology, Inc. and The National Bank of reference to Blacksburg Exhibit 10(e) of the Annual Report on Form 10-K for fiscal year ended December 31, 1992) *10(iii)(A) Employment Agreement dated January 1, 1992, (incorporated by and between National Bankshares, Inc. and herein by James G. Rakes reference to Exhibit 10(a) of the Annual Report on Form 10-K for fiscal year ended December 31, 1992) *10(iii)(A) Capital Accumulation Plan (included in (incorporated Exhibit No. 10(a)) herein by reference to Exhibit 10(b) of the Annual Report on Form 10-K for fiscal year ended December 31, 1992) 44 Page No. in Exhibit No. Description Sequential System - ----------- ----------- ----------------- *10(iii)(A) Employee Lease Agreement dated May 7, 1992, (incorporated by and between National Bankshares, Inc. and herein by The National Bank of Blacksburg reference to Exhibit 10(c) of the Annual Report on Form 10-K for fiscal year ended December 31, 1992) *10(iii)(A) National Bankshares, Inc. 1999 Stock Option (incorporated Plan herein 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) 2001 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. 23.1 Consent of Yount, Hyde & Barbour, P.C. to incorporation by reference of independent auditor's report included in this Form 10-K, into registrant's registration statement on Form S-8. 23.2 Consent of KPMG LLP to incorporation by reference of independent auditors' report included in this Form 10-K, into registrant's registration statement on Form S-8. 99 Independent Auditor's Report of KPMG LLP on consolidated financial statements of National Bankshares, Inc. and subsidiaries for the year ended December 31, 1999. * Indicates a management contract or compensatory plan required to be filed herein. 45 EX-99 4 ex99.txt INDEPENDENT AUDITOR'S REPORT Exhibit 99 Independent Auditors' Report The Board of Directors and Stockholders National Bankshares, Inc.: We have audited the accompanying consolidated statements of income, changes in stockholders' equity, and cash flows of National Bankshares, Inc. and subsidiaries for the year 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 audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of National Bankshares, Inc. and subsidiaries for the year ended December 31, 1999, in conformity with accounting principles generally accepted in the United States of America. /s/ KPMG LLP Roanoke, Virginia February 11, 2000 EX-23 5 ex231.txt CONSENT OF INDEPENDENT AUDITORS Exhibit 23.1 Consent of Independent Auditors 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 January 23, 2002, relating to the consolidated balance sheets of National Bankshares, Inc. and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for the years then ended, which report is included in the December 31, 2001 Annual Report on Form 10-K of National Bankshares, Inc. /s/Yount, Hyde & Barbour, P.C. Winchester, Virginia March 29, 2002 EX-23 6 ex232.txt CONSENT OF INDEPENDENT AUDITORS Exhibit 23.2 Consent of Independent Auditors 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 statements of income, changes in stockholders' equity, and cash flows of National Bankshares, Inc. and subsidiaries for the year ended December 31, 1999, which report is included in the December 31, 2001 Annual Report on Form 10-K of National Bankshares, Inc. /s/ KPMG LLP Roanoke, Virginia March 29, 2002 EX-13 7 annual2001.txt 2001 ANNUAL REPORT TO SHAREHOLDERS National Bankshares 2001 Annual Report 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 institutions 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. Contents - -------------------------------------------------------------------------------- 1 Financial Highlights 2 To Our Stockholders 4 Selected Consolidated Financial Data 5 Management's Discussion and Analysis 12 Independent Auditor's Report 13 Consolidated Financial Statements 17 Notes to Consolidated Financial Statements (unaudited) 36 Selected Quarterly Data 38 Boards of Directors 40 Corporate Information - -------------------------------------------------------------------------------- Financial Highlights ($ In thousands, except per share data) 2001 2000 1999 - -------------------------------------------------------------------------------- Net income $ 7,314 7,309 7,088 Basic and diluted net income per share 2.08 2.08 1.96 Cash dividends per share 0.86 0.85 0.80 Book value per share 18.59 17.04 14.99 Loans, net $ 394,042 355,795 291,562 Total securities 191,476 156,344 137,492 Total assets 644,623 593,497 472,134 Total deposits 576,618 530,648 407,187 Stockholders' equity 65,261 59,834 52,723 - -------------------------------------------------------------------------------- Graph of "Cash Dividends Per Share" (dollars) 2001 2000 1999 1998 1997 - ---------------- --------------- --------------- --------------- --------------- .86 .85 .80 .74 .68 Graph of "Book Value Per Share" (1) (dollars) 2001 2000 1999 1998 1997 - ---------------- --------------- --------------- --------------- --------------- 18.59 17.04 14.99 16.00 14.73 (1) Includes the amount related to common stock subject to ESOP put option excluded from stockholders' equity on the Consolidated Balance Sheets in 1998 and 1997. 1 To Our Stockholders Photographs of "Bank of Clinch Valley" "Green Hotel" "Bank of Graham" Photo Caption "Top to bottom: Bank of Clinch Valley on Main Street in Tazewell, early 1900's; Green Hotel, NBB's first building, early 1900's; Inside the Bank of Graham in Bluefield, 1920." For National Bankshares, 2001 was a year of accomplishments achieved during a time of challenges. Following rather quickly on the acquisition in late 2000 of six branch offices from AmSouth Bank, Bank of Tazewell County closed the purchase of the Bluefield, Virginia office of First Union National Bank on March 8. With this purchase, BTC consolidated its already strong position in the growing Bluefield market. In addition, we were able to utilize some of that bank's excess capital to expand our core business, community banking. Throughout the year we have focused on profitably integrating the seven new locations into existing operations at The National Bank and Bank of Tazewell County. Employee training went well, and new customers were patient with changes. Now that the transition is complete, we are working to capitalize on the opportunities offered in these new and expanded markets. National Bankshares Financial Services Another highlight of the past year was the formation of a new corporate subsidiary. National Bankshares Financial Services, Inc. is doing business throughout Southwest Virginia as National Bankshares Investment Services and National Bankshares Insurance Services. Through a partnership with UVEST Investment Services, National Bankshares Investment Services offers individuals who are not bank Trust Department customers the opportunity to invest in annuities, stocks, bonds and mutual funds. National Bankshares Insurance Services provides competitive pricing and excellent service on a full range of personal and business insurance products. We believe that we can now conveniently meet all of the financial and insurance needs of our community bank customers, and at the same time provide new sources of income for the holding company. A Challenging Year The business environment last year offered unique challenges. The Federal Reserve Bank's eleven interest rate cuts compressed interest margins while our banks made adjustments. The recession and no-interest car loans negatively affected consumer loan demand. Turmoil in the financial markets after the September 11 terrorist attacks made choosing good investments very difficult. I am pleased to report to you that our employees successfully met these and many other challenges, and we were able to post positive earnings that slightly exceeded 2000 totals. 2 Photographs of "Farmers Bank of Clinch Valley" "NBB's Main Office" "Hubbard Street Headquarters" Photo Caption "Top to bottom: Farmers Bank of Clinch Valley, circa 1933; Architect's rendition of NBB's Main Office, 1942; National Bankshares Hubbard Street Headquarters, 1999." Summary Of Results Net income for 2001 was $7.314 million, as compared with $7.309 million for 2000. Total assets of National Bankshares at December 31, 2001 were $664.62 million, versus $593.49 million for the comparable period in 2000, an increase of 8.61%. Net loans at year-end were at $394.04 million, 10.75% higher than last year. Stockholders received a cash dividend of $0.86 per share for 2001, as compared with $0.85 last year. Continuing The Tradition Both of our bank subsidiaries have long histories of successfully surviving and thriving in difficult days. The National Bank celebrated its 110th anniversary last May, and Bank of Tazewell County is even older, tracing its history back to a charter issued to Clinch Valley Bank in 1889. Clinch Valley Bank, later Farmers Bank of Clinch Valley, merged in 1964 with Bank of Graham to become Bank of Tazewell County. While we all have been dealing with the emotional and financial effects of the September 11 attacks on our nation and with the war on terrorism, I cannot help but think of bankers from previous generations who worked to keep our local communities strong and prosperous as our country faced other serious challenges. We intend to continue in their tradition. We will work hard to provide quality hometown banking with a modern outlook. We are grateful for the support of our stockholders, the loyalty of customers and the hard work of directors, officers and employees. Thank you for your investment and confidence in National Bankshares, Inc. Picture of /s/ James G. Rakes "James G. Rakes" James G. Rakes Chairman of the Board President and Chief Executive Officer 3
Selected Consolidated Financial Data $ In thousands, except per share data. Years ended December 31, 2001 2000 1999 1998 1997 - --------------------------------------------------------------------------------------------------------------- Selected Income Statement Data: Interest income $ 45,527 38,358 33,603 31,828 29,797 Interest expense 22,771 18,163 14,203 13,928 13,106 Net interest income 22,756 20,195 19,400 17,900 16,691 Provision for loan losses 1,408 1,329 1,400 624 435 Noninterest income 5,204 4,082 3,512 3,174 2,834 Noninterest expense 16,953 12,876 11,868 11,061 10,031 Income taxes 2,285 2,763 2,556 2,591 2,499 Net income 7,314 7,309 7,088 6,798 6,560 Per Share Data: Basic and diluted net income $ 2.08 2.08 1.96 1.79 1.73 Cash dividends declared 0.86 0.85 0.80 0.74 0.68 Book value per share(1) 18.59 17.04 14.99 16.00 14.73 Selected Balance Sheet Data at Year End: Loans, net $ 394,042 355,795 291,562 236,578 214,552 Total securities 191,476 156,344 137,492 166,754 149,974 Total assets 644,623 593,497 472,134 445,166 402,907 Total deposits 576,618 530,648 407,187 382,696 344,867 Stockholders' equity 65,261 59,834 52,723 58,503 54,029 Selected Balance Sheet Daily Averages: Loans, net $ 380,970 310,624 266,431 225,613 204,540 Total securities 188,809 142,686 151,424 152,432 157,179 Total assets 635,692 500,381 454,189 420,988 395,932 Total deposits 569,139 433,673 391,583 359,970 339,439 Stockholders' equity(1) 63,460 55,682 56,196 58,282 53,712 Selected Ratios: Return on average assets 1.15% 1.46% 1.56% 1.61% 1.66% Return on average equity(1) 11.53% 13.13% 12.61% 11.66% 12.21% Dividend payout ratio 41.29% 40.87% 39.70% 41.29% 39.31% Average equity to average assets(1) 9.98% 11.13% 12.37% 13.84% 13.57% - ---------------------------------------------------------------------------------------------------------------
(1) Includes the amount related to common stock subject to ESOP put option excluded from stockholders' equity on the Consolidated Balance Sheets in 1998 and 1997. 4 Management's Discussion and Analysis ($ In thousands, except per share data) Performance Summary Net income in 2001 for National Bankshares, Inc. (Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg (NBB), Bank of Tazewell County (BTC), and National Bankshares Financial Services, Inc., (the Company), was $7,314, an increase of $5 or 0.07% over the previous year. This produced a return on average assets and a return on average equity of 1.15% and 11.53%, respectively. Net income for the Company for 2000 was $7,309, an increase of $221 or 3.12% over 1999. The return on average assets and return on average equity for 2000 were 1.46% and 13.13%, respectively. While 2000 net income increased 3.12%, total asset growth increased at a rate of approximately 26%, resulting in a 6.41% decline in the return on average assets. Basic net income per share over the three-year period was $1.96 per share in 1999 compared to $2.08 in 2000 and 2001. The dividend payout ratio for 2001 was 41.29%, which compares to 40.87% in 2000 and 39.70% in 1999. Net Interest Income Net interest income for 2001 was $22,756, an increase of $2,561 or 12.68%. The net interest margin for 2001 was 4.11%, a 42 basis point decrease from 2000. These results were in part caused by the rising interest rate environment that existed throughout 2000, which steadily increased interest expense until January 2001. In January 2001, the Federal Reserve Bank initiated a series of interest rate reductions to stimulate the faltering national economy. The falling rate environment began to benefit the Company immediately, though the full effect of this trend is not expected to be realized until some point in the future. Graph of "Net Income" (in millions) 2001 2000 1999 1998 1997 - ---------------- --------------- --------------- --------------- --------------- 7.3 7.3 7.1 6.8 6.6 A second factor that affected the interest rate margin was acquisition activity. In late 2000, the Company purchased six branches from AmSouth Bank . While the assumption of the interest expense was immediate, it was not possible to channel the new funds immediately into the loan portfolio due to economic conditions. Surplus funds, instead, were placed in the lower yielding investment portfolio. Accordingly, interest expense grew at a faster rate than interest income, adversely affecting the net interest margin. Net interest income for 2000 was $20,195, an increase of $795 or 4.10% over 1999. The net interest margin on earning assets for 2000 was 4.53% and 4.82% in 1999. The yield on earning assets for 2000 was 8.36%, down 18 basis points from the previous year. At the same time the cost to fund earning assets, which was 3.83%, increased 50 basis points. This produced a net decrease in the net interest margin of 32 basis points. This decrease was due primarily to the rising interest rate environment that occurred in 2000. 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 provides management with information related to repricing opportunities, while interest rate shock simulations indicate potential economic loss due to future interest rate changes. During 1999 and 2000 interest rates rose substantially. In addition to the adverse effects on the net interest margin, the rising rates reduced the Company's ability to respond to interest rate movements. At December 31, 2000, the Company's investment portfolio contained a substantial amount of longer-term securities with call features. Due to the higher interest rate levels the call features of these securities were not exercised. At the time, the net unrealized losses made the sale of the securities impractical, thereby depriving management of one of its primary means of controlling the effects of interest rate changes. With the onset of the declining rate environment that began in January 2001, both of these problems began to abate. Interest expense, which had been at high levels at the beginning of 2001, declined rapidly and market values of the securities rebounded, making the sale of the securities feasible, if deemed necessary. Management anticipates that the net interest margin will continue to improve into 2002. In addition to the contribution to net income made by lower deposit rates, the ongoing economic recovery may provide an opportunity to rechannel investments in securities into the higher yielding loan portfolio. Any improvement in performance, however, is contingent upon the pace and extent to which the economy ultimately recovers. 5 As previously stated, the Company uses simulation analysis to forecast its balance sheet and monitor interest rate sensitivity. One test is a shock analysis that measures the effect of a hypothetical, immediate, and parallel shift in interest rates. The following table shows the results of a rate shock and the effects on net income and return on average assets and return on average equity projected at December 31, 2002. ($ in thousands, except for percent data) Rate Shift Net Return on Return on (Basis Points) Income Average Equity Average Assets - ------------------------------------------------------------------------- 300 $ 8,501 12.24% 1.24% 200 9,766 13.95% 1.42% 100 10,904 15.47% 1.58% (-) 100 13,263 18.55% 1.93% (-) 200 13,616 19.01% 1.98% - ------------------------------------------------------------------------- Simulation analysis allows the Company to test asset and liability management strategies under rising and falling rate conditions. As a part of the simulation process, certain estimates and assumptions must be made. These include, but are not limited to, asset growth, the mix of assets and liabilities, rate environment, and 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. This data indicates that the Company's performance is vulnerable to sudden changes in interest rates. This can also be seen by the operating results in the 1999 to early 2001 period in which interest rates rose substantially, adversely affecting net income. 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. Changing trends in the loan mix are also evaluated in determining the adequacy of the allowance for loan losses. 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. Loan loss and other industry indicators related to asset quality are presented in the Loan Loss Data table (following page). Nonperforming loans include nonaccrual loans and restructured loans, but do not include accruing loans past due 90 days or more. Nonperforming assets at December 31, 2001 were $ 565, a decrease of $ 63 or 10.03% from 2000. Net charge-offs to average net loans for 2001 was .27%. The provision for loan losses for 2001 was $1,408, an increase of $79 or 5.94% from 2000. Overall asset quality, in management's opinion, remains satisfactory. Nonperforming assets for 2000 decreased $10 from 1999. Net charge-offs to average net loans for the year 2000 were 0.21%, down from 0.31% 1999. The provision for loan losses for 2000 declined by $71 or 5.07% from 1999. Management is unable to estimate when and under what exact terms existing and future 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 2001 was $5,204, an increase of $1,122 or 27.49% from 2000. The increase in most part was due to the acquisition of the six AmSouth Bank branches in late 2000 and the purchase of a seventh branch from First Union National Bank in the first quarter of 2001. Noninterest income for 2000 increased by $570 or 16.23% over 1999. This increase was mostly due to increases in service charges on deposit accounts, which grew because of acquisition activity. 6
Loan Loss Data Table ($ In thousands) 2001 2000 1999 - ------------------------------------------ ------------------ ----------------- ----------------- Provision for loan losses $ 1,408 1,329 1,400 Net charge-offs to average net loans 0.27% 0.21% 0.31% Allowance for loan losses to loans, net of unearned income and deferred fees 1.07% 1.08% 1.10% Allowance for loan losses to nonperforming loans 1206.78% 4,415.91% 1,691.62% Allowance for loan losses to nonperforming assets 756.11% 618.79% 506.43% Nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned 0.14% 0.17% 0.22% Nonaccrual loans $ 354 88 151 Restructured loans --- --- 40 Other real estate owned, net 211 540 447 - ------------------------------------------ ----------------- ----------------- ----------------- Total nonperforming assets $ 565 628 638 ========================================== ================= ================= ================= Accruing loans past due 90 days or more $ 980 1,321 1,077 - ------------------------------------------ ----------------- ----------------- -----------------
Credit card income also increased substantially, primarily due to increased debit card activity. The level of service charges on deposits 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 fee waiver policy for these fees. Services charges on deposit accounts for 2001 were $2,246, an increase of $563 or 33.45% from 2000. The increase was caused primarily by an increase in the number of deposit accounts resulting from the purchase of six branches in late 2000 and a single branch purchase in the first quarter of 2001. An increase in service charges and fees also contributed to the increase, though to a lesser extent. Service charges on deposits for 2000 totaled $1,683, an increase of $288 or 20.65% from 1999. This increase was due primarily to volume, a portion of which was due to the purchase of six AmSouth Bank branches. Other service charges and fees are comprised of safe deposit box rent, charges associated with letters of credit, and other miscellaneous items. Due to the nature of these charges they are subject to periodic fluctuation. In 2001 these charges were $306, down $42 from 2000. In 2000, these charges were $348, an increase of $69 or 24.73% from 1999. Trust income is affected by several factors, including the number of accounts managed, the average value of the accounts, and types of trust accounts. In 2001 trust income was $1,091, an increase of $206 or 23.28% over 2000. This increase was mostly due to a higher level of estate business. Because of its nature, estate business volume and the related income is not within management's ability to predict and may fluctuate considerably from time to time. Trust income for 2000 was $885, which represents a decrease of $42 or 4.53% over 1999. The decline was due in most part to a reduction in estate business, which as previously mentioned, lacks predictability. Credit card income is composed of several types of fees and charges, including transaction or interchange fees, merchant discount fees, and over-limit charges. Credit card fees for 2001 were $1,227, an increase of $215 or 21.25% over 2000. This increase was caused in part by the purchase of six branches, which expanded the company's service area, and to the introduction of the Company's debit card service to BTC's trade area. In 2000, credit card income totaled $1,012, an increase of $210 or 26.18% over 1999. The increase in this category was attributable to an increase in debit card activity. 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. These increases result in higher transaction volume. Net realized gains for 2001 of $4 on available for sale securities were primarily caused by the write down of the Company's investment in two limited liability companies established for the sale of title insurance and insurance services, offset by the call of a single bond in late 2001. Net realized securities gains were $9 in 2000, down $15 from 1999. Gains and losses can occur as a result of portfolio restructuring, securities called prior to maturity, and certain market adjustments. 7 Noninterest Expense Noninterest expense for 2001 was $16,953, an increase of $4,077 or 31.66%. In November of 2000 the Company purchased six AmSouth Bank branches. Since the acquisition was in late 2000, the full effect on noninterest expense was not realized until 2001. Categories such as salaries and benefits, occupancy, intangibles, and other operating expense all increased because of these acquisitions. Noninterest expense for 2001 also increased with the purchase of a branch in March of 2001. Occupancy expense for 2001 was $1,715 an increase of $400 or 30.42% over the year 2000. Acquisition activity caused a majority of the increase. In 2000, occupancy expense increased $163 or 14.15% again primarily due to the acquisition of six branches in the fourth quarter of that year. Data processing expenses for 2001 were $1,343, an increase of $412 or 44.25% over 2000. The acquisition of six AmSouth Bank branches late in 2000 and the purchase of one branch in March 2001 were the primary contributors to the increase. Data processing and ATM expense was $931 for 2000, an increase over 1999 of $42 or 4.72%. This increase is mostly attributable to a host computer software upgrade and to the costs associated with the AmSouth acquisition. The cost of Federal Deposit Insurance increased by $26 or 30.23% from 2000. This increase was due in most part to the acquisition of deposits in the previously mentioned branches. The cost of deposit insurance was $86 in 2000, an increase of $39 from 1999. 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. Credit card processing costs for 2001 were $1,004, or a decrease of $21 or 2.05%. The decrease in costs was caused by a combination of factors. First, volume increases were experienced with the addition of the previously mentioned branches. In addition, the introduction of debit card services at the company's BTC affiliate added to this expense. A onetime loss experienced in 2000, as described below, offset the volume-related increases to produce the net decrease. Credit card processing expense for 2000 was $1,025, an increase of $313 or 43.96% over 1999. Included in credit card expenses is approximately $192 in losses incurred by the Company's NBB affiliate. The loss was the result of charged-back items from a single merchant. The remainder of the increase was attributable to volume. The net cost of other real estate owned includes expenses to acquire, maintain, and dispose of foreclosed properties. Net gains and losses on disposition are also included. During 2001 these expenses were $125 an increase of $42 or 50.60%. Net costs of other real estate owned for 2000 were $83, an increase of $57 from 1999, due to the volume of properties handled. Other operating expenses for 2001 were $3,655, an increase of $808 or 28.38%. Most of the increase was the result of acquisition activities, which, as expected, increased various categories such as telephone, courier service, and stationery and supplies. Other operating expenses were $3,038 in 2000, up $82 or 2.77% from 1999, which was primarily the result of increases in stationery and supplies, telephone, and state franchise tax expense at BTC. Income Taxes Income tax expense decreased in 2001 because of the decline in income before income tax expense and a higher level of investment in tax free obligations. 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 2001, 2000 and 1999 were 23.80%, 27.43% and 26.50%, 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 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. 8 Balance Sheet Total assets for the Company were $644,623 at December 31, 2001. This represents an increase of $51,126 or 8.61% over 2000. This increase resulted primarily from the acquisition of a branch from First Union National Bank in March 2001. The transaction included the acquisition of approximately $34,000 in deposits and approximately $9,200 in loans. Total assets at year-end 2000 were $593,497, which represented an increase of $121,363 or 25.71% 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. In late 2000 the Company acquired six AmSouth Bank branches. The transaction resulted in an increase of approximately $94,000 in deposits and $42,000 in loans. The additional liquidity provided by the acquisition allowed the Company to repay $10,000 in funds borrowed from the Federal Home Loan Bank. At year-end 2000 the Company had a total of $42,669 in federal funds sold and deposits in the Federal Home Loan Bank. Graph of "Total Assets" (in millions) 2001 2000 1999 1998 1997 - ---------------- --------------- --------------- --------------- --------------- 644.6 593.5 472.1 445.2 402.9 Loans Loans, net of unearned income and deferred fees, grew by $38,633 or 10.74% in 2001. Of this amount approximately $9,200 was due to the First Union Bank branch purchase referred to previously. The Company has, excluding purchased loans, experienced moderately strong growth in 2001. Management expects internally generated loan growth to increase as the overall economy recovers. Loans, net of unearned income and deferred fees, grew by $64,888 or 22.01% in 2000. Commercial loans grew by $14,543 or 9.74%, with loans to individuals increasing by $36,351 or 49.24%. Real estate mortgage loans grew by $12,334, an increase of 20.97%. Real estate construction loans grew by 14.02%. This growth was largely attributable to the AmSouth Bank acquisition, which added approximately $42,000 to the loan portfolio. The Company engages in the origination and sale of mortgage loans in the secondary market. In 2001 and 2000, the Company originated $28,247 and $20,129, respectively, and sold $27,102 and $20,358 in 2001 and 2000, respectively, of mortgage loans. Graph of "Net Loans" (in millions) 2001 2000 1999 1998 1997 - ---------------- --------------- --------------- --------------- --------------- 394.0 355.8 291.6 236.6 214.6 Securities Securities available for sale at December 31, 2001 were $ 88,667. This represents a decrease of $35,118 or 28.37% from December 31, 2000. Securities held to maturity increased $70,250 or 215.76% when the two periods are compared. The increased emphasis on held to maturity securities portfolio represents an effort to manage the level of unrealized gains and losses, which have fluctuated substantially in the past three years. New volume was the result of the previously discussed branch acquisitions. At December 31, 2001, net unrealized securities gains net of deferred tax expense were $566. This is compared to ($575) at December 31, 2000. This increase was primarily due to the declining rate environment experienced in 2001. With the completion of the AmSouth transaction and because of aggressive deposit procurement efforts, the Company generated excess liquidity in 2000. A portion of these excess funds was invested in the available for sale portfolio, which increased by $9,940 or 8.73%, and a portion was invested in the held to maturity category, which increased by $8,912 or 37.69%. As previously mentioned, the net unrealized loss in the available for sale portfolio decreased significantly in 2000. At December 31, 2000, net unrealized securities loss, net of deferred tax benefit, was approximately ($575) compared to ($3,453) at December 31, 1999. 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, 2001 and 2000, the Company had no investment concentrations in any single issues (excluding U.S. Government) that exceeded ten percent of capital. 9 Deposits At December 31, 2001, total deposits were $576,618, an increase of $45,970 or 8.66% over December 31, 2000. Approximately $34,000 of this increase was attributable to the First Union National Bank purchase which has been previously discussed. As a result of aggressive marketing efforts and the acquired branches, total deposits grew by $123,461 or 30.32% in 2000. The AmSouth purchase accounted for approximately $94,000 of the increase. 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 involvement in the future in high risk derivative products. The Company has investments in mortgage-backed securities, principally GNMA's, with a fair value of approximately $27,111, which includes $1,397 of structured notes. In addition, the Company has investments in nonmortgage-backed structured notes with fair value of approximately $1,801. 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 credit risk when a loan is granted and monitors 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 the 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 help 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 2001 and 2000. The Company's liquidity position remained satisfactory throughout 2001. The acquisition of the First Union National Bank branch in March 2001 further enhanced liquidity, which was already satisfactory following the late 2000 acquisition of the AmSouth branches. The most significant use of funds was in securities purchases. The primary sources of funds were the purchased branch deposits and an increase in the other deposits category. Net cash from operating activities for 2001 was $10,017, up from $9,691 in 2000. Cash used in investing activities was $47,987, down from $113,774 in 2000. Purchases of loans and federal funds sold declined substantially from 2000. This corresponded to a substantial increase in cash provided by financing activities in 2000 which was due to acquisition activity. In 2000, the Company's liquidity greatly improved. In the first half of 2000 the Company aggressively marketed its deposit products. In the fourth quarter it acquired the six AmSouth Bank branches. This allowed the Company to repay a $10,000 advance from the Federal Home Loan Bank and to end 2000 with $42,669 in federal funds sold and deposits in the Federal Home Loan Bank. Net cash from operating activities of $9,691 in 2000 decreased by $1,757 from 1999, primarily due to the decrease in accrued interest receivable and the decrease in mortgage loans held for sale. Net cash flows provided by operating activities and financing activities for 2000 of $9,691 and $101,902 respectively, were used primarily to fund loan growth. 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. 10 Capital Resources Total stockholder's equity increased by $5,427 or 9.07% for the year 2001. Growth was the result of net income of $7,314, offset by dividends to shareholders of $3,020. Stock in the amount of $8, was repurchased. Total stockholders' equity increased by $7,111 or 13.49% in the year 2000. Growth was the result of net income of $7,309, offset by dividends to shareholders of $2,987. Accumulated comprehensive income increased by $2,878. Stock in the amount of $89 was repurchased. 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, 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 12 of Notes to Consolidated Financial Statements for additional information. Recent Accounting Pronouncements See note 1 of Notes to Consolidated Financial Statements for information relating to recent accounting pronouncements. Branch Acquisitions On November 8, 2000 the Company acquired six branches of AmSouth Bank of Birmingham, Alabama (AmSouth). Approximately $42,000 in loans and $94,000 in deposits were acquired. Three of the six branches, located in Radford, Pulaski, and Dublin, Virginia, are being operated by the Company's NBB affiliate. The remaining three, located in Wytheville, Abingdon, and Marion, Virginia, are being operated by the Company's BTC affiliate. In another move to improve the Company's competitive position, BTC acquired a branch in Bluefield, Virginia from First Union National Bank on March 8, 2001. The acquisition involved the purchase of approximately $34,000 in deposits and $9,200 in loans. 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, 2001, there were 1,045 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 2001 and 2000. 2001 2000 Dividends per share ----------------- ------------------- ------------------- High Low High Low 2001 2000 - ------------- -------- ------- --------- -------- ------ ------ First Quarter $ 20.25 18.00 $ 20.50 18.75 --- --- - ------------- Second Quarter 20.80 17.80 19.00 15.50 0.43 0.42 - -------------- Third Quarter 24.60 20.00 17.50 16.06 --- --- - ------------- Fourth Quarter 23.00 20.10 18.75 15.125 0.43 0.43 - -------------- -------- ------- --------- -------- ------ ------ 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. 11 Independent Auditors' Report The Board of Directors and Stockholders National Bankshares, Inc. Blacksburg, Virginia We have audited the accompanying consolidated balance sheets of National Bankshares, Inc. and subsidiaries as of December 31, 2001 and 2000 and the related consolidated statements of income, changes in stockholders' equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of National Bankshares, Inc. for the year ended December 31, 1999 were audited by other auditors whose report, dated February 11, 2000, expressed an unqualified opinion on those statements. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting 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 2001 and 2000 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, 2001 and 2000 and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Winchester, Virginia January 23, 2002 12
Consolidated Balance Sheets $ In thousands, except per share data. December 31, 2001 and 2000. 2001 2000 - -------------------------------------------------------------------------- ------------- ------------- Assets Cash and due from banks $ 12,293 11,130 Interest-bearing deposits 15,510 13,579 Federal funds sold 1,080 29,090 Securities available for sale 88,667 123,785 Securities held to maturity (fair value approximates $103,234 at December 31, 2001 and $32,602 at December 31, 2000) 102,809 32,559 Mortgage loans held for sale 1,145 --- Loans: Real estate construction loans 19,573 16,726 Real estate mortgage loans 77,339 71,163 Commercial and industrial loans 189,764 163,929 Loans to individuals 113,413 110,176 ------------- ------------- Total loans 400,089 361,994 Less unearned income and deferred fees (1,775) (2,313) ------------- ------------- Loans, net of unearned income and deferred fees 398,314 359,681 Less allowance for loan losses (4,272) (3,886) ------------- ------------- Loans, net 394,042 355,795 ------------- ------------- Bank premises and equipment, net 10,132 10,324 Accrued interest receivable 4,917 5,049 Other real estate owned 211 540 Intangible assets and goodwill, net 11,866 9,038 Other assets 1,951 2,608 ------------- ------------- Total assets $ 644,623 593,497 ============= ============= Liabilities and Stockholders' Equity Noninterest-bearing demand deposits $ 71,751 60,165 Interest-bearing demand deposits 134,230 101,257 Savings deposits 48,827 42,560 Time deposits 321,810 326,666 Total deposits 576,618 530,648 Other borrowed funds 203 270 Accrued interest payable 1,101 1,538 Other liabilities 1,440 1,207 ------------- ------------- Total liabilities 579,362 533,663 ------------- ------------- Stockholders' equity: 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 3,511,377 in 2001 and 3,511,877 shares in 2000 8,778 8,780 Retained earnings 55,917 51,629 Accumulated other comprehensive income (loss) 566 (575) ------------- ------------- Total stockholders' equity 65,261 59,834 ------------- ------------- Total liabilities and stockholders'equity $ 644,623 593,497 ============= ============= - -------------------------------------------------------------------------- ------------- -------------
The accompanying notes are an integral part of these consolidated financial statements. 13
Consolidated Statements of Income $ In thousands, except per share data. Years ended December 31, 2001, 2000 and 1999. 2001 2000 1999 - --------------------------------------------------------------------- -------------- ------------- ------------- Interest Income Interest and fees on loans $ 33,456 28,326 24,105 Interest on federal funds sold 652 338 170 Interest on interest-bearing deposits 577 689 269 Interest on securities - taxable 7,501 6,760 6,820 Interest on securities - nontaxable 3,341 2,245 2,239 -------------- ------------- ------------- Total interest income 45,527 38,358 33,603 -------------- ------------- ------------- Interest Expense Interest on time deposits of $100,000 or more 4,605 3,455 2,487 Interest on other deposits 18,158 14,080 11,484 Interest on borrowed funds 8 628 232 -------------- ------------- ------------- Total interest expense 22,771 18,163 14,203 -------------- ------------- ------------- Net interest income 22,756 20,195 19,400 Provision for loan losses 1,408 1,329 1,400 -------------- ------------- ------------- Net interest income after provision for loan losses 21,348 18,866 18,000 -------------- ------------- ------------- Noninterest Income Service charges on deposit accounts 2,246 1,683 1,395 Other service charges and fees 306 348 279 Credit card fees 1,227 1,012 802 Trust income 1,091 885 927 Other income 330 145 85 Realized securities gains, net 4 9 24 ------------- ------------- ------------- Total noninterest income 5,204 4,082 3,512 ------------- ------------- ------------- Noninterest Expense Salaries and employee benefits 8,085 6,360 6,048 Occupancy and furniture and fixtures 1,715 1,315 1,152 Data processing and ATM 1,343 931 889 FDIC assessment 112 86 47 Credit card processing 1,004 1,025 712 Intangible assets and goodwill amortization 914 229 152 Net costs of other real estate owned 125 83 26 Other operating expenses 3,655 2,847 2,842 ------------- ------------- ------------- Total noninterest expense 16,953 12,876 11,868 ------------- ------------- ------------- Income before income tax expense 9,599 10,072 9,644 Income tax expense 2,285 2,763 2,556 ------------- ------------- ------------- Net income $ 7,314 7,309 7,088 ============= ============= ============= Basic and diluted net income per share $ 2.08 2.08 1.96 ============= ============= ============= - --------------------------------------------------------------------- -------------- ------------- -------------
The accompanying notes are an integral part of these consolidated financial statements. 14
Consolidated Statements of Changes in Stockholders' Equity $ In thousands, except per share data. Years ended December 31, 2001, 2000 and 1999. Accumulated Other Common Stock Comprehen- Comprehen- Subject to Common Retained sive Income sive ESOP Put Stock Earnings (Loss) Income Option Total - ----------------------------------- ------------ ----------- ------------ ----------- ------------ ------------ Balances, December 31, 1998 $ 9,482 50,182 1,019 (2,180) 58,503 Net income --- 7,088 --- 7,088 --- 7,088 Other comprehensive income: Unrealized holding losses on available for sale securities net of deferred taxes of $2,297 --- --- --- (4,459) --- --- Less: reclassification adjustment, net of income taxes of $7 --- --- --- (13) --- --- ----------- Other comprehensive (loss), net of tax of ($2,304) --- --- (4,472) (4,472) --- (4,472) ----------- Total comprehensive income, net of tax of $252 --- --- --- 2,616 --- --- =========== Common stock repurchased (690) (7,072) --- --- (7,762) Cash dividends ($0.80 per share) --- (2,814) --- --- (2,814) Change in common stock subject to ESOP put option --- --- --- 2,180 2,180 ------------ ----------- ------------ ------------ ------------ - ---------------------------------------------------------------------------------------------------------------- Balances, December 31, 1999 $ 8,792 47,384 (3,453) --- 52,723 Net income --- 7,309 --- 7,309 --- 7,309 Other comprehensive income: Unrealized holding gains on available for sale securities net of deferred taxes of $1,486 --- --- --- 2,884 --- --- Less: reclassification adjustment, net of income taxes of $3 --- --- --- (6) --- --- ----------- Other comprehensive income, net of tax of $1,483 --- --- 2,878 2,878 --- 2,878 ----------- Total comprehensive income, net of tax of $4,246 --- --- --- 10,187 --- --- =========== Common stock repurchased (12) (77) --- --- (89) Cash dividends ($0.85 per share) --- (2,987) --- --- (2,987) ------------ ----------- ------------ ------------ ------------ - ---------------------------------------------------------------------------------------------------------------- Balances, December 31, 2000 $ 8,780 51,629 (575) --- 59,834 Net income --- 7,314 --- 7,314 --- 7,314 Other comprehensive income: Unrealized holding gains on available for sale securities net of deferred taxes of $588 --- --- --- 1,144 --- --- Less: reclassification adjustment, net of income taxes of $1 --- --- --- (3) --- --- ----------- Other comprehensive income, net of tax of $587 --- --- 1,141 1,141 --- 1,141 ----------- Total comprehensive income, net of tax of $2,872 --- --- --- 8,455 --- =========== Common stock repurchased (2) (6) --- --- (8) Cash dividends ($0.86 per share) --- (3,020) --- --- (3,020) ------------ ----------- ------------ ------------ ------------ - ---------------------------------------------------------------------------------------------------------------- Balance at December 31, 2001 $ 8,778 55,917 566 --- 65,261 ============ =========== ============ ============ ============ - ----------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. 15
Consolidated Statements of Cash Flows $ In thousands. Years ended December 31, 2001, 2000 and 1999. 2001 2000 1999 - ------------------------------------------------------------ --------------- --------------- -------------- Cash Flows from Operating Activities: Net income $ 7,314 7,309 7,088 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,408 1,329 1,400 Provision for deferred income taxes (166) (253) (214) Depreciation of bank premises and equipment 1,106 1,015 903 Amortization of intangibles 914 229 152 Amortization of premiums and accretion of discounts, net 367 132 350 (Gains) losses on sales and calls of securities available for sale, net (4) 4 (20) Gains on calls of securities held to maturity, net --- (13) (4) Losses and writedowns on other real estate owned 62 26 --- Originations of mortgage loans held for sale (28,247) (20,129) (31,538) Sales of mortgage loans held for sale 27,102 20,358 33,489 (Gains) losses on sale of fixed assets (2) (4) 22 Net change in: Accrued interest receivable 132 (1,035) (237) Other assets 235 (258) (134) Accrued interest payable (437) 887 4 Other liabilities 233 94 187 --------------- --------------- -------------- Net cash provided by operating activities 10,017 9,691 11,448 --------------- --------------- -------------- Cash Flows from Investing Activities: Net change in federal funds sold 28,010 (26,290) 2,290 Net change in interest-bearing deposits (1,931) (4,360) (2,192) Proceeds from sales of securities available for sale --- 935 1,300 Proceeds from calls, maturities and principal repayments of securities available for sale 58,403 7,732 21,495 Proceeds from repayments of mortgage-backed securities available for sale 3,482 1,558 4,558 Proceeds from calls, maturities and principal repayments of securities held to maturity 24,160 3,192 6,997 Purchases of securities available for sale (25,209) (15,914) (12,190) Purchases of securities held to maturity (94,602) (12,117) --- Purchases of loan participations (4,296) (2,759) (5,643) Collections of loan participations 4,702 3,768 3,408 Loans purchased, including premium (9,255) (42,187) --- Loan originations and principal collections, net (31,740) (24,869) (54,456) Proceeds from disposal of other real estate owned 1,095 271 336 Recoveries on loans charged off 106 95 130 Additions to premises and equipment (921) (2,839) (2,757) Proceeds from sale of premises and equipment 9 10 5 --------------- --------------- -------------- Net cash used in investing activities (47,987) (113,774) (36,719) --------------- --------------- -------------- Cash Flows from Financing Activities: Deposits acquired, net of premium 29,862 85,944 --- Net change in time deposits (38,460) 40,031 22,709 Net change in other deposits 50,826 (10,807) 1,782 Net change in other borrowed funds (67) (10,190) 10,246 Cash dividends paid (3,020) (2,987) (2,814) Common stock repurchase (8) (89) (7,762) --------------- --------------- -------------- Net cash provided by financing activities 39,133 101,902 24,161 --------------- --------------- -------------- Net change in cash and due from banks 1,163 (2,181) (1,110) Cash and due from banks at beginning of year 11,130 13,311 14,421 --------------- --------------- -------------- Cash and due from banks at end of year $ 12,293 11,130 13,311 =============== =============== ============== Supplemental Disclosures of Cash Flow Information: Interest paid on deposits and borrowed funds $ 23,208 17,276 14,199 Income taxes paid 2,383 2,958 2,941 Supplemental Disclosures of Noncash Investing Activities: Loans charged against the allowance for loan losses 1,129 770 978 Loans transferred to other real estate owned 828 390 177 Unrealized gain (loss) on securities available for sale 1,728 4,361 (6,776) =============== =============== ============== - ------------------------------------------------------------ --------------- --------------- --------------
The accompanying notes are an integral part of these consolidated financial statements. 16 Notes to Consolidated Financial Statements ($ In thousands, except share data and per share data. December 31, 2001, 2000 and 1999.) Note 1: Summary of Significant Accounting Policies The consolidated financial statements include the accounts of National Bankshares, Inc. (Bankshares) and its wholly-owned subsidiaries, the National Bank of Blacksburg (NBB), Bank of Tazewell County (BTC), and National Bankshares Financial Services (NBFS), (the Company). All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following is a summary of the more significant accounting policies. Cash and Cash Equivalents For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and due from banks. Securities Debt securities that management has the positive intent and ability to hold to maturity are classified as "held to maturity" and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as "available for sale" and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method. Loans Held for Sale Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Loans The Company grants mortgage, commercial, and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans. The ability of the Company's debtors to honor their contracts is dependent upon the real estate and general economic conditions in the Company's market area. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method. The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Credit card loans and other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, 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. Allowance for Loan Losses The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. 17 The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures. Premises and Equipment 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. Other Real Estate Real estate acquired through, or in lieu of, foreclosure is held for sale and is initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other operating expenses. Intangible Assets Intangible assets and goodwill include deposit intangibles of $11,559 and $8,693 at December 31, 2001 and 2000, respectively, and goodwill of $307 and $345 at December 31, 2001 and 2000, 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. Stock Option Plan Statement of Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations, whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company's stock option plan have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is recognized for them. The Company has elected to continue with the accounting methodology in Opinion No. 25 and, as a result, has adopted the disclosure requirements of SFAS No. 123. 18 Pension Plans The Company sponsors two separate defined benefit pension plans, which cover substantially all full-time officers and employees. The benefits are based upon length of service and a percentage of the employee's compensation during the final years of employment. Pension costs are computed based upon the provisions of SFAS No. 87. The Company contributes to the pension plans amounts deductible for federal income tax purposes. Income Taxes Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. 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. Earnings Per Share Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury stock method. The following shows the weighted average number of shares used in computing earnings per share and the effect on the weighted average number of shares of dilutive potential common stock. Potential dilutive common stock had no effect on income available to common shareholders.
2001 2000 1999 - ----------------------------------------------------------------- --------------- -------------- --------------- --------------- -------------- --------------- Average number of common shares outstanding 3,511,380 3,514,586 3,607,669 Effect of dilutive options 1,216 --- --- Average number of common shares outstanding used to calculate diluted earnings per share 3,512,596 3,514,586 3,607,669 =============== ============== =============== - ----------------------------------------------------------------- --------------- -------------- ---------------
In 2001, 2000 and 1999, stock options representing 4,125, 8,265 and 5,500 shares, respectively, were not included in the calculation of earnings per share as their effect would have been anti-dilutive. Advertising The Company practices the policy of charging advertising costs to expenses as incurred. Use of Estimates In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of foreclosed real estate and deferred tax assets. Changing economic conditions, adverse economic prospects for borrowers, as well as regulatory agency action as a result of 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. 19 Comprehensive Income Effective January 1, 2001, the Company changed its method of presentation concerning comprehensive income. Prior to 2001, comprehensive income was reflected as part of the consolidated statement of income. Comprehensive income is now presented as a separate component of the Company's consolidated statement of changes in stockholders' equity. Reclassifications Certain reclassifications have been made to prior period balances to conform to the current year presentation. Recent Accounting Pronouncements In July 2001, the Financial Accounting Standards Board issued two statements, SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, which will potentially impact the accounting for goodwill and other intangible assets. SFAS No. 141 eliminates the pooling method of accounting for business combinations and requires that intangible assets that meet certain criteria be reported separately from goodwill. The Statement also requires negative goodwill arising from a business combination to be recorded as an extraordinary gain. SFAS No. 142 eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life. The Statement requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life. Upon adoption of these Statements, an organization is required to reevaluate goodwill and other intangible assets that arose from business combinations entered into before July 1, 2001. If the recorded other intangible assets do not meet the criteria for recognition, they should be classified as goodwill. Similarly, if there are other intangible assets that meet the criteria for recognition but were not separately recorded from goodwill, they should be reclassified as goodwill. An organization also must reassess the useful lives of intangible assets and adjust the remaining amortization periods accordingly. Any negative goodwill must be written-off. The Company believes that the effects of these new pronouncements on its financial statements will be minimal since all of the intangible assets arose from branch acquisitions and will continue to be amortized over their estimated lives in accordance with SFAS 72, Accounting for Certain Banking or Thrift Institutions. The Statements generally are required to be implemented by the Company in its 2002 financial statements. Note 2: Restriction on Cash As members of the Federal Reserve System, the Company's subsidiary banks are required to maintain certain average reserve balances. For the final weekly reporting period in the years ended December 31, 2001 and 2000, the aggregate amounts of daily average required balances were approximated $2,458 and $1,523, respectively. Note 3: Securities The amortized cost and fair value of securities available for sale, with gross unrealized gains and losses, follows:
December 31, 2001 ------------------------------------------------- ($ In thousands) Gross Gross Amortized Unrealized Unrealized Available for sale: Costs Gains Losses Fair Value - -------------------------------------------------------- ----------- ----------- ------------ ------------ U.S. Treasury $ 6,248 242 --- 6,490 U.S. Government agencies and corporations 5,340 43 8 5,375 States and political subdivisions 51,030 605 446 51,189 Mortgage-backed securities 13,178 306 69 13,415 Corporate debt securities 9,066 143 116 9,093 Federal Home Loan Bank stock 1,411 --- --- 1,411 Federal Reserve Bank stock 209 --- --- 209 Other securities 1,328 157 --- 1,485 ----------- ----------- ------------ ------------ Total securities available for sale $ 87,810 1,496 639 88,667 =========== =========== ============ ============ - -------------------------------------------------------- ----------- ----------- ------------ ------------
20
December 31, 2000 ------------------------------------------------- ($ In thousands) Gross Gross Amortized Unrealized Unrealized Available for sale: Costs Gains Losses Fair Value - -------------------------------------------------------- ----------- ----------- ------------ ------------ U.S. Treasury $ 6,246 85 --- 6,331 U.S. Government agencies and corporations 54,815 87 868 54,034 States and political subdivisions 35,456 395 245 35,606 Mortgage-backed securities 11,818 18 60 11,776 Corporate debt securities 14,341 63 346 14,058 Federal Home Loan Bank stock 1,329 --- --- 1,329 Federal Reserve Bank stock 209 --- --- 209 Other securities 442 --- --- 442 ----------- ----------- ------------ ------------ Total securities available for sale $ 124,656 648 1,519 123,785 =========== =========== ============ ============ - -------------------------------------------------------- ----------- ----------- ------------ ------------
The amortized cost and fair value of single maturity securities available for sale at December 31, 2001, 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 categorized by final maturity at December 31, 2001. December 31, 2001 ------------------------------ ($ In thousands) Amortized Fair Costs Values - -------------------------------------------- ---------------- ------------- Due in one year or less $ 3,411 3,474 Due after one year through five years 19,391 20,029 Due after five years through ten years 25,622 25,596 Due after ten years 36,438 36,463 Equity securities 2,948 3,105 ---------------- ------------- $ 87,810 88,667 ================ ============= - -------------------------------------------- ---------------- ------------- The amortized costs and fair value of securities held to maturity, with gross unrealized gains and losses, follows:
December 31, 2001 ---------------------------------------------- ($ In thousands) Gross Gross Amortized Unrealized Unrealized Fair Held to maturity: Costs Gains Losses Value - ---------------------------------------------- ----------- ----------- ----------- ---------- U.S. Government agencies and corporations $ 17,025 95 29 17,091 States and political subdivisions 49,230 319 381 49,168 Mortgage-backed securities 13,723 123 150 13,696 Corporate debt securities 22,831 579 131 23,279 ----------- ----------- ----------- ---------- Total securities held to maturity $ 102,809 1,116 691 103,234 =========== =========== =========== ========== - ---------------------------------------------- ----------- ----------- ----------- ----------
December 31, 2000 ---------------------------------------------- ($ In thousands) Gross Gross Amortized Unrealized Unrealized Fair Held to maturity: Costs Gains Losses Value - ---------------------------------------------- ----------- ----------- ----------- ---------- U.S. Government agencies and corporations $ 8,500 8 195 8,313 States and political subdivisions 17,288 207 4 17,491 Mortgage-backed securities 288 5 --- 293 Corporate debt securities 6,483 29 7 6,505 ----------- ----------- ----------- ---------- Total securities held to maturity $ 32,559 249 206 32,602 =========== =========== =========== ========== - ---------------------------------------------- ----------- ----------- ----------- ----------
21 The amortized costs and fair values of single maturity securities held to maturity at December 31, 2001, 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 categorized by final maturity at December 31, 2001. December 31, 2001 ------------------------------ ($ In thousands) Amortized Fair Costs Values - --------------------------------------------- --------------- -------------- Due in one year or less $ 2,624 2,657 Due after one year through five years 20,881 21,537 Due after five years through ten years 40,741 40,693 Due after ten years 38,563 38,347 --------------- -------------- Total $ 102,809 103,234 =============== ============== - --------------------------------------------- --------------- -------------- At December 31, 2001 and 2000, securities with a carrying value of $30,800 and $48,810, respectively, were pledged to secure public and trust deposits and for other purposes as required or permitted by law. 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 totaling approximately $99,843, and NBB and BTC's capital stock investment in the FHLB. At December 31, 2001, the available borrowing limit was approximately $85,000. Note 4: Loans to Officers and Directors In the ordinary course of business, the Company has granted loans to executive officers and directors of Bankshares and its subsidiaries amounting to $5,782 at December 31, 2001 and $2,084 at December 31, 2000. During the year ended December 31, 2001, total principal additions were $6,972 and principal payments were $3,274. Note 5: Allowance for Loan Losses An analysis of the allowance for loan losses follows: Years ended December 31, --------------------------------------- ($ In thousands) 2001 2000 1999 - --------------------------------------- ------------ ------------ ------------- Balance at beginning of year $ 3,886 3,231 2,679 Provision for loan losses 1,408 1,329 1,400 Loans charged off (1,128) (770) (978) Recoveries of loans previously charged off 106 96 130 ------------ ------------ ------------- Balance at end of year $ 4,272 3,886 3,231 ============ ============ ============= - --------------------------------------- ------------ ------------ ------------- The following is a summary of information pertaining to impaired loans: December 31, --------------------- ($ In thousands) 2001 2000 - ------------------------------------------------ ---------- ---------- Impaired loans without a valuation allowance $ 275 321 Impaired loans with a valuation allowance 65 135 ---------- ---------- Total impaired loans $ 340 456 ========== ========== Valuation allowance related to impaired loans $ 39 135 ========== ========== - ------------------------------------------------ ---------- ---------- 22
Years ended December 31, -------------------------------- ($ In thousands) 2001 2000 1999 - ------------------------------------------------------------------ ----------- ---------- --------- Average investment in impaired loans $ 671 657 292 Interest income recognized on impaired loans 57 43 13 Interest income recognized on a cash basis on impaired loans --- --- --- - ------------------------------------------------------------------ ----------- ---------- ---------
No additional funds are committed to be advanced in connection with impaired loans. Nonaccrual loans excluded from impaired loan disclosure under FAS 114 amounted to $59 at December 31, 2001. If interest on these loans had been accrued, such income would have approximated $4. No nonaccrual loans were excluded from impaired loan disclosure under FASB 114 at December 31, 2000 and 1999. Note 6: Bank Premises and Equipment A summary of the cost and accumulated depreciation of premises and equipment follows: December 31, ------------------------ ($ In thousands) 2001 2000 - ----------------------------------------------------- ----------- ------------ Premises $ 11,051 10,413 Furniture and equipment 7,435 7,040 Construction-in-progress 13 141 ----------- ------------ 18,499 17,594 Less accumulated depreciation (8,367) (7,270) ----------- ------------ Bank premises and equipment, net $ 10,132 10,324 =========== ============ - ----------------------------------------------------- ----------- ------------ Depreciation expense for the years ended December 2001, 2000 and 1999 amounted to $1,106, $1,015 and $903, respectively. The Company leases three branch facilities under noncancellable operating leases. The future minimum lease payments under these leases (with initial or remaining lease terms in excess of one year) as of December 31, 2001 are as follows: $133 in 2002, $131 in 2003, $123 in 2004, $102 in 2005, $57 in 2006 and $247 thereafter. Note 7: Deposits The aggregate amount of time deposits in denominations of $100 or more at December 31, 2001 and 2000 was $77,214 and $72,307, respectively. At December 31, 2001, the scheduled maturities of time deposits are as follows: ($ In thousands) - ------------------------- ------------------ For the year: 2002 $ 236,661 2003 55,931 2004 12,084 2005 11,276 2006 5,180 Thereafter 678 --------- Total maturities $ 321,810 ========= - ------------------------- ------------------ 23 Note 8: Employee Benefit Plans Pension Plans The Company 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. Effective January 1, 2002, the NBB plan was amended, restated, and renamed The National Bankshares, Inc. Retirement Income Plan. At the same time, the BTC plan was merged into it, and National Bankshares, Inc. and National Bankshares Financial Services, Inc. were added as participating employers in the pension plan. The merged NBI plan did not alter the eligibility standards of the bank plans, and subtantially all employees are covered. The merged NBI plan benefit formula is still based upon the length of service of retired employees and a percentage of qualified W-2 compensation during their final years of employment. The NBB pension plan's assets are invested principally in U.S. Government agency obligations (13%), mutual funds (29%), corporate bonds (26%), equity securities (30%) and cash (2%). BTC's pension plan's assets are invested principally in corporate bonds (23%), U.S. Government agency obligations (40%) and equity securities (37%). Information pertaining to activity in the plans is as follows: Pension Benefits December 31, ----------------------------- ($ In thousands) 2001 2000 1999 - ------------------------------------------------ --------- --------- --------- Change in benefit obligation Benefit obligation at beginning of year $ 5,668 5,694 5,995 Service cost 422 354 398 Interest cost 422 425 415 Actuarial gain (53) (142) (749) Benefits paid (445) (663) (365) --------- --------- --------- Benefit obligation at end of year 6,014 5,668 5,694 --------- --------- --------- Change in plan assets Fair value of plan assets at beginning of year 4,692 4,877 4,971 Actual return on plan assets 55 202 85 Employer contribution 348 276 186 Benefits paid (445) (663) (365) --------- --------- --------- Fair value of plan assets at end of year 4,650 4,692 4,877 --------- --------- --------- Funded status (1,364) (976) (817) Unrecognized net actuarial loss 931 610 522 Unrecognized prior service cost 171 186 201 Unrecognized transition asset (114) (137) (160) --------- --------- --------- Net accrued pension cost $ (376) (317) (254) ========= ========= ========= - ------------------------------------------------ --------- --------- --------- The components of net periodic cost are as follows:
Years ended December 31, ----------------------------------------------- ($ In thousands) 2001 2000 1999 - --------------------------------------------- -------------- --------------- ---------------- Components of net periodic benefit cost Service cost $ 422 354 398 Interest cost 422 424 415 Expected return on plan assets (434) (441) (457) Amortization of prior service cost 15 15 15 Recognized net actuarial loss 5 8 18 Amortization of transition asset (23) (23) (23) -------------- --------------- ---------------- Net periodic benefit cost $ 407 337 366 ============== =============== ================ - --------------------------------------------- -------------- --------------- ----------------
24 The actuarial assumptions for both plans are as follows:
($ in thousands) 2001 2000 1999 - ------------------------------------------------------ -------------- -------------- ------------- Weighted average assumptions as of December 31 Weighted average discount rate 7.50% 7.50% 7.50% Expected return on plan assets 9.00% 9.00% 9.00% Rate of compensation increase 5.00% 5.00% 5.00% - ------------------------------------------------------ -------------- -------------- -------------
401(k) Plan The Company has a Retirement Accumulation Plan qualifying under IRS Code Section 401(k), in which NBB and BTC are participating employers. Effective on January 1, 2002, National Bankshares, Inc. and National Bankshares Financial Services, Inc. became participating employers in the plan. Eligible participants in the plan can contribute up to 10% of their total annual compensation to the plan. Employee contributions are matched by NBB and BTC based on a percentage of an employee's total annual compensation contributed to the plan. Prior to 2000, NBB was the only participating employer in the plan. For the years ended December 31, 2001 and 2000, NBB and BTC contributed $196 and $156, respectively, to the plan. For the year ended December 31, 1999, NBB contributed $102. Employee Stock Ownership Plan Bankshares has a non-leveraged Employee Stock Ownership Plan (ESOP) which enables employees 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. Effective on January 1, 2002, National Bankshares, Inc. and National Bankshares Financial Services, Inc. joined NBB and BTC as participating employers in the plan. Contributions to the ESOP for each participating employer are determined annually by the Boards of Directors of the participating employers if predetermined performance goals have been met. Contribution expense amounted to $179, $162 and $162 for the years ended December 31, 2001, 2000 and 1999, respectively. Dividends on ESOP shares are charged to retained earnings. As of December 31, 2001, the number of allocated shares held by the ESOP was 76,597 and the number of unallocated shares was 12,501. All shares held by the ESOP are treated as outstanding in computing the Company's basic and diluted net income per share. Upon reaching age 55 with ten years of plan participation, a vested participant has the right to diversify 50% of his or her allocated ESOP shares and Bankshares or the ESOP, with the agreement of the Trustee, would be obligated to purchase those shares. The ESOP contains a put option which allows a withdrawing participant to require Bankshares or the ESOP, if the plan administrator agrees, to purchase his or her allocated shares if the shares are not readily tradable on an established market at the time of its distribution. Since the shares were not readily tradable 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. 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 25 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 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, 2001, there were 216,000 additional shares available for grant under the Plan. The Company applies APB Opinion No. 25 and related Interpretations in accounting for the stock option plan. Accordingly, no compensation cost has been recognized. Pro forma compensation cost determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed in SFAS No. 123 was not material and had no impact on earnings per share as presented. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: 2001 - expected cash dividend yield of 1.86%, risk-free interest rate of 4.48%, expected volatility of 22.77%, and an expected life of ten years; 2000 - expected cash dividend yield of 1.79%, risk-free interest rate of 5.12%, expected volatility of 19.52%, and an expected life of ten years; 1999 - expected cash dividend yield of 3.41%, risk-free interest rate of 6.38%, expected volatility of 18.60%, and an expected life of ten years. A summary of the status of the Company's stock option plan is presented below:
2001 2000 1999 --------------------------- ------------------------- ------------------------- Weighted Weighted Weighted Average Average Average Number of Exercise Number of Exercise Number of Exercise Shares Price Shares Price Shares Price - -------------------------------- ----------- --------------- ----------- ------------- ----------- ------------- Outstanding, beginning of year 18,000 $ 19.57 5,500 $ 22.00 --- $ --- Granted 16,000 23.00 12,500 18.50 5,500 22.00 Exercised --- --- --- --- --- --- Forfeited --- --- --- --- --- --- Expired --- --- --- --- --- --- --- --- --- --- --- Outstanding, end of year 34,000 $ 21.18 18,000 $ 19.57 5,500 $ 22.00 ====== ======= ====== ======= ===== ======= Options exercisable at year-end 5,875 $ 20.14 1,375 $ 22.00 --- $ --- Weighted-average fair value of options granted during the year $ 4.89 $ 3.90 $ 2.38 - -------------------------------- ----------- --------------- ----------- ------------- ----------- -------------
Information pertaining to options outstanding at December 31, 2001 is as follows:
Options Outstanding Options Exercisable - -------------------------------------- ------------------------------------ ------------------------------------ Remaining Range of Number Weighted Average Number Weighted Average Contractual Life Exercise Price Outstanding Exercise Price Exercisable Exercise Price - -------------------- ----------------- ------------------ ----------------- ----------------- ------------------ 9.83 years $ 23.00 16,000 $ 23.00 --- $ --- 8.83 years 18.50 12,500 18.50 3,125 18.50 7.83 years 22.00 5,500 22.00 2,750 22.00 - -------------------- ----------------- ------------------ ----------------- ----------------- ------------------
26 Note 10: Income Taxes Allocation of income tax expense between current and deferred portions is as follows: Years ended December 31, ----------------------------------- ($ In thousands) 2001 2000 1999 - ------------------------------------- ----------- ----------- ----------- Current $ 2,451 3,016 2,770 Deferred (166) (253) (214) ----------- ----------- ----------- Total income tax expense $ 2,285 2,763 2,556 =========== =========== =========== - ------------------------------------- ----------- ----------- ----------- 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) 2001 2000 1999 - ------------------------------------------- ------------ --------- ---------- Computed "expected" income tax expense $ 3,264 3,424 3,279 Tax-exempt interest income (1,239) (862) (866) Nondeductible interest expense 220 168 109 Other, net 40 33 34 ------------ --------- ---------- Reported income tax expense $ 2,285 2,763 2,556 ============ ========= ========== - ------------------------------------------- ------------ --------- ---------- The components of the net deferred tax asset, included in other assets, are as follows:
December 31, ----------------------------- ($ In thousands) 2001 2000 - --------------------------------------------------------------------- -------------- -------------- Deferred tax assets: Allowance for loan losses and unearned fee income $ 1,155 995 Valuation allowance on other real estate owned 21 21 Deferred compensation and other liabilities 119 143 Deposit intangibles and goodwill 78 68 Community development corporation related tax credit 11 15 Other 9 36 Net unrealized losses on securities available for sale --- 296 -------------- -------------- 1,393 1,574 -------------- -------------- Deferred tax liabilities: Net unrealized gains on securities available for sale (292) --- Accumulated depreciation (71) (93) Accumulated discount accretion (72) (74) Accrued late fee income (24) (48) Other (64) (67) -------------- -------------- (523) (282) -------------- -------------- Net deferred tax asset $ 870 1,292 ============== ============== - --------------------------------------------------------------------- -------------- --------------
27 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, 2001, 2000 and 1999, dividends received from subsidiary banks were $3,761, $2,987 and $10,538, respectively. Additional funds paid to the parents as dividends 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, 2001, retained net income, which was free of such restriction, at NBB, amounted to approximately $1,059. BTC is permitted to pay dividends to the extent such do not exceed current year net income. Note 12: Minimum Regulatory Capital Requirements The Company (on a consolidated basis) and the Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks 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. The capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2001 and 2000, that the Company and the Banks meet all capital adequacy requirements to which they are subject. As of December 31, 2001, the most recent notifications from the appropriate regulatory authorities categorized the Company and the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since these notifications that management believes have changed the Company's and the Banks' category. 28 The Company's and the Banks' actual capital amounts and ratios as of December 31, 2001 and 2000 are also presented in the following tables.
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------------- --------------------- ---------------------- ($ In thousands) Amount Ratio Amount Ratio Amount Ratio - -------------------------------------------- ----------- ---------- ---------- ---------- ----------- ---------- December 31, 2001 Total capital (to risk weighted assets) Bankshares consolidated $ 57,231 12.9% 35,511 8.0% N/A N/A NBB 31,383 12.5% 20,150 8.0% 25,188 10.0% BTC 22,567 11.9% 15,105 8.0% 18,881 10.0% Tier I capital (to risk weighted assets) Bankshares consolidated $ 52,959 11.9% 17,756 4.0% N/A N/A NBB 28,781 11.4% 10,075 4.0% 15,113 6.0% BTC 20,897 11.1% 7,553 4.0% 11,329 6.0% Tier I capital (to average assets) Bankshares consolidated $ 52,959 8.4% 25,160 4.0% N/A N/A NBB 28,781 8.3% 13,927 4.0% 17,409 5.0% BTC 20,897 7.5% 11,079 4.0% 13,849 5.0% - -------------------------------------------- ----------- ---------- ---------- ---------- ----------- ----------
To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions ---------------------- --------------------- ---------------------- ($ In thousands) Amount Ratio Amount Ratio Amount Ratio - -------------------------------------------- ----------- ---------- ---------- ---------- ----------- ---------- December 31, 2000 Total capital (to risk weighted assets) Bankshares consolidated $ 55,256 14.2% 31,073 8.0% N/A N/A NBB 28,234 11.6% 19,531 8.0% 24,414 10.0% BTC 24,601 17.3% 11,383 8.0% 14,228 10.0% Tier I capital (to risk weighted assets) Bankshares consolidated $ 51,371 13.2% 15,536 4.0% N/A N/A NBB 25,834 10.6% 9,765 4.0% 14,648 6.0% BTC 23,116 16.3% 5,691 4.0% 8,537 6.0% Tier I capital (to average assets) Bankshares consolidated $ 51,371 9.5% 21,721 4.0% N/A N/A NBB 25,834 8.2% 12,648 4.0% 15,810 5.0% BTC 23,116 10.2% 9,072 4.0% 11,340 5.0% - -------------------------------------------- ----------- ---------- ---------- ---------- ----------- ----------
29 Note 13: 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) 2001 2000 - ----------------------------------------------------------- -------------- -------------- Assets Cash due from subsidiaries $ 76 38 Securities available for sale 2,879 2,365 Investment in subsidiaries, at equity 62,428 57,405 Refundable income taxes due from subsidiaries 29 11 Other assets 45 46 -------------- -------------- Total assets $ 65,457 59,865 ============== ============== Liabilities and Stockholders' Equity Other liabilities $ 196 31 Stockholders' equity 65,261 59,834 -------------- -------------- Total liabilities and stockholders' equity $ 65,457 59,865 ============== ============== - ----------------------------------------------------------- -------------- --------------
Condensed Statements of Income and Comprehensive Income Years Ended December 31, -------------------------------------- ($ In thousands) 2001 2000 1999 - -------------------------------------------------------------------- ------------- ----------- ------------ Income Dividends from subsidiaries $ 3,761 2,987 10,538 Interest on securities - taxable 12 11 17 Interest on securities - nontaxable 91 99 118 Other income --- 40 --- Realized securities losses (13) (3) --- ------------- ----------- ------------ 3,851 3,134 10,673 Expenses Other expenses 207 157 194 ------------- ----------- ------------ Income before income tax benefit and equity in undistributed net income (distributions in excess of equity in net income) of subsidiaries 3,644 2,977 10,479 Applicable income tax benefit 69 36 59 ------------- ----------- ------------ Income before equity in undistributed net income (distributions in excess of equity in net income) of subsidiaries 3,713 3,013 10,538 Equity in undistributed net income (distributions in excess of equity in net income) of subsidiaries 3,601 4,296 (3,450) ------------- ----------- ------------ Net income $ 7,314 7,309 7,088 ============= =========== ============ - -------------------------------------------------------------------- ------------- ----------- ------------
30
Condensed Statements of Cash Flows Years ended December 31, -------------------------------------------- ($ In thousands) 2001 2000 1999 - ------------------------------------------------------------------- --------------- ------------- -------------- Cash Flows from Operating Activities Net income $ 7,314 7,309 7,088 Adjustments to reconcile net income to net cash provided by operating activities: (Equity in undistributed net income) distributions in excess of equity in net income of subsidiaries (3,601) (4,296) 3,450 Amortization of premiums and accretion of discounts, net 5 6 7 Realized securities losses 13 3 --- Net change in refundable income taxes due from subsidiaries (18) 48 (29) Net change in other assets 3 (34) (10) Net change in other liabilities 102 10 (45) --------------- ------------- -------------- Net cash provided by operating activities 3,818 3,046 10,461 --------------- ------------- -------------- Cash Flows from Investing Activities Purchases of securities available for sale (777) (529) (207) Maturities of securities available for sale --- 30 299 Calls of securities available for sale 25 562 --- --------------- ------------- -------------- Net cash provided by (used in) investing activities (752) 63 92 --------------- ------------- -------------- Cash Flows from Financing Activities Cash dividends paid (3,020) (2,987) (2,814) Common stock repurchase (8) (89) (7,762) --------------- ------------- -------------- Net cash used in financing activities (3,028) (3,076) (10,576) --------------- ------------- -------------- Net change in cash 38 33 (23) Cash due from subsidiaries at beginning of year 38 5 28 --------------- ------------- -------------- Cash due from subsidiaries at end of year $ 76 38 5 =============== ============= ============== - ------------------------------------------------------------------- --------------- ------------- --------------
31 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. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. 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: At December 31, 2001 and 2000, the following financial instruments were outstanding whose contract amounts represent credit risk:
December 31, ------------------------------- ($ In thousands) 2001 2000 - ------------------------------------------------------------ --------------- --------------- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $ 78,749 60,614 Standby letters of credit $ 6,045 4,269 Mortgage loans sold with potential recourse $ 27,102 20,358 - ------------------------------------------------------------ --------------- ---------------
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. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management's credit evaluation of the customer. Unfunded commitments under commercial lines of credit, revolving credit lines, and overdraft protection agreements are commitments for possible future extensions of credit. Some of these commitments are uncollateralized and do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed. 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 2001, the Company originated $28,247 and sold $27,102 to investors, compared to $20,129 originated and $20,358 sold in 2000. 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. The Company maintains cash accounts in other commercial banks. The amount on deposit with correspondent institutions at December 31, 2001 that exceeded the insurance limits of the Federal Deposit Insurance Corporation was $562. 32 Note 15: Concentrations of Credit Risk The Company does a general banking business, serving the commercial and personal banking needs of its customers. NBB's market area, commonly referred to as Virginia's New River Valley and Mountain Empire, consists of Montgomery, Giles and Pulaski Counties and the cities of Radford and Galax, together with portions of adjacent counties. BTC's market area adjoins NBB's and includes the counties of Tazewell, Wythe, Smyth and Washington in Virginia, as well as contiguous portions of McDowell and Mercer Counties in West Virginia. Substantially all of NBB's and BTC's loans are made within their market area. The ultimate collectibility of the banks' loan portfolios and the ability to realize the value of any underlying collateral, if needed, are influenced by the economic conditions of the market area. The Company's operating results are therefore closely correlated with the economic trends within this area. At December 31, 2001 and 2000, approximately $176,667 and $151,000, respectively, of the loan portfolio was concentrated in commercial real estate. This represents approximately 44% and 42% of the loan portfolio at December 31, 2001 and 2000, respectively. Included in commercial real estate at December 31, 2001 and 2000 was approximately $100,640 and $84,000, respectively, in loans for college housing and professional office buildings. Loans secured by residential real estate were approximately $119,437 and $110,000 at December 31, 2001 and 2000, respectively. This represents approximately 30% and 31% of the loan portfolio at December 31, 2001 and 2000 respectively. Loans secured by automobiles were approximately $32,373 and $36,000 at December 31, 2001 and 2000, respectively. This represents approximately 8% of the loan portfolio at December 31, 2001 and 10% at December 31, 2000. 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. Management considers the concentration of credit risk to be minimal. Note 16: Fair Value of Financial Instruments and Interest Rate Risk The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. Loan commitments on which the committed interest rate is less than the current market rate are insignificant at December 31, 2001 and 2000. The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits. 33 The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments: Cash and Due from Banks, Interest-Bearing Deposits, and Federal Funds Sold The carrying amounts approximate fair value. 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. Loans Held for Sale Fair values of loans held for sale are based on commitments on hand from investors or prevailing market prices. 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 loan classification, modified, as required, by an estimate of the effect of economic conditions on lending. 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. Deposits The fair value of demand and savings deposits is the amount payable on demand. The fair value of fixed maturity term deposits and certificates of deposit is estimated using the rates currently offered for deposits with similar remaining maturities. Accrued Interest The carrying amounts of accrued interest approximate fair value. 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. 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, 2001 and 2000, and as such, the related fair values have not been estimated. 34 The estimated fair values, and related carrying amounts, of the Company's financial instruments are as follows:
December 31, 2001 2000 ------------------------------ ---------------------------- ($ In thousands) Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value - --------------------------------- -------------- --------------- ------------- -------------- Financial assets: Cash and due from banks $ 12,293 12,293 11,130 11,130 Interest-bearing deposits 15,510 15,510 13,579 13,579 Federal funds sold 1,080 1,080 29,090 29,090 Securities 191,476 191,901 156,344 156,387 Mortgage loans held for sale 1,145 1,145 --- --- Loans, net 394,042 457,965 355,795 348,753 Accrued interest receivable 4,917 4,917 5,049 5,049 Financial liabilities: Deposits $ 576,618 577,612 530,648 531,829 Other borrowed funds 203 203 270 270 Accrued interest payable 1,101 1,101 1,538 1,538 - --------------------------------- -------------- --------------- ------------- --------------
Note 17: Branch Acquisitions On August 17, 2000, the Company entered into an agreement to purchase six branches from AmSouth Bank of Birmingham, Alabama. The acquisitions involved approximately $94,000 in deposits and $42,000 in loans. Three of the branches, Radford, Dublin and Pulaski, Virginia were acquired by the Company's NBB affiliate, with the remaining offices located in Wytheville, Abingdon and Marion, Virginia acquired by the Company's BTC affiliate. The acquisition was completed in November of 2000. In another move to improve the Company's competitive position, BTC announced on September 15, 2000 that it would acquire a branch in Bluefield, Virginia from First Union National Bank. The acquisition involved the purchase of approximately $34,000 in deposits and $9,200 in loans. The acquisition was completed in the first quarter of 2001. 35 Selected Quarterly Data (unaudited) The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2001 and 2000:
($ In thousands, except 2001 share data) ------------------------------------------------------------ First Third Fourth Quarter Second Quarter Quarter Quarter - ---------------------------------- --------------- --------------- -------------- ------------- Income Statement Data: - --------------------- Interest income $ 11,381 11,682 11,446 11,018 Interest expense 5,998 6,185 5,695 4,893 --------------- --------------- -------------- ------------- Net interest income 5,383 5,497 5,751 6,125 Provision for loan losses 332 332 377 367 Noninterest income 1,195 1,296 1,312 1,401 Noninterest expense 4,061 4,285 4,176 4,431 Income taxes 569 495 600 621 --------------- --------------- -------------- ------------- Net income $ 1,616 1,681 1,910 2,107 =============== =============== ============== ============= Per Share Data: - -------------- Basic net income per share $ 0.46 0.48 0.54 0.60 Cash dividends per share --- 0.43 --- 0.43 Book value per share 17.91 17.94 18.70 18.59 Selected Ratios: - --------------- Return on average assets 1.06% 1.04% 1.18% 1.30% Return on average equity 10.54% 10.83% 11.84% 12.69% Average equity to average assets 10.09% 9.63% 9.94% 9.97% - ---------------------------------- --------------- --------------- -------------- -------------
($ In thousands, except 2000 share data) ------------------------------------------------------------ First Third Fourth Quarter Second Quarter Quarter Quarter - ---------------------------------- --------------- --------------- -------------- ------------- Income Statement Data: - --------------------- Interest income $ 8,844 9,286 9,586 10,642 Interest expense 3,886 4,274 4,550 5,453 --------------- --------------- -------------- ------------- Net interest income 4,958 5,012 5,036 5,189 Provision for loan losses 353 313 331 332 Noninterest income 925 962 976 1,219 Noninterest expense 2,991 3,094 3,291 3,500 Income taxes 687 698 639 739 --------------- --------------- -------------- ------------- Net income $ 1,852 1,869 1,751 1,837 =============== =============== ============== ============= Per Share Data: - -------------- Basic net income per share $ 0.53 0.53 0.50 0.52 Cash dividends per share --- 0.42 --- 0.43 Book value per share $ 15.54 15.64 16.39 17.04 Selected Ratios: - --------------- Return on average assets 1.58% 1.54% 1.42% 1.33% Return on average equity 13.98% 13.94% 12.42% 12.52% Average equity to average assets 11.30% 11.05% 11.46% 10.62% - ---------------------------------- --------------- --------------- -------------- -------------
36 On January 3, 2002, the Directors and employees of National Bankshares were deeply saddened by the death of DR. CHARLES L. BOATWRIGHT Dr. Boatwright served as a Director of The National Bank of Blacksburg for more than thirty-seven years and as its Vice-Chairman from 1992 to 1999. He also served as a Director for National Bankshares, Inc. from the corporation's founding in 1986 and was the Vice-Chairman of the Board from 1992 to 2002. Because he was widely respected and greatly admired, he was a positive and effective representative of NBB in the community. Dr. Boatwright brought strong and quiet leadership, wise counsel, strength of conviction, and good humor to his Board service. He will be greatly missed. 37 Boards of Directors Picture "National Bankshares Board of Directors" National Bankshares, Inc. Board of Directors Foreground, from left: William T. Peery, Retired; Cameron L. Forrester, President and Chief Executive Officer, Bank of Tazewell County; Alonzo A. Crouse, Executive Vice President, Secretary, Bank of Tazewell County; Jeffrey R. Stewart, Educational Consultant; James G. Rakes, Chairman of the Board, President, Chief Executive Officer, National Bankshares, Inc., President and Chief Executive Officer, The National Bank; President and Treasurer, National Bankshares Financial Services, Inc.; L. Allen Bowman, Retired; Paul A. Duncan; President, Holiday Motor Corp.; James A. Deskins, Sr., Retired; James M. Shuler, Delegate, Virginia House of Delegates (not pictured). Picture "The National Bank Board of Directors" The National Bank Board of Directors From left: Ellen G. Burnop, Co-Owner, New River Office Supply; J. Louis Webb, Jr., Dentist; Paul P. Wisman, Vice President of Investments, Grundy National Bank, Manager of Assets, Nicewonder Investments; Paul A. Duncan, President, Holiday Motor Corp; James G. Rakes, Chairman, President and Chief Executive Officer, National Bankshares, Inc., President and Chief Executive Officer, The National Bank, President and Treasurer, National Bankshares Financial Services; L. Allen Bowman, Vice-Chairman of the Board, Retired; Jeffrey R. Stewart, Chairman of the Board, Educational Consultant; James M. Shuler, Delegate, Virginia House of Delegates. 38 Picture "Bank of Tazewell County Board of Directors" Bank of Tazewell County Board of Directors Seated, from left: James G. Rakes, Chairman, President and Chief Executive Officer, National Bankshares, Inc., President and Chief Executive Officer, The National Bank, President and Treasurer, National Bankshares Financial Services, Inc.; Cameron L. Forrester, President and Chief Executive Officer, Bank of Tazewell County; William T. Peery, Retired; E.P. Greever, Retired; J.M. Pope, Retired; Alonzo A. Crouse, Executive Vice President, Secretary, Bank of Tazewell County. Standing, from left: William H. VanDyke, Vice President, Candlewax Smokeless Fuel Co; James A. Deskins, Sr., Retired; James S. Gillespie, Jr., President, Jim Sam Gillespie Farm; Charles E. Green, III, Financial Planner, AXA Advisors, LLC; Jack Harry, President, Harry's Enterprises, Inc. The National Bank Advisory Boards: Montgomery County Advisory Board Dan A. Dodson, W. Clinton Graves, Gary A. Huff, Mary Guy Miller, James J. Owen, Robert L. Pack, Arlene A. Saari, James C. Stewart, T. Cooper Via Giles County Advisory Board Paul B. Collins, John H. Givens, Jr., Robert C. McCracken, Ross E. Martin, Kenneth L. Rakes, Scarlet B. Ratcliffe, Morris D. Reece, H. M. Scanland, Jr. Galax Advisory Board Willie T. Green, Sr., Jerry R. Mink, Kathy J. Price, James A. Williams, Jr. Radford/Pulaski County Advisory Board Gary C. Elander, Jack M. Lewis, Jack D. Nunley Bank of Tazewell County Advisory Boards: Bluefield Advisory Board Michael E. Dye, William H. King, Daniel G. MacMillan, Constance M. Saunders Richlands Advisory Board Steven R. Davis, Marvin D. Harman, Peter M. Mulkey 39 Corporate Information National Bankshares, Inc. Executive Officers James G. Rakes, Chairman F. Brad Denardo President and Chief Executive Officer Corporate Officer J. Robert Buchanan Cameron L. Forrester Treasurer Corporate Officer Marilyn B. Buhyoff Secretary and Counsel Annual Meeting The Annual Meeting of Stockholders will be held on Tuesday, April 9, 2002 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 jrakes@nbbank.com bbuchanan@nbbank.com 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 mbuhyoff@nbbank.com 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, Virginia 24060 P.O. Box 90002 Blacksburg, Virginia 24062-9002 www.nationalbankshares.com (540) 951-6300 40 -----END PRIVACY-ENHANCED MESSAGE-----