-----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, NgYMRuNwMsXlhV4Pp4M4AekbfLyXK+3Kn5kEC62dcWdlJPiH+zeV1I5XY/bOuTb0 ZnGmXBRsyHYMdV4WQecFDg== 0000796534-04-000021.txt : 20040809 0000796534-04-000021.hdr.sgml : 20040809 20040809124726 ACCESSION NUMBER: 0000796534-04-000021 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040809 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-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-15204 FILM NUMBER: 04960290 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-Q 1 form10q_q204.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 ------------------ FORM 10-Q ------------------ Quarterly Report Pursuant to Section 13 or 15(d) Of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2004 Commission file number 0-15204 National Bankshares, Inc. (Exact name of registrant as specified in its charter) State or other jurisdiction of incorporation or organization - Virginia Internal Revenue Service - Employer Identification No. 54-1375874 101 Hubbard Street, P.O. Box 90002, Blacksburg, VA 24062-9002 (540) 951-6300 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days. Yes _X_ No ___ Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b - 2 of the Exchange Act) Yes _X_ No ___ Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at August 9, 2004 - ----------------------------- ----------------------------- Common Stock, $2.50 Par Value 3,521,502 (This report contains 34 pages) ================================================================================ 2 NATIONAL BANKSHARES, INC. AND SUBSIDIARIES Form 10-Q Index Part I Financial Information Page - ---------------------------- Item 1 Financial Statements Consolidated Balance Sheets, June 30, 2004 (Unaudited) and December 31, 2003..............................................3 Consolidated Statements of Income for the Three Months Ended June 30, 2004 and 2003 (Unaudited)..........................5 Consolidated Statements of Income for the Six Months Ended June 30, 2004 and 2003 (Unaudited)................................7 Consolidated Statements of Changes in Stockholders' Equity, Six Months Ended June 30, 2004 and 2003 (Unaudited)..................................9 Consolidated Statements of Cash Flows, Six Months Ended June 30, 2004 and 2003 (Unaudited)...............10 Notes to Consolidated Financial Statements.........................12 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations.....................17 Item 3 Quantitative and Qualitative Disclosures about Market Risk........................................................8 Item 4 Controls and Procedures.............................................8 Part II Other Information - ------------------------- Item 1 Legal Proceedings.................................................28 Item 2 Changes in Securities and Use of Proceeds and Issuer Purchases of Equity Securities...................................28 Item 3 Defaults Upon Senior Securities...................................28 Item 4 Submission of Matters to a Vote of Security Holders..................................................29 Item 5 Other Information..................................................30 Item 6 Exhibits and Reports on Form 8-K...................................30 Signatures.................................................................30 Index of Exhibits..........................................................30 2 Part I Financial Information Item 1. Financial Statements National Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets June 30, 2004 and December 31, 2003
(Unaudited) June 30, December 31, ($ In thousands, except share and per share data) 2004 2003 ================ ================= Assets: Cash and due from banks $16,973 $11,733 Federal Funds sold 4,765 --- Interest-bearing deposits 9,720 36,220 Securities available for sale 147,592 129,300 Securities held to maturity (fair value $111,155 in 2004 and $105,026 in 2003) 110,422 100,854 Mortgage loans held for sale 298 714 Loans: Real estate construction loans 21,836 28,055 Real estate mortgage loans 126,581 87,899 Commercial and industrial loans 229,891 208,997 Loans to individuals 87,268 82,742 ---------------- ----------------- Total loans 465,576 407,693 Less unearned income and deferred fees (837) (896) ---------------- ----------------- Loans, net of unearned income and deferred fees 464,739 406,797 Less allowance for loan losses (5,886) (5,369) ---------------- ----------------- Loans, net 458,853 401,428 ---------------- ----------------- Bank premises and equipment, net 11,682 10,094 Accrued interest receivable 5,087 4,610 Other real estate owned, net 1,489 1,663 Intangible assets and goodwill, net 17,759 9,958 Other assets 3,789 1,986 ---------------- ----------------- Total assets $788,429 $708,560 ================ ================= Liabilities and Stockholders' Equity: - ------------------------------------- Noninterest-bearing demand deposits $94,036 $83,671 Interest-bearing demand deposits 205,168 172,370 Savings deposits 64,209 53,084 Time deposits 340,914 316,253 ---------------- ----------------- Total deposits 704,327 625,378 ---------------- ----------------- Other borrowed funds 374 135 Accrued interest payable 484 489 Other liabilities 1,814 1,917 ---------------- ----------------- Total liabilities 706,999 627,919 ---------------- ----------------- 3 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 10,000,000 shares; issued and outstanding 3,521,502 shares in 2004 and 3,515,377 in 2003 8,804 8,788 Retained earnings 73,850 70,063 Accumulated other comprehensive income (loss), net (1,224) 1,790 ---------------- ----------------- Total stockholders' equity 81,430 80,641 ---------------- ----------------- Total liabilities and stockholders' equity $788,429 $708,560 ================ =================
See accompanying notes to the consolidated financial statements. 4 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income Three Months Ended June 30, 2004 and 2003 (Unaudited)
June 30, June 30, ($ In thousands, except share and per share data) 2004 2003 ================================================= ================== ================= Interest income =============== Interest and fees on loans $7,086 $7,617 Interest on interest-bearing deposits 50 73 Interest on federal funds sold 1 7 Interest on securities - taxable 1,549 1,356 Interest on securities - nontaxable 1,331 1,343 ------------------ ----------------- Total interest income 10,017 10,396 ------------------ ----------------- Interest expense ================ Interest on time deposits $100,000 or more 765 782 Interest on other deposits 1,893 2,474 Interest on borrowed funds 1 --- ------------------ ----------------- Total interest expense 2,659 3,256 ------------------ ----------------- Net interest income 7,358 7,140 Provision for loan losses 304 402 ------------------ ----------------- Net interest income after provision for loan losses 7,054 6,738 ------------------ ----------------- Noninterest income ================== Service charges on deposit accounts 735 647 Other service charges and fees 58 66 Credit card fees 496 448 Trust income 322 245 Other income 77 93 Realized securities gains (losses), net (7) 5 ------------------ ----------------- Total noninterest income 1,681 1,504 ------------------ ----------------- Noninterest expense =================== Salaries and employee benefits 2,574 2,360 Occupancy and furniture and fixtures 426 398 Data processing and ATM 285 289 Credit card processing 388 338 Intangibles amortization 228 239 Net costs of other real estate owned 53 13 Other operating expenses 961 932 ------------------ ----------------- Total noninterest expense 4,915 4,569 ------------------ ----------------- Income before income tax expense 3,820 3,673 Income tax expense 884 872 ------------------ ----------------- Net income $2,936 $2,801 ================== ================= 5 Net income per share - basic $0.84 $0.80 ================== ================= - diluted 0.83 0.79 ================== ================= Weighted average number of common shares outstanding - basic 3,518,882 3,512,514 ================== ================= - diluted 3,535,274 3,532,960 ================== ================= Dividends declared per share $0.63 $0.54 ================== =================
See accompanying notes to consolidated financial statements. 6 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income Six Months Ended June 30, 2004 and 2003
(Unaudited) June 30, June 30, ($ In thousands, except share and per share data) 2004 2003 ================================================= ================== ================= Interest income - --------------- Interest and fees on loans $14,031 $15,271 Interest on interest-bearing deposits 114 137 Interest on federal funds sold 1 11 Interest on securities - taxable 2,994 2,800 Interest on securities - nontaxable 2,674 2,653 ------------------ ----------------- Total interest income 19,814 20,872 ------------------ ----------------- Interest expense ================ Interest on time deposits $100,000 or more 1,458 1,615 Interest on other deposits 3,799 5,118 Interest on borrowed funds 1 1 ------------------ ----------------- Total interest expense 5,258 6,734 ------------------ ----------------- Net interest income 14,556 14,138 Provision for loan losses 592 842 ------------------ ----------------- Net interest income after provision for loan losses 13,964 13,296 ------------------ ----------------- Noninterest income ================== Service charges on deposit accounts 1,410 1,173 Other service charges and fees 130 141 Credit card fees 882 794 Trust income 831 504 Other income 180 265 Realized securities (losses), net (13) (4) ------------------ ----------------- Total noninterest income 3,420 2,873 ------------------ ----------------- Noninterest expense =================== Salaries and employee benefits 5,092 4,765 Occupancy and furniture and fixtures 864 832 Data processing and ATM 564 541 Credit card processing 702 625 Intangibles amortization 466 477 Net costs of other real estate owned 112 19 Other operating expenses 1,935 1,877 ------------------ ----------------- Total noninterest expense 9,735 9,136 ------------------ ----------------- Income before income tax expense 7,649 7,033 Income tax expense 1,753 1,600 ------------------ ----------------- Net income $5,896 $5,433 ================== ================= 7 Net income per share - basic $1.68 $1.55 ================== ================= - diluted 1.67 1.54 ================== ================= Weighted average number of common shares outstanding - basic 3,517,130 3,511,949 ================== ================= - diluted 3,538,929 3,530,416 ================== ================= Dividends declared per share $0.63 $0.54 ================== =================
See accompanying notes to consolidated financial statements. 8 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity Six Months Ended June 30, 2004 and 2003 (Unaudited)
Accumulated Other ($ In thousands, except per Common Retained Comprehensive Comprehensive share data) Stock Earnings Income Income Total ============ ============== ================ ================ =========== Balances, December 31, 2002 $8,778 $62,525 $1,798 --- $73,101 Net income --- 5,433 --- 5,433 5,433 Dividend ($0.54 per share) --- (1,897) --- --- (1,897) Exercise of stock options 4 25 --- --- 29 Other comprehensive income, net of tax: Unrealized losses (gains)on securities available for sale, net of income tax $970 --- --- --- 1,802 --- Reclass adjustment net of tax $1 --- --- --- 3 --- ------------ -------------- ---------------- ---------------- ----------- Other comprehensive income --- --- 1,805 1,805 1,805 ------------ -------------- ---------------- ---------------- ----------- Comprehensive income --- --- --- 7,238 --- ============ ============== ================ ================ =========== Balances, June 30, 2003 $8,782 $66,086 $3,603 $--- $78,471 ============ ============== ================ ================ =========== Balances, December 31, 2003 $8,788 $70,063 $1,790 $--- $80,641 Net income --- 5,896 --- 5,896 5,896 Dividends ($0.63 per share) --- (2,216) --- --- (2,216) Exercise of stock options 16 107 --- --- 123 Other comprehensive income, net of tax Unrealized losses on securities available for sale, net of income tax $1,623 --- --- --- (3,022) Reclass adjustment net of income tax $5 --- --- --- 8 --- ------------ -------------- ---------------- ---------------- ----------- Other comprehensive income --- --- (3,014) (3,014) (3,014) ------------ -------------- ---------------- ---------------- ----------- Comprehensive income --- --- --- $2,882 --- ============ ============== ================ ================ =========== Balances, June 30,2004 $8,804 $73,850 $(1,224) $--- $81,430 ============ ============== ================ ================ ===========
See accompanying notes to consolidated financial statements. 9 National Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows Six Months Ended June 30, 2004 and 2003 (Unaudited)
June 30, June 30, ($In thousands) 2004 2003 ================== ================= Cash flows from operating activities - ------------------------------------- Net income $5,896 $5,433 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 592 842 Depreciation of bank premises and equipment 464 442 Amortization of intangibles 466 477 Amortization of premiums and accretion of discount, net 68 377 Losses on sales of bank premises and equipment --- 40 Losses on sales and calls of securities available for sale, net 26 6 (Gains) on calls of securities held to maturity (19) (2) Losses and writedowns on other real estate owned 95 9 (Increase) decrease in: Mortgage loans held for sale 416 661 Accrued interest receivable (477) (770) Other assets 3,443 347 Increase (decrease) in: Accrued interest payable (5) (126) Other liabilities (103) (1,117) ------------------ ----------------- Net cash provided by operating activities 10,862 6,619 ------------------ ----------------- Cash flows from investing activities - ------------------------------------- Net (increase) in federal funds sold (4,765) (1,718) Net decrease in interest-bearing deposits 26,500 1,036 Proceeds from calls, principal payments, sales and maturities of securities available for sale 15,792 12,284 Proceeds from calls, principal payments and maturities of securities held to maturity 4,252 8,222 Purchases of securities available for sale (28,718) (16,127) Purchases of securities held to maturity (13,841) (13,251) Purchases of loan participations (376) (1,975) Collections of loan participations 168 215 Net (increase) in loans to customers (17,813) (7,789) Acquisition of CNB 12,819 Proceeds from disposal of other real estate owned 347 67 Recoveries on loans charged off 107 161 Purchase of bank premises and equipment (2,056) (894) Proceeds from disposal of bank premises and equipment 4 400 ------------------ ----------------- Net cash (used in) investing activities (33,218) (19,369) ------------------ ----------------- 10 Cash flows from financing activities - ------------------------------------- Net increase (decrease) in other deposits $14,049 $(2,173) Net increase (decrease) in time deposits (15,048) 19,749 Net increase(decrease)in other borrowed funds 239 (227) Stock options exercised 123 29 Cash dividends (2,216) (1,897) ------------------ ----------------- Net cash provided by financing activities 17,116 15,481 ------------------ ----------------- Net increase in cash and due from banks 5,240 2,731 Cash and due from banks at beginning of period 11,733 12,316 ------------------ ----------------- Cash and due from banks at end of period $16,973 $15,047 ================== ================= Supplemental disclosure of cash flow information - ------------------------------------------------- Cash paid for interest $5,263 $6,860 ================== ================= Cash paid for income taxes $1,575 $1,603 ================== ================= Loans charged to the allowance for loan losses $680 $602 ================== ================= Loans transferred to other real estate owned $268 $282 ================== ================= Unrealized gains (losses)on securities available for sale $(4,632) $2,776 ================== ================= Transactions related to the acquisition of CNB - ----------------------------------------------- Increase in assets and liabilities: Investments $10,052 $ --- Loans 40,371 --- Deposits 59,979 ---
See accompanying notes to consolidated financial statements. 11 National Bankshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements June 30, 2004 (Unaudited) Note (1) The consolidated financial statements 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, Inc. (NBFS), (the Company), conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The accompanying interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments consisting of normal recurring adjustments which are necessary for a fair presentation of the consolidated financial statements have been included. The results of operations for the six months ended June 30, 2004 are not necessarily indicative of results of operations for the full year or any other interim period. The interim period consolidated financial statements and financial information included herein should be read in conjunction with the notes to consolidated financial statements included in the Company's 2003 Form 10-K. Note (2) Stock-Based Compensation At June 30, 2004, the Company had a stock-based employee compensation plan, which is described more fully in the Company's Form 10-K dated December 31, 2003. The Company accounts for this plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
Six months ended June 30, Three months ended June 30, -------------- ------------ -------------- ------------ ($ In thousands, except per share data) 2004 2003 2004 2003 - ---------------------------------------------------- -------------- ------------ -------------- ------------ Net income, as reported $5,896 $5,433 $2,936 $2,801 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards (51) (20) (26) (13) -------------- ------------ -------------- ------------ Pro forma net income $5,845 $5,413 $2,910 $2,788 - ---------------------------------------------------- -------------- ------------ -------------- ------------ Earnings per share: Basic-as reported $1.68 $1.55 $0.84 $0.80 - ---------------------------------------------------- -------------- ------------ -------------- ------------ Basic-pro forma $1.66 $1.54 $0.83 $0.79 - ---------------------------------------------------- -------------- ------------ -------------- ------------ Diluted-as reported $1.67 $1.54 $0.83 $0.79 - ---------------------------------------------------- -------------- ------------ -------------- ------------ Diluted-pro forma $1.65 $1.53 $0.82 $0.79 - ---------------------------------------------------- -------------- ------------ -------------- ------------
Stock options for 6,125 shares of NBI common stock were exercised in the second quarter of 2004. There were no stock options granted or forfeited during the period. For teh quarterended June 30, 2004, 16,500 options were excluded from the calculation of diluted earnings per share as the effect would have been anti-dilutive. 12 Note (3) Acquisitions On December 24, 2003, the Company's BTC subsidiary entered into an agreement to acquire the loans and assume the deposit liabilities of the Richlands, Virginia branch office of FNB Southeast of Reidsville, North Carolina (FNB). BTC received approval for this transaction from its primary regulator, the Federal Reserve Bank on February 18, 2004. The transaction, which does not include the purchase of fixed assets, was closed in the second quarter of 2004. The purchase and assumption added approximately $7.2 million in loans and approximately $15.0 million in deposits. The Company has determined that the transaction does not constitute the acquisition of a business, and therefore will be accounted for under the provisions of SFAS No. 147, Acquisitions of Certain Financial Institutions. The Company's NBB subsidiary entered into an agreement with The South Financial Group of Greenville, South Carolina on February 2, 2004. The contract provided that NBB would purchase substantially all of the assets and assume all of the liabilities of The South Financial Group's wholly-owned subsidiary, Community National Bank located in Pulaski, Virginia (CNB). This transaction closed in June of 2004 at a purchase price of $12,850. It added approximately $60 million in deposits and approximately $69 million in total assets. Any goodwill and intangible assets arising from the transaction will be accounted for under the provisions of SFAS No. 142 Goodwill and other Intangible Assets. As of June 30,2004, it is estimated that the transaction will result in the addition of approximately $6.7 in goodwill and $0.8 million in core deposit intangible. The results of operations are included in the financial statements from the date of acquisition. Note (4) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended June 30, December 31, 2004 2003 2003 ============== ============== ================= ($In thousands, except for % data) Balance at beginning of period $5,369 $5,092 $5,092 Provision for loan losses 592 842 1,691 Loans charged off (680) (602) (1,660) Acquisition of CNB assets 498 --- --- Recoveries 107 161 246 Balance at the end of period $5,886 $5,493 $5,369 ============== ============== ================= Ratio of allowance for loan losses to the end of period loans net of unearned income and deferred fees 1.27% 1.31% 1.32% ============== ============== ================= Ratio of net charge-offs to average loans, net of unearned income and deferred fees(1) .28% .22% .34% ============== ============== ================= Ratio of allowance for loan losses to nonperforming loans(2) 1,070.18% 5,182.08% 1,516.67% ============== ============== =================
(1) Net charge-offs are on an annualized basis. (2) The Company defines nonperforming loans as total nonaccrual and restructured loans. Loans 90 days past due and still accruing are excluded. 13
June 30, December 31, 2004 2003 2003 ============= ============ ================ ($In thousands, except % data) Nonperforming Assets Nonaccrual loans $550 $106 $354 Restructured loans --- --- --- ------------- ------------ ---------------- Total nonperforming loans 550 106 354 Foreclosed property 1,489 743 1,663 ------------- ------------ ---------------- Total nonperforming assets $2,039 $849 $2,017 ============= ============ ================ Ratio of nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned .44% .21% .49% ============= ============ ================
June 30, December 31, 2004 2003 2003 ============= ============ =============== Accruing Loans Past Due 90 Days or More Past due 90 days or more and still accruing $1,053 $1,088 $931 ============= ============ =============== Ratio of loans past due 90 days or more and still accruing to loans, net of unearned income and deferred fees .23% .26% .23% ============= ============ =============== Impaired Loans: Total impaired loans $540 $276 $871 ============= ============ =============== Impaired loans with a valuation allowance $530 --- $506 Valuation allowance (242) --- (135) ------------- ------------ --------------- Impaired loans net of allowance $288 --- $371 ============= ============ =============== Impaired loans with no valuation allowance $10 $276 $365 ============= ============ =============== Average recorded investment in impaired loans $725 $172 $353 ============= ============ =============== Income recognized on impaired loans $--- $8 $66 ============= ============ =============== Amount of income recognized on a cash basis $--- --- --- ============= ============ ===============
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 at June 30, 2004 were $10. Interest recognized on these loans was $1. 14 Note (5) Securities The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities available for the sale by major security type as of June 30, 2004 are as follows:
Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values ----------------- ----------------- ----------------- ------------------ U.S. Treasury $4,043 $49 $163 $3,929 U.S. Government agencies and corporations 9,848 --- 41 9,807 State and political subdivisions 79,189 1,092 1,483 78,798 Mortgage-backed securities 17,330 234 78 17,486 Corporate debt securities 34,910 324 1,407 33,827 Federal Reserve Bank stock- restricted 209 --- --- 209 Federal Home Loan Bank stock-restricted 1,552 --- --- 1,552 Other securities 1,841 143 --- 1,984 ----------------- ----------------- ----------------- ------------------ Total securities available for sale $148,922 $1,842 $3,172 $147,592 ================= ================= ================= ==================
The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities held to maturity by major security type as of June 30, 2004 are as follows:
Gross Gross Amortized Unrealized Unrealized Fair Costs Gains Losses Values ----------------- ----------------- ----------------- ------------------ U.S. Government agencies and corporations $15,974 $65 $521 $15,518 State and political subdivisions 56,562 911 477 56,996 Mortgage-backed securities 3,971 123 10 4,084 Corporate securities 33,915 1,263 621 34,557 ----------------- ----------------- ----------------- ------------------ Total securities held to maturity $110,422 $2,362 $1,629 $111,155 ================= ================= ================= ==================
15 Note (6) Defined Benefit Plan Components of Net Periodic Benefit Cost Six months ended June 30 ($ in Thousands) Pension Benefits 2004 2003 ---------- --------- Service cost $ 248 $ 214 Interest cost 268 250 Expected return on plan assets (250) (210) Amortization of prior service cost 4 4 Recognized net actuarial loss 60 56 Amortization of transition cost (6) (6) ---------- ---------- Net periodic benefit cost $ 324 $ 308 ========== ========== Employer Contributions Bankshares previously disclosed in its financial statements for the year ended December 31, 2003, an estimated minimum contribution of $623 to its pension plan in 2004. That estimate has since been revised and Bankshares now expects to contribute $522 to the pension plan for 2004. As of June 30, 2004, the company has made contributions totaling $223. Bankshares anticipates making all required contributions prior to the end of 2004. National Bankshares, Inc. and Subsidiaries (In thousands, except per share data) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The purpose of this discussion is to provide information about the financial condition and results of operations of National Bankshares, Inc. and its wholly owned subsidiaries (the Company), which are not otherwise apparent from the consolidated financial statements and other information included in this report. Reference should be made to the financial statements and other information included in this report as well as the 2003 Annual Report on Form 10-K for an understanding of the following discussion and analysis. This Quarterly Report on Form 10-Q 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. Critical Accounting Policies General The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. 16 Allowance for Loan Losses The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Our allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when actual events occur. The formula allowance uses a historical loss view as an indicator of future losses and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The specific allowance uses various techniques to arrive at an estimate of loss. Historical loss information, expected cash flows and fair market value of collateral are used to estimate these losses. The use of these values is inherently subjective and our actual losses could be greater or less than the estimates. The unallocated allowance captures losses that are attributable to various economic events, industry or geographic sectors, whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance. Core deposit intangibles Effective January 1, 2002, the Corporation adopted Financial Accounting Standards Board Statement No. 142, Goodwill and Other Intangible Assets. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment by applying a fair value based test. Additionally, Statement 142 requires that acquired intangible assets (such as core deposit intangibles) be separately recognized if the benefit of the asset can be sold, transferred, licensed, rented, or exchanged and amortized over its estimated useful life. Branch acquisition transactions were outside the scope of the Statement and therefore any intangible asset arising from such transactions remained subject to amortization over their estimated useful life. In October 2002, the Financial Accounting Standards Board issued Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement amends previous interpretive guidance on the application of the purchase method of accounting to acquisitions of financial institutions, and requires the application of Statement No. 141, Business Combinations, and Statement No. 142 to branch acquisitions if such transactions meet the definition of a business combination. The provisions of the Statement do not apply to transactions between two or more mutual enterprises. In addition, the Statement amends Statement No. 144, Accounting for the Impairment of Long-Lived Assets, to include in its scope core deposit intangibles of financial institutions. Accordingly, such intangibles are subject to a recoverability test based on undiscounted cash flows and to the impairment recognition and measurement provisions required for other long-lived assets held and used. An outside evaluation of the intangible assets associated with the CNB acquisition is presently being conducted. Exact allocations are not available at this time. Based on available information, management believes that the amount disclosed above as core deposit intangible could be increased or decreased by as much as 25%. Overview National Bankshares, Inc. (NBI) is a financial holding company located in Southwest Virginia. It conducts operations primarily through two full-service banking affiliates, the National Bank of Blacksburg and Bank of Tazewell County. It also has one nonbanking affiliate, National Bankshares Financial Services, Inc., which offers investment and insurance products. Net income derived from 17 the nonbanking affiliate is not significant at this time or for the foreseeable future. Management characterizes NBI as a "community bank" operation. Performance Summary The following table shows NBI's key performance ratios for the six months ended June 30, 2004 and December 31, 2003 and 2002:
June 30, 2004 December 31, 2003 December 31, 2002 - ------------------------------------------------- -------------------- -------------------- ---------------------- Return on average assets 1.65% 1.64% 1.53% - ------------------------------------------------- -------------------- -------------------- ---------------------- Return on average equity 14.27% 14.77% 14.33% - ------------------------------------------------- -------------------- -------------------- ---------------------- Net interest margin (1) 4.70% 4.82% 4.74% - ------------------------------------------------- -------------------- -------------------- ---------------------- Noninterest margin (2) 1.76% 1.81% 1.84% - ------------------------------------------------- -------------------- -------------------- ---------------------- Basic net earnings per share $1.68 $3.26 $2.85 - ------------------------------------------------- -------------------- -------------------- ---------------------- Fully diluted net earnings per share $1.67 $3.24 $2.85 - ------------------------------------------------- -------------------- -------------------- ----------------------
(1) Net Interest Margin - Year-to-date tax-equivalent net interest income divided by year-to-date average earning assets. (2) Noninterest Margin - Noninterest income (including securities gains and losses) less noninterest expense (excluding the provision for bad debts and income taxes) divided by average year-to-date assets. Earnings for the period ending June 30,2004 were $5,896 up $463 from the same period in 2003. As illustrated in the above table, the return on average assets continues to improve. The return on average equity has declined in part because of an increase in capital due to earnings. Since the Company pays semi-annual dividends, capital builds in the first and third quarters, which reduces the return on average equity. In the second and fourth quarters the payout of capital for dividends has a positive effect. Unrealized gains and losses on securities available for sale, which can fluctuate by a substantial amount, can also affect the return on average equity. The interest margin and noninterest margin have remained relatively stable. Basic earnings per share were $1.68 for the period ending June 30, 2004 and $1.55 for the period ending June 30, 2003. Overall profitability indicators remain stable or improving. Management believes that the current trend will continue in the short term, providing that interest rates remain stable. Rising interest rates may have an adverse affect on profitability in the short to intermediate term especially if such rate increases move to substantially higher levels in a short period of time. Based on current information, rate increases are not expected to rise sharply. (See the discussion on "Net Interest Income" for more information.) Growth The following table shows NBI's key growth indicators:
June 30, 2004 December 31, 2003 December 31, 2002 - ----------------------- ---------------------- --------------------- ---------------------- Securities $258,014 $230,154 $219,294 - ----------------------- ---------------------- --------------------- ---------------------- Loans, net 458,853 401,428 404,247 - ----------------------- ---------------------- --------------------- ---------------------- Deposits 704,327 625,378 608,271 - ----------------------- ---------------------- --------------------- ---------------------- Total assets 788,429 708,560 684,935 - ----------------------- ---------------------- --------------------- ----------------------
Bank-owned securities have increased by $27,860 in the first half of 2004. Approximately $10.1 million was due to the purchase of substantially all of the assets of the Community National Bank, Pulaski, VA (CNB) in the latter part of the second quarter. Loans net of unearned income increased by $57,942 in the first half of 2004. Loans assumed in the CNB transaction totaled approximately $40.4 million and $7.2 in the purchase and assumption of certain assets and liabilities of the Richlands, Virginia office of FNB Southeast (FNB). (See the discussion on "Net Interest Income" for more details.) Deposits increased in the first half of 2004 by $78,949. Deposits acquired in the CNB transaction were approximately $60 million and $15 million in the FNB branch purchase. 18 Total assets increased $79,869 in the first half of 2004 mostly due to the CNB and FNB transactions. Asset Quality Key asset quality indicators are shown below:
June 30, 2004 December 31,2003 December 31, 2002 - --------------------------------------------- ------------------- ------------------- ------------------- Nonperforming loans $ 550 $ 354 $ 288 - --------------------------------------------- ------------------- ------------------- ------------------- Loans past due over 90 days 1,053 931 977 - --------------------------------------------- ------------------- ------------------- ------------------- Other real estate owned 1,489 1,663 537 - --------------------------------------------- ------------------- ------------------- ------------------- Allowance for loan losses to loans 1.27% 1.32% 1.24% - --------------------------------------------- ------------------- ------------------- ------------------- Net charge-off ratio .28% .34% .35% - --------------------------------------------- ------------------- ------------------- -------------------
Asset quality generally remains good, however there has been an increased level of foreclosed properties, as shown in the above table. Management has recognized the problem and has undertaken efforts to work with delinquent borrowers. When these efforts are unsuccessful, management is moving quickly to liquidate loan collateral and to institute legal collection activities. To date the net charge-off ratio has remained stable. Loans past due ninety days or more were $1,053 at June 30, 2004, slightly higher than the $931 at December 2003 and the $977 at December 31, 2002. Net Interest Income Net interest income for the period ended June 30, 2004 was $14,556, an increase of $418 or 2.96%. The net interest margin was 4.70% for the period ended June 30,2004 and 4.81% for the period ended June 30, 2003. During the past two years the Company has benefited from a relatively long period of low interest rates, which has no recent precedent. The trend continued into the first half of 2004. In June of 2004 the Federal Reserve Board raised the federal funds rates 25 basis points, signaling the start of a higher interest rate environment. Many forecasters agree that interest rates will trend upward in small increments over the next several quarters. However, the impact of world events, such as but not limited to, oil prices, problems in the Middle East and terrorist related activities, could negatively impact the national economy and alter plans for future interest rate increases. If such events were to occur the Company, together with the entire banking industry, could be affected to some extent. The general impact of a rising interest rate scenario on the Company's balance sheet follows. Federal Funds Sold and Interest-bearing Deposits - These are overnight funds used primarily for liquidity purposes. They mature daily and, accordingly, interest rates change daily, which is advantageous in a period of rising interest rates. However these funds yield low interest, making other investments more attractive from an earnings standpoint. Securities Available for Sale - This category provides a higher level of earnings than overnight funds and can under certain circumstances be a source of liquidity and also demonstrate the ability to re-price. While these securities technically can be sold to provide liquidity and for interest rate sensitivity purposes, temporary declines in fair market value due to rising interest rates may make it unprofitable to sell the securities. In addition, embedded call features may not be activated during periods of high rates, leaving the Company with a "hold" or "sell" decision. See page 26 of the Company's 2003 Form 10-K for re-pricing data. Securities Held to Maturity - This category due to its nature is not necessarily structured to be a source of liquidity or to moderate interest rate sensitivity. These securities must be held to maturity except under extenuating 19 circumstances. In a rising rate environment, the difference in the amount of interest-income earned and cost to fund the securities decreases. In other words, net interest income from these investments declines. Embedded call features may not be activated during periods of high rates. See the Company's 2003 Form 10-K for re-pricing data. Mortgage loans held for sale - This category is primarily driven by volume. In periods of low interest rates, mortgage refinancing activity and home sales tend to accelerate and generate higher revenue levels than are experienced in times of high interest rates. In the last two years, re-financing activity has been significant. Recently, however, despite the continuing low rate environment, activity has declined. This may signal the end to what many have characterized as a refinancing boom. Loans - While the low rate environment of the recent past is more conducive to loan production than periods of extremely high interest rates, interest rates that are unusually low are a sign of a weak or a recovering economy. Ideal volumes may in fact be achieved in a more robust economy in which more moderate rate levels exist. If the economy continues to recover as forecast, higher loan volumes would have a positive impact on net interest income. Of particular concern is the area of loans to individuals, which has been in a downward trend for several quarters, with the only growth coming from loans purchased in purchase and assumption transactions. Management believes the decline is due to several reasons. o General economic conditions and the lack of employment in portions of the Company's market area. o A decline in consumer requests for new car financing because of special incentives offered by automobile companies. o Consumers' use of credit cards and home equity lines with higher credit limits. o Consumers taking advantage of low mortgage rates to refinance home mortgages to obtain funds that might otherwise have been borrowed through a consumer loan. A reversal of this trend may occur to some extent as economic conditions change and higher interest rates make mortgage refinancing less appealing. However, management believes that the automotive related financing offers and competition from the credit card sector will remain. Since loans to individuals are generally higher yielding, this trend will not have a favorable effect on net interest income. Interest Expense During periods of rising interest rates interest-bearing demand deposits, and to a lesser degree savings deposits, migrate to higher rate, longer-term time deposits. Generally, as rates climb, more migration occurs. Given their re-pricing characteristics, interest-bearing demand deposits readily respond to any interest rate movement. In other words, increases or decreases in interest expense can occur quite quickly. With a definite bias towards higher interest rates in the future, it is expected that the net interest margin will decline, at least temporarily, in response to rising interest rates. As previously stated, the ultimate impact of rising interest rates is dependent upon the number of rate increases, the amount of such and the level to which they ultimately rise is a matter of uncertainty. Provision and Allowance for Loan Losses The provision for loan losses for the period ended June 30, 2004 was $592 a decrease of $250 from June 30, 2003. Nonperforming assets at June 30, 2004 were $2,039 and $2,017 at December 31, 2003. Of the nonperforming assets outstanding at June 30, 2004, $550 were nonaccrual loans and $1,489 foreclosed properties. 20 Efforts specifically designed to focus on and work intensively with delinquent borrowers have been undertaken. When these efforts have been unsuccessful, other more stringent legal collection measures and foreclosures have been initiated. Depending on the type of property and/or the circumstances surrounding a particular credit, the time to deal with each situation may vary widely. Hence, management cannot predict with any degree of certainty at what point in the future problems associated with these credits will be resolved. Based on current information, management believes that the volume of problem credits are at or near their peak. Loans ninety days past due and still accruing were $1,053 at June 30, 2004 and $931 at December 31, 2003. The ratio of the allowance for loan losses to loans net of unearned income and deferred fees was 1.27% at June 30, 2004, which compares to 1.32% at December 31, 2003. The annualized ratio of net charge-off to loans net of unearned income was .28% at June 30, 2004 and .34% at December 31, 2003. Noninterest Income
June 30, 2004 June 30, 2003 June 30, 2002 - ----------------------------------- ----------------------- ------------------------ --------------------------- Service charges on deposits $1,410 $1,173 $1,104 - ----------------------------------- ----------------------- ------------------------ --------------------------- Other service charges and fees 130 141 134 - ----------------------------------- ----------------------- ------------------------ --------------------------- Credit card fees 882 794 683 - ----------------------------------- ----------------------- ------------------------ --------------------------- Trust fees 831 504 480 - ----------------------------------- ----------------------- ------------------------ --------------------------- Other income 180 265 349 - ----------------------------------- ----------------------- ------------------------ --------------------------- Realized securities gains/losses (13) (4) 165 - ----------------------------------- ----------------------- ------------------------ ---------------------------
Noninterest income is comprised of several categories. Following is a description of each, as well as the factors that influence each. Service charges on deposit accounts consist of a variety of charges imposed on demand deposits, interest-bearing deposits and savings deposit accounts. These include, but are not limited to, the following: o Demand deposit monthly activity fees o Service charges for checks for which there are non-sufficient funds or overdraft charges o ATM transaction fees The principal factors affecting current or future income are: o Internally generated growth o Acquisitions of other banks/branches or de novo branches o Adjustments to service charge structures In 2003, the Company made certain changes to its service charge structure. These changes were not in effect in the first quarter of 2003. The remainder of the increase was due to volume, combined with routine charge-offs. Revenues are expected to continue to grow if for no other reason than the two acquisitions. (See the comments under "Acquisitions.") Other service charges and fees consist of several categories. The primary categories are listed below. o Fees for the issuance of official checks o Safe deposit box rent o Income from the sale of customer checks o Income from the sale of credit life and accident and health insurance Levels of income derived from these categories vary. Fees for the issuance of official checks and customer check sales tend to grow as the existing franchise grows and as new offices are added. Fee schedules, while subject to change, generally do not alone yield a significant or discernable increase in income 21 when they change. The most significant growth in safe deposit box rent also comes with an expansion of offices. Safe deposit box fee schedules, which are already at competitive levels, are occasionally adjusted. Income derived from the sale of credit life insurance and accident and health insurance varies with loan volumes. Credit card fees consist of three types of revenues as follows. o Credit card transaction fees o Debit card transaction fees o Merchant fees In all three cases volume is critical to growth in income. For debit and credit cards the number of accounts, whether obtained from internal growth or by acquisition, is the key factor. Merchant fees also depend on the number of merchants in the Company's program, as well as the type of business and the level of transaction discounts associated with them. Trust income is somewhat dependent upon market conditions and the number of estate accounts being handled at any given point in time. Financial market conditions, which affect the value of trust assets managed, can vary, leading to fluctuations in the related income. Over the past few years and into 2004, the financial markets have experienced a significant degree of volatility. Of the $327 increase, approximately $205 was attributable to income from the settlement of estates. Improvement in market conditions accounts for the majority of the remaining increase. The other income category is used for types of income that cannot be classified with other forms of noninterest income. The category includes such things as: o Net gains on the sale of fixed assets o Rent on foreclosed property o Income from cash value life insurance o Other infrequent or minor forms of income o Revenue from investment and insurance sales Given the nature of the items included in this category, it is difficult to determine trends or patterns. Items warranting discussion are usually non-recurring in nature. Other income for the first half of 2004 was down $85 when compared to the first half of 2003. Two items unique to 2003 accounted for a large part of the decrease. The first was a $40 rebate received by an affiliate bank from a vendor. The second was a dividend paid to the Company's financial services affiliate. Net realized losses on securities at June 30, 2004 were a nominal $(13). Noninterest Expense
June 30, 2004 June 30, 2003 June 30, 2002 - ----------------------------- --------------------------- -------------------------- --------------------------- Salaries and employee $5,092 $4,765 $4,443 benefits - ----------------------------- --------------------------- -------------------------- --------------------------- Occupancy and furniture and 864 832 824 fixtures - ----------------------------- --------------------------- -------------------------- --------------------------- Data processing and ATM 564 541 586 - ----------------------------- --------------------------- -------------------------- --------------------------- Credit card processing 702 625 484 - ----------------------------- --------------------------- -------------------------- --------------------------- Intangibles and goodwill 466 477 478 amortization - ----------------------------- --------------------------- -------------------------- --------------------------- Net costs of other real 112 19 123 estate owned - ----------------------------- --------------------------- -------------------------- --------------------------- Other operating expenses 1,935 1,877 1,799 - ----------------------------- --------------------------- -------------------------- ---------------------------
Noninterest expense includes several categories. Following is a brief description of the factors that affect each. 22 In addition to employee salaries, the salaries and benefits expense category includes the costs of employment taxes and employee fringe benefits. Certain of these are: o Health insurance o Employee life insurance o Dental insurance o Executive compensation plans (1) o Pension plans (1) o Employee stock option plan (1) o Employer FICA o Unemployment taxes (1) See the 2003 Form 10-K and the Proxy Statement for the 2004 Annual Stockholders meeting for further information. For the first half of 2004, salary and benefits expense was up $327. Routine salary increases and health insurance cost increases contributed to the increase. Of more significance are the recent purchase and assumption transactions. While the FNB branch acquisition added no employees to the payroll, the CNB purchase and assumption initially added twenty-one employees. Because the Company's NBB subsidiary is operating the former CNB office as a branch office, many former CNB employees were retained in their previous positions. Some former CNB employees hold jobs that are performed elsewhere at NBB. It is the Company's plan to place these employees in various areas of NBB as vacancies arise in the normal course of business. While this strategy may incur some increased cost in the short term, it will ultimately allow the Company to add to its already experienced staff and preserve valuable community relations. Occupancy costs include such items as depreciation expense, maintenance of the properties, repairs and real estate taxes. This category is most affected by new property acquisitions resulting from mergers, branch purchases or construction of new branch facilities. Conversely, expense can be lowered by branch office consolidations or closures, which though infrequent, have occurred. On occasion repairs and other expense items can rise to significant levels, though not frequently. This category increased a $32 when the first six months of 2004 and 2003 are compared. The CNB purchase and assumption transaction did not add significantly to this category because it was completed very near quarter-end. The Company maintains its own data processing facility and has ATM's at twenty-two subsidiary bank offices and other locations. Costs to operate these are reflected in this category and include depreciation, maintenance, communication lines and certain supplies. Data processing costs were up $23 when the first halves of 2004 and 2003 are compared. While these cost increases are nominal, larger increases are expected because of the completion of the two previously mentioned purchase and assumption transactions. The first purchase and assumption transaction is quite small and is not expected to greatly impact data processing and ATM expense. The second acquisition involved the assets and liabilities of an existing bank, including assumption of its existing data processing contract, which will remain in force until mid 2005. While the contract terminates in mid 2005, no substantial decreases in processing costs are expected. The Company also added three ATM's at its bank affiliates during the second quarter. Credit card processing includes costs associated with the processing of credit cards, debit cards and merchant transactions. These expenses are related to credit card income previously discussed in the "Noninterest Income" section, and the comments in that section are applicable. Intangibles expense is increased in 2004 due to the purchase and assumption transactions that have been mentioned previously. 23 At June 30, 2004 the net cost of other real estate owned was $112. Given the number and value of the OREO properties, more losses are possible. Expense has risen steadily for the past three years. The June 30, 2004 costs are not necessarily indicative of the full year for 2004. Other real estate owned at June 30, 2004 was $1,489, which compares to $1,663 at December 31, 2003 and $537 at December 31, 2002. Given the number of foreclosures, it is likely that higher costs will continue for 2004, possibly into 2005. Other operating expenses include all other forms of expense not classified elsewhere in the Company's statement of income. Included in this category are such items as stationery and supplies, franchise taxes, contributions, telephone, postage and other operating costs. Many of the expenses included in this category are relatively stable or increase with inflation moderately from year-to-year. However, there are some items included in the category, such as other losses and charge-offs and repossession expense, which can vary from time to time. While many of the items in this category have identifiable trends, others may have frequent nonrecurring items or items that occur at no particular frequency. Overall cost for this category increased 3.10%, when the periods ending June 30, 2004 and June 30, 2003 are compared. Income Taxes In 2003 the Company moved from the 34% tax rate to 35%. In addition to the actual taxes paid, this change affected other areas including the book tax provision, deferred taxes and tax equivalency calculations. Balance Sheet Year-to-date daily averages for the major balance sheet categories are as follows: Assets June 30, 2004 December 31, 2003 - ------------------------------------- ------------------- -------------------- Federal funds sold $ 207 $ 1,320 Interest-bearing deposits 23,600 21,958 Securities available for sale 138,839 125,042 Securities held to maturity 106,050 103,962 Mortgage loans held for sale 480 1,159 Real estate construction loans 22,340 29,575 Real estate mortgage loans 95,250 84,363 Commercial and industrial loans 215,284 207,855 Loans to individuals 83,085 90,365 Total Assets $ 719,195 $ 697,012 Liabilities and stockholders equity - ------------------------------------- Noninterest-bearing demand deposits $86,779 $79,760 Interest-bearing demand deposits 174,550 167,428 Savings deposits 53,995 51,646 Time deposits 317,925 317,989 Other borrowings 226 194 Shareholders' equity $83,085 $77,486 Securities available for sale increased by $18,292 from December 31, 2003, while securities held to maturity increased by $9,568. As shown in the statement of cash flow, of that increase $10,052 was attributable to the CNB transaction. During the first half of 2004, $281 in securities held to maturity were sold. This represents the sale of one issue and was prompted by credit quality concerns. 24 The mix of loan categories at June 30, 2004 and December 31, 2003 is shown in the following table. June 30, 2004 December 31, 2003 - ------------------------------ --------------------- ----------------------- Construction loans (1) $21,836 $28,055 - ------------------------------ --------------------- ----------------------- Real estate loans 126,581 87,899 - ------------------------------ --------------------- ----------------------- Commercial and industrial loans 229,891 208,997 - ------------------------------ --------------------- ----------------------- Loans to individuals 87,268 82,742 - ------------------------------ --------------------- ----------------------- (1) All categories shown reflect gross loans at period-end. The volume of mortgage loans held for sale is directly related to interest rate levels. Activity generally peaks during periods of low interest rates, declining as interest rates rise. Period-end balances are not indicative of volume, as loans are constantly being originated and sold. The balance shown at period-end reflects only loans held by NBB for which there are purchase commitments from investors, but which have not yet been funded. At June 30, 2004 there were approximately $1,357 million in commitments to extend mortgage loans outstanding. Construction loans were $21,836 at June 30, 2004 and $28,055 at December 31, 2003, a decrease of $6,219. This category tends to fluctuate because of demand and with the seasons. Demand may vary because of economic conditions. Completion of construction projects generally occurs within one year, at which time permanent financing through one of the Company's banking affiliates or another lender is obtained. Loans for which the Company retains permanent financing move into the commercial and industrial loan or mortgage loan categories. Real estate loans at June 30, 2004 were $126,581, which represents an increase of $38,682 from December 31, 2003. Loans in this category are for one-to-four family housing and are loans the banking affiliates elected to retain rather than sell on the secondary market. Of that increase, approximately $27.9 million were acquired from CNB and $2.6 million acquired from FNB, Commercial and industrial loans were $229,891 at June 30, 2004, which represents an increase of $20,894 from December 31, 2003. Included in this category are loans for working capital, equipment, commercial real estate and other loans for legitimate business needs. The CNB transaction accounted for approximately $6.7 million of this growth and the FNB acquisition $2.4 million. See Footnote 15 of the Company's 2003 Form 10-K for information related to "Concentrations of Credit". Historically, growth in this category has been satisfactory, and based on present knowledge, no adverse trends are anticipated. Loans to individuals increased by $4,526 when June 30, 2004 is compared to December 31, 2003. Growth attributable to the CNB transaction was approximately $5.3 million and $2.2 million from FNB. This category has experienced a downward trend. Growth observed in this area is the result of acquisitions. See the comments under the caption "Net Interest Income" in this report. At June 30, 2004 total deposits were $704,327 compared to $625,378 at December 31, 2004. Of the $78,949 increase, approximately $60 million came from CNB and $15 million from FNB. Liquidity and Capital Resources Net cash provided by operating activities was $10,862 for the period ended June 30, 2004, which compares to $6,619 for the same period the previous year. Included in this segment of the cash flow statement is a change in other assets of $7,619. Net cash used in investing activities was $33,218 provided for the period ended June 30, 2004, and $19,369 used for the period ended June 30, 2003. Net cash used in financing activities was $76,265 for the period ending June 30, 2004. The substantial changes in cash used in investing activities and cash provided by financing activities are due to the CNB and FNB transactions. Included in the supplemental cash flow data is interest paid on deposits, which declined substantially when the periods June 30, 2004 and June 25 30, 2003 are compared. The decrease is due to a decline in interest expense due to the lower interest rate environment. The Company has other available sources of liquidity. They include lines of credit with a correspondent bank, advances from the Federal Home Loan Bank, and Federal Reserve Bank discount window borrowings. Management is unaware of any commitment that would have a material and adverse effect on liquidity at June 30, 2004. Total shareholders' equity grew by $789 from December 31, 2003 to June 30, 2004. Earnings net of the change in unrealized gains and losses for securities available for sale and dividends paid accounted for most of the increase. Stock options exercised provided $123. The Tier I and Tier II risk-based capital ratios at June 30, 2004 were 11.62% and 12.69%, respectively. Derivatives 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. Management does not plan any future involvement in high- risk derivative products. The Company has investments in collateralized mortgage obligations, structured notes and other similar instruments that are included in securities available for sale and securities held to maturity. The fair value of these investments at June 30, 2004 was approximately $2,877. Amortized cost for these securities was approximately $2,743. Management Discussion and Analysis of the Financial Condition and results of operations for the three months ended June 30,2004. Performance Summary The following table shows NBI's performance ratios for the three months ended June 30,2004 and June 30,2003 June 30,2004 June 30,2003 - ------------------------------------------- ----------------- ---------------- Return on Average Assets 1.62% 1.60% - ------------------------------------------- ----------------- ---------------- Return on Average Equity 14.23% 14.57% - ------------------------------------------- ----------------- ---------------- Net Interest Margin 4.70% 4.72% - ------------------------------------------- ----------------- ---------------- Basic Net Earnings per Share $0.84 $0.80 - ------------------------------------------- ----------------- ---------------- Fully diluted Net Earnings per Share $0.83 $0.79 - ------------------------------------------- ----------------- ---------------- As can be seen by the above data, these key indicators have been relatively stable. The return on equity has declined slightly. Earnings per share data reflects the continued growth in net income. Following is a comparison of quarter-to-date daily averages for related categories. June 30,2004 June 30,2003 - ------------------- ---------------- ----------------- Securities $249,375 $228,010 - ------------------- ---------------- ----------------- Loans, net 421,679 407,415 - ------------------- ---------------- ----------------- Deposits 642,838 620,838 - ------------------- ---------------- ----------------- Total Assets 728,378 700,575 - ------------------- ---------------- ----------------- As can be seen by the above data, the Company has experienced solid growth when the two quarters are compared. Much of the growth experienced was due to the acquisition of the FNB branch loans and deposits by the company's BTC affiliate that was completed in April of 2004. The CNB transaction occurred very late in 26 the second quarter, and it therfore had a much lesser effect on the quarterly averages. The quarterly average for the upcoming third quarter will more accurately reflect the impact of that transaction. Net Income Net income for the second quarter of 2004 was $2,936 compared to $2,801 for the same period in 2003. This result is a $0.04 increase in Basic Earnings per Share. While the FNB transaction had a small unquantifiable effect upon net income in the second quarter of 2004, the CNB transaction, completed late in the quarter, had virtually no effect. Net Interest Income Net interest income rose by $218 when the second quarter of 2004 and 2003 are compared. Overall interest income declined by $379, while deposit expenses decreased by $597. The ongoing effect of the low interest rate environment is apparent. (Previous comments in the discussion of year-to-date "Net Interest Income" section apply.) Provision for Loan Losses The provision for loan losses was down $98 when the two periods are compared. Noninterest Income Overall noninterest income increased by $177 or 11.77%. Areas experiencing the greatest changes are as follows: o Service charges on deposits, increased $88 o Credit Care Processing, increased $48 o Trust Income, increased $77 General comments made in the year-to-date discussion apply. There were no material non-routine items in the second quarter of 2004. Noninterest Expense Overall non-interest expense grew by $346 when June 30, 2004 and June 30, 2003 are compared. Three areas with the greatest increases follow: o Salaries and employee benefits, increased $214 o Credit Card processing, increased $ 50 o OREO expense, increased $ 40 General comments made pertaining to salaries and employee benefits made in the year-to-date discussion apply here. In addition, the CNB purchase and assumption transaction affected this catergory. Nearly all of CNB's employees were hired by the Company's NBB affiliate. This resulted in approximately $35 in additional salaries and employee benefits expense in the second quarter of 2004. General comments related to credit card processing in the year-to-date discussion apply. There were no material reportable non-routine transactions. OREO expense is up. See the year-to-date discussion for additional comments. 27 Item 3. Quantitative and Qualitative Disclosures about Market Risk 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 to adverse movement in interest rates. Interest rate shock analyses provide management with an indication of potential economic loss due to future rate changes. There have not been any changes, which would significantly alter the results disclosed as of December 31, 2003. (See the comments and other data under "Interest Rate Sensitivity.") Item 4. Controls and Procedures Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our principal executive officer and principal financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Disclosure controls and procedures are our controls and procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Part II Other Information Item 1 Legal Proceedings None for the six months ended une 30, 2004. Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities On May 12, 2004 the Company's Board of Directors approved a common stock repurchase plan (the Plan). Under the terms of the Plan, management isauthorized to purchase in the open market through a stockbroker at such time or times as management deems to be advantageous to the Company and its stockholders the number of shares deemed appropriate, with a total value not to exceed $1 million. The Plan extends to May 31, 2005. No shares of common stock were repurchased in the quarter ended June 30, 2004. Item 3 Defaults upon Senior Securities None for the six months ended June 30, 2004. Item 4. Submission of Matters to a Vote of Security Holders Three Class 2 Directors of the Company were elected by a vote of the security holders for a term of three years each. (a) This matter was submitted to a vote at the Company's Annual Meeting of Stockholders held on April 13, 2004. 28 (b) The name of each director elected at the meeting follows: Jack M. Lewis James G. Rakes Jeffrey R. Stewart The name of each director whose term of office continued after the meeting is listed: L. Allen Bowman James A. Deskins, Sr. Paul A. Duncan Mary G. Miller William T. Peery James M. Shuler (c) The number of votes cast for or against each nominee is provided below. There were no abstaining votes and no broker non-votes. Election of Directors ------------------------- ---------------------- --------------------- Director Votes For Votes Against ------------------------- ---------------------- --------------------- Jack M. Lewis 2,833,951 6,604 ------------------------- ---------------------- --------------------- James G. Rakes 2,833,718 6,837 ------------------------- ---------------------- --------------------- Jeffrey R. Stewart 2,825,115 15,440 ------------------------- ---------------------- --------------------- Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K Form 8-K dated April 14, 2004 - Press release announcing earnings for the first quarter of 2004, incorporated herein by reference. Form 8-K dated May 13, 2004 - Press release announcing that the Board of Directors of National Bankshares, Inc. had authorized the repurchase of up to $1 million of the Company's common stock until May 31, 2005, incorporated herein by reference. Form 8-K dated June 28, 2004 - Press release announcing the June 25, 2004 completion by the Company's NBB subsidiary of the purchase of substantially all of the assets and the assumption of all of the liabilities of Community National Bank of Pulaski, Virginia, incorporated herein by reference. 29 Signatures National Bankshares, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DATE: August 9, 2004 NATIONAL BANKSHARES, INC. /s/ JAMES G. RAKES ---------------------- James G. Rakes Chief Executive Officer /s/ J. ROBERT BUCHANAN ----------------------- J. Robert Buchanan Chief Financial Officer (1) Index of Exhibits
Page No. in Exhibit No. Description Sequential System - ----------- ----------- ----------------- 3(i) Articles of Incorporation, as amended, of National (incorporated herein by Bankshares, Inc. reference to Exhibit 3(a) of the Annual Report on Form 10-K for fiscal year ended December 31, 1993) 3(i) Articles of Amendment to Articles of Incorporation (incorporated herein by of National Bankshares, Inc., dated reference to exhibit 3(i) April 8, 2003. of The Annual Report on Form 10-K for the fiscal year ended December 31, 2003) 4(i) Specimen copy of certificate for National (incorporated herein by Bankshares, Inc. common stock, $2.50 par 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 Incorporation (incorporated herein by of National Bankshares, Inc. included in reference to Exhibit 4(b) Exhibit No. 3(a)) of the Annual Report on Form 10-K for fiscal year ended December 31, 1993) 10(ii)(B) Computer software license agreement dated (incorporated herein by June 18, 1990, by and between Information reference to Exhibit 10(e) Technology, Inc. and The National Bank of of the Annual Report on Form Blacksburg 10-K for fiscal year ended December 31, 1992) *10(iii)(A) National Bankshares, Inc. 1999 Stock Option (incorporated herein by Plan reference to Exhibit 4.3 of the Form S-8, filed as Registration No. 333-79979 with the Commission on June 4, 1999) *10(iii)(A) Employment Agreement dated January 2002 between (incorporated herein by National Bankshares, Inc. and James G. Rakes reference to Exhibit 10(iii)(A) of Form 10-Q for the period ended June 30, 2002) 30 *10(iii)(A) Employment Lease Agreement dated August 14, 2002, (incorporated herein by between National Bankshares, Inc. and reference to Exhibit 10(iii)(A) The National Bank of Blacksburg of form 10-Q for the period ended September 30, 2002) *10(iii)(A) Change in Control Agreement dated January 5, (incorporated herein by 2003, between National Bankshares, Inc. and reference to Exhibit 10 iii(A) Marilyn B. Buhyoff of Form 10-K for the period ended December 31, 2002) *10(iii)(A) Change in Control Agreement dated January 8, (incorporated herein by 2003, between National Bankshares, Inc. and reference to Exhibit 10 iii(A) F. Brad Denardo of Form 10-K for the period ended December 31, 2002) *10(iii)(A) Change in Control Agreement dated June 1, (incorporated herein by 1998, between Bank of Tazewell County and reference to Exhibit 10 iii(A) Cameron L. Forester of Form 10-K for the period ended December 31, 2002) 31(i) Section 302 Certification of Chief Page 32 Executive Officer 31(ii) Section 302 Certification of Chief Page 32 Financial Officer 32(i) 18 U.S.C. Section 1350 Certification of Chief Page 34 Executive Officer 32(ii) 18 U.S.C. Section 1350 Certification of Chief Page 34 Financial Officer
* Indicates a management contract or compensatory plan required to be filed herein. 31 EX-31 3 ex31a.txt Section 302 Certifications Exhibit 31 (i) I, James G. Rakes, certify that: 1. I have reviewed this report on Form 10-Q of National Bankshares, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report. 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15 (e) and 15d - 15 (e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; and (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluations; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 /s/ JAMES G. RAKES - ------------------------- James G. Rakes Chairman, President and Chief Executive Officer (Principal Executive Officer) EX-31 4 ex31b.txt Section 302 Certifications Exhibit 31 (ii) I, J. Robert Buchanan, certify that: 1. I have reviewed this report on Form 10-Q of National Bankshares, Inc. 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report. 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report. 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15 (e) and 15d - 15 (e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; and (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluations; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting. 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 /s/ J. ROBERT BUCHANAN - ---------------------------- J. Robert Buchanan Treasurer (Principal Financial Officer) EX-32 5 ex32a.txt Exhibit 32 (i) CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 In connection with the Form 10-Q of National Bankshares, Inc. for the quarter ended June 30, 2004, I, James G. Rakes, President and Chief Executive Officer of National Bankshares, Inc. (Principal Executive Officer), hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge and belief, that: (1) such Form 10-Q for the quarter ended June 30, 2004, fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934; and (2)the information contained in such Form 10-Q for the quarter ended June 30, 2004, fairly presents, in all material respects, the financial condition and results of operations of National Bankshares, Inc. /s/ JAMES G. RAKES - ------------------ James G. Rakes Chairman, President and Chief Executive Officer (Principal Executive Officer) EX-32 6 ex32b.txt Exhibit 32 (ii) CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 In connection with the Form 10-Q of National Bankshares, Inc. for the quarter ended June 30, 2004, I, J. Robert Buchanan, Treasurer (Principal Financial Officer) of National Bankshares, Inc., hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge and belief, that: (1) such Form 10-Q for the quarter ended June 30, 2004, fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934; and (2)the information contained in such Form 10-Q for the quarter ended June 30, 2004, fairly presents, in all material respects, the financial condition and results of operations of National Bankshares, Inc. /s/ J. ROBERT BUCHANAN - ---------------------- J. Robert Buchanan Treasurer (Principal Financial Officer) -----END PRIVACY-ENHANCED MESSAGE-----