-----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, BVOyev8sV1vryqyU/BdJKaUzo4ju3ZHtVRRRwMyj8Rerchk7W2GCnksxPepYeJ9R zS4Rbe1kGb9g54Vm3dtehA== 0000796534-97-000005.txt : 19970329 0000796534-97-000005.hdr.sgml : 19970329 ACCESSION NUMBER: 0000796534-97-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970328 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL BANKSHARES INC CENTRAL INDEX KEY: 0000796534 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 541375874 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-15204 FILM NUMBER: 97567835 BUSINESS ADDRESS: STREET 1: 100 SOUTH MAIN ST CITY: BLACKSBURG STATE: VA ZIP: 24062-9002 BUSINESS PHONE: 7035522011 MAIL ADDRESS: STREET 1: 100 SOUTH MAIN STREET STREET 2: PO BOX 90002 CITY: BLACKSBURG STATE: VA ZIP: 24062-9002 10-K 1 10-K FORM 1996 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, 1996 O-15204 NATIONAL BANKSHARES, INCORPORATED - -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Virginia 54-1375874 - ------------------------------- --------------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 100 South Main Street Blacksburg, Virginia 24060 - ---------------------------------------- -------------------- (Address of principal executive offices) Zip Code Registrant's telephone number, including area code (540) 552-2011 -------------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $2.50 per Share - -------------------------------------------------------------------------------- (Title of Class) Indicate by a check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X ------- The aggregate market value of voting stock held by nonaffiliates of the Registrant as of March 14, 1997 was $87,477,875. The aggregate market value was computed based on a price determined from transactions known to management of the Registrant since its stock is not extensively traded, listed on any exchange, or quoted by NASDAQ. (In determining this amount, the registrant assumes that all of its Directors and principal Officers are affiliates. Such assumption shall not be deemed conclusive for any other purposes.) Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date. Class Outstanding at March 14, 1997 - ------------------------------ ------------------------------- COMMON STOCK, $2.50 PAR VALUE 3,792,833 DOCUMENTS INCORPORATED BY REFERENCE Selected information from the Registrants' Annual Report to Stockholders for the year ended December 31, 1996, 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 8, 1997 and filed with the Securities and Exchange Commission pursuant to Regulation 14A, is incorporated by reference into Part III of this report. (This report contains 40 pages.) (The Index of Exhibits are on pages 39-40.) NATIONAL BANKSHARES, INCORPORATED ANNUAL REPORT FOR 1996 ON FORM 10-K TABLE OF CONTENTS PAGE ---- PART I Item 1. Business 4-31 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 33 Item 6. Selected Financial Data 33 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 33 Item 8. Financial Statements and Supplementary Data 33 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 34 PART III Item 10. Directors and Executive Officers of the Registrant 34 Item 11. Executive Compensation 34 Item 12. Security Ownership of Certain Beneficial Owners and Management 34 Item 13. Certain Relationships and Related Transactions 34 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 35-37 -3- PART I ------ Item 1. Business. - ----------------- History and Business National Bankshares, Inc. (Bankshares) is a bank holding company organized under the laws of Virginia in 1986 and registered under the Bank Holding Company Act (BHCA). Bankshares conducts its operations through its two wholly-owned subsidiaries, The National Bank of Blacksburg (NBB) and Bank of Tazewell County (BTC), collectively referred to as "the Company". On June 1, 1996, Bankshares issued 1,888,209 shares of its common stock in a one-for-one exchange for all the outstanding common stock of Bank of Tazewell County, Tazewell, Virginia. This business combination has been accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements for the periods prior to the combination have been restated to include the accounts and results of operations of Bank of Tazewell County. There were no adjustments of a material amount resulting from Bank of Tazewell County's adoption of Bankshares' accounting policies. In May 1996, Bankshares declared a stock split of .11129 per share effected in the form of a stock dividend to the holders of Bankshares common stock just prior to the merger effective date to facilitate the one-for-one common stock exchange ratio. All stockholders' equity accounts, share and per share data have been adjusted retroactively to reflect the stock split. The National Bank of Blacksburg The National Bank of Blacksburg was originally chartered in 1891. NBB operates a full-service banking business from its headquarters in Blacksburg, Virginia, and its six area branch offices. A seventh branch is expected to open in the second quarter of 1997. NBB offers general retail and commercial banking services to individuals, businesses, local government units and institutional customers. These products and services include accepting deposits in the form of checking accounts, money market deposit accounts, interest-bearing demand deposit accounts, savings accounts and time deposits; making real estate, commercial, revolving, consumer and agricultural loans; offering letters of credit; providing other consumer financial services, such as automatic funds transfer, collections, night depository, safe deposit, travelers checks, savings bond sales and utility payment services; and providing other miscellaneous services normally offered by commercial banks. NBB also conducts a general trust business in Blacksburg near its headquarters location. Through its trust operation, NBB offers a variety of personal and corporate trust services. NBB makes loans in all major loan categories, including commercial, commercial and residential real estate, construction and consumer loans. Bank of Tazewell County The antecedents of BTC are in a charter issued on September 28, 1889 for Clinch Valley Bank. On December 22, 1893, a second charter was issued in substantially the same form for Bank of Clinch Valley. In 1929, Bank of Clinch Valley merged with Farmers Bank under the charter of the former, and the name of the resulting institution became Farmers Bank of Clinch Valley. Bank of Tazewell County resulted from the 1964 merger of Bank of Graham, Bluefield, -4- Virginia with Farmers Bank of Clinch Valley. BTC provides general retail and commercial banking services to individuals, businesses and local government units. These services include commercial, real estate and consumer loans. Deposit accounts offered include demand deposit accounts, interest-bearing demand deposit accounts, money market deposit accounts, savings accounts and certificates of deposit. Other services include automatic funds transfer, collections, night depository, safe deposit, travelers checks, savings bond sales and utility payment services; and providing other miscellaneous service normally offered by commercial banks. BTC also conducts a general trust business. BTC makes commercial, residential real estate and consumer loans. Commercial Loans NBB and BTC make loans to businesses and to individuals for business purposes on both secured and unsecured bases. Loan requests are granted based upon several factors including credit history, past and present relationships with the bank and marketability of collateral. Unsecured commercial loans must be supported by a satisfactory balance sheet and income statement. Business loans made on a secured basis may be secured by a security interest in marketable equipment, accounts receivable, business equipment and/or general intangibles of the business. In addition, or in the alternative, the loan may be secured by a deed of trust lien on business real estate. The risks associated with commercial loans are related to the strength of the individual business, the value of loan collateral and the general health of the economy. Residential Real Estate Loans Loans secured by residential real estate are originated by both bank subsidiaries. Loans originated by BTC are typically held in the bank's loan portfolio. NBB sells in the secondary market on a servicing released basis a substantial percentage of the residential real estate loans it originates. There are occasions when a borrower or the real estate do not qualify under secondary market criteria, but the loan request represents a reasonable credit risk. Also, an otherwise qualified borrower may choose not to have their mortgage loan sold. On these occasions, if the loan meets NBB's internal underwriting criteria, the loan will be closed and placed in NBB's portfolio. In its secondary market operation, NBB participates in insured loan programs sponsored by the Department of Housing and Urban Development, the Veterans Administration and the Virginia Housing Development Authority. It is anticipated that BTC will also become engaged in sales of mortgages in the secondary market. 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 limited due to the nature of its market area. -5- In addition to the risks associated with all real estate loans, construction loans bear the risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may be at any point in time 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 permanent financing of construction loans may likewise under certain circumstances be affected by external financial pressures on those customers. Consumer Loans NBB and BTC routinely make consumer loans, both secured and unsecured. The credit history and character of individual borrowers is evaluated as a part of the credit decision. Loans used to purchase vehicles or other specific personal property and loans associated with real estate are usually secured with a lien on the subject vehicle or property. NBB also originates a small number of student loans that are sold to the Student Loan Marketing Association. Negative changes in a customer's financial circumstances due to a large number of factors, such as illness or loss of employment, can place the repayment of a consumer loan at risk. In addition, deterioration in collateral value can add risk to consumer loans. Sales and Purchases of Loans NBB and BTC will occasionally buy or sell all or a portion of a loan. These purchases and sales are in addition to the secondary market mortgage loans and student loans regularly sold by NBB. Because the demand for loans, particularly for commercial loans, is greater in NBB's market area than in BTC's market area, NBB regularly sells loans and participations in loans to BTC. BTC's loan to deposit ratio is at a level where additional loans are desirable, and NBB's loan to deposit ratio is at a level which its management considers to be optimal without the loans sold to BTC. Both banks will consider selling a loan or a participation in a loan, if: (i) the full amount of the loan will exceed the bank's legal lending limit to a single borrower; (ii) the full amount of the loan, when combined with a borrower's previously outstanding loans, will exceed the bank's legal lending limit to a single borrower; (iii) the Board of Directors or an internal Loan Committee believes that a particular borrower has a sufficient level of debt with the bank; (iv) the borrower requests the sale; (v) the loan to deposit ratio is at or above the optimal level as determined by bank management; and/or (vi) the loan may create too great a concentration of loans in one particular location or in one particular type of loan. The banks will consider purchasing a loan, or a participation in a loan, from another financial institution (including from another subsidiary of the Company) if the loan meets all applicable credit quality standards and (i) the bank's loan to deposit ratio is at a level where additional loans would be desirable; and/or (ii) a common customer requests the purchase. -6- The following table sets forth, for the three fiscal years ended December 31, 1996, 1995 and 1994 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, 1996 Interest and Fees on Loans 54.98% Interest on Investments 34.61% December 31, 1995 Interest and Fees on Loans 51.72% Interest on Investments 38.16% December 31, 1994 Interest and Fees on Loans 48.97% Interest on Investments 42.15% Market Area The National Bank of Blacksburg Market Area NBB's primary market area consists of the northern portion of Montgomery County and all of Giles County, Virginia. This area includes the towns of Blacksburg and Christiansburg in Montgomery County and the towns of Pearisburg and Pembroke in Giles County. The local economy is diverse and is oriented toward higher education, retail and service, light manufacturing and agriculture. For the years 1996, 1995 and 1994 the unemployment rate in Montgomery County was 3.3%, 3.0% and 3.2%, respectively, and the rate in Giles County during those years was 8.4%, 8.4% and 7.4%, respectively. Montgomery County's largest employer is Virginia Polytechnic Institute and State University (VPI & SU) located in Blacksburg. VPI & SU is the Commonwealth's land grant college and also its largest university. Employment at VPI & SU has remained stable over the past three years, and it is not expected to change materially in the next few years. A second state supported university, Radford University, is located in the western edge of NBB's service area. It too has provided stable employment opportunities in the region. Giles County's primary employer is a Hoechst-Celanese plant, which manufactures the material from which cigarette filters are made. Employment at that location has remained steady or declined slightly in the past three years. Several other small manufacturing concerns are located in Montgomery and Giles Counties. These concerns manufacture diverse products and are not dependent upon one sector of the economy. Since 1988, Montgomery County has developed into a regional retail center, with the construction of two large shopping areas. Two area hospitals, each of which are affiliated with different large health care systems, have in the past several years constructed additional facilities and attracted additional health care providers to Montgomery County, making it a center for basic health care services. VPI & SU's Corporate Research Center has brought several small high tech companies to Blacksburg, and further expansion is planned. Montgomery County has experienced good growth, with the total fair market value of real estate, measured in constant dollars, increasing 49% in the years between 1980 and 1992. Growth is predicted to continue through the year 2000; however, the rate may be somewhat slower, as the predicted rate of population growth in Montgomery County is expected to moderate. Neighboring Giles County is more rural and had only 22% of Montgomery County's total population in 1990. Giles County has experienced a slight decline in population since the 1990 census. Total fair market value of real estate, measured in real dollars, increased in Giles County by 54% between 1980 and 1992, but declined by 9% over -7- that twelve-year period, as measured in constant dollars. The continued slow decline of Giles County's population is predicted to continue through the year 2000. However, since the total population of the County reported in the 1990 census was only 16,366, and the population projected by the Virginia Employment Commission for Giles in the year 2000 is 16,121, the predicted decline of 245 individuals is not expected to materially impact NBB's business in Giles County. NBB's primary market area offers the advantages of a good quality of life, scenic beauty, moderate climate and the cultural attractions of two major universities. The region has marketed itself as a retirement destination, and it has had some recent success attracting retirees, particularly from the Northeast and urban Northern Virginia. These marketing efforts are expected to continue. Bank of Tazewell County Market Area Most of BTC's business originates from Tazewell County, Virginia and Mercer County, Virginia. This includes the towns of Tazewell and Bluefield, Virginia and Bluefield, West Virginia. BTC's primary market area has largely depended on the coal mining industry and farming for its economic base. In recent years, coal companies have mechanized and this has reduced the number of individuals required for the production of coal. There are still a number of support industries for the coal mining business that continue to provide employment in the area. Additionally, several new businesses have been established in the area, and Bluefield, West Virginia has begun to emerge as a regional medical center. Unemployment has stabilized, and real estate values also remain stable and comparable to other areas in southwest Virginia. For 1996, 1995 and 1994 the unemployment rate for Tazewell County was 9.5%, 10.2% and 13.9%, respectively. In the same years, Mercer County, West Virginia's unemployment rate was 5.2%, 5.7% and 7.2%, respectively. Competition The banking and financial service business in Virginia generally, and in NBB's and BTC's market areas specifically, is highly competitive. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems and the accelerating pace of consolidation among financial service providers. The Company's bank subsidiaries compete for loans and deposits with other commercial banks, savings and loan associations, securities and brokerage companies, mortgage companies, money market funds, credit unions and other nonbank financial service providers. Many of these competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services than NBB and BTC. In order to compete with these other financial service providers, NBB and BTC rely upon service-based business philosophies, personal relationships with customers, specialized services tailored to meet customers' needs and the convenience of office locations. In addition, the banks are generally competitive with other financial institutions in their market areas with respect to interest rates paid on deposit accounts, interest rates charged on loans and other service charges on loans and deposit accounts. Registrant's Organization and Employment Bankshares, NBB and BTC are organized in a holding company/subsidiary bank structure. Bankshares has no employees, except for executive officers, and conducts substantially all of its operations through its subsidiaries. All compensation paid to officers and employees is paid by NBB, except for fees paid -8- by Bankshares to President and Chief Executive Officer James G. Rakes for his service as a director of the Company. At December 31, 1996, NBB employed 103 full time equivalent employees at its main office, operations center and branch offices. BTC at December 31, 1996 employed 67 in its various offices and operational areas. Certain Regulatory Considerations Bankshares, NBB and BTC are subject to various state and federal banking laws and regulations which impose specific requirements or restrictions on and provide for general regulatory oversight with respect to virtually all aspects of operations. As a result of the substantial regulatory burdens on banking, financial institutions, including Bankshares, NBB and BTC, are disadvantaged relative to other competitors who are not as highly regulated, and their costs of doing business are much higher. The following is a brief summary of the material provisions of certain statutes, rules and regulations which affect Bankshares, NBB and/or BTC. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be an exhaustive description of the statutes or regulations which are applicable to the businesses of Bankshares, NBB and/or BTC. Any change in applicable laws or regulations may have a material adverse effect on the business and prospects of Bankshares, NBB and/or BTC. National Bankshares, Inc. Bankshares is a bank holding company within the meaning of the BHCA and Chapter 13 of the Virginia Banking Act, as amended (the Virginia Banking Act). The activities of Bankshares also are governed by the Glass-Steagall Act of 1933 (the Glass-Steagall Act). The Bank Holding Company Act. The BHCA is administered by the Federal Reserve Board, and Bankshares is required to file with the Federal Reserve Board an annual report and such additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board also is authorized to examine Bankshares and its subsidiaries. The BHCA requires every bank holding company to obtain the prior approval of the Federal Reserve Board before (i) it or any of its subsidiaries (other than a bank) acquires substantially all the assets of any bank; (ii) it acquires ownership or control of any voting shares of any bank if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank; or (iii) it merges or consolidates with any other bank holding company. The BHCA and the Change in Bank Control Act, together with regulations promulgated by the Federal Reserve Board, require that, depending on the particular circumstances, either Federal Reserve Board approval must be obtained or notice must be furnished to the Federal Reserve Board and not disapproved prior to any person or company acquiring "control" of a bank holding company, such as Bankshares, subject to certain exemptions. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of Bankshares. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities of Bankshares. The regulations provide a procedure for challenging the rebuttable control presumption. Under the BHCA, a bank holding company is generally prohibited from engaging in, or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in nonbanking activities, unless the Federal Reserve -9- Board, by order or regulation, has found those activities to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve Board has determined by regulation to be proper incidents to the business of a bank holding company include making or servicing loans and certain types of leases, engaging in certain insurance and discount brokerage activities, performing certain data processing services, acting in certain circumstances as a fiduciary or investment or financial adviser, owning savings associations and making investments in certain corporations or projects designed primarily to promote community welfare. The Federal Reserve Board imposes certain capital requirements on Bankshares under the BHCA, including a minimum leverage ratio and a minimum ratio of "qualifying" capital to risk-weighted assets. Subject to its capital requirements and certain other restrictions, Bankshares can borrow money to make a capital contribution to NBB or BTC, and such loans may be repaid from dividends paid from NBB or BTC to Bankshares (although the ability of NBB or BTC to pay dividends are subject to regulatory restrictions). Bankshares can raise capital for contribution to NBB and BTC by issuing securities without having to receive regulatory approval, subject to compliance with federal and state securities laws. The Virginia Banking Act. All Virginia bank holding companies must register with the Virginia State Corporation Commission (the Commission) under the Virginia Banking Act. A registered bank holding company must provide the Commission with information with respect to the financial condition, operations, management and intercompany relationships of the holding company and its subsidiaries. The Commission also may require such other information as is necessary to keep itself informed about whether the provisions of Virginia law and the regulations and orders issued thereunder by the Commission have been complied with, and may make examinations of any bank holding company and its subsidiaries. In March 1994, the Virginia General Assembly adopted an amendment to Chapter 15 of the Virginia Banking Act to allow bank holding companies located in any state to acquire a Virginia bank or bank holding company if the Virginia bank or bank holding company could acquire a bank holding company in their state and the Virginia bank or bank holding company to be acquired has been in existence and continuously operated for more than two years. This amendment may permit bank holding companies from throughout the United States to enter the Virginia market, subject to federal and state approval. Glass-Steagall Act. Bankshares is also restricted in its activities by the provisions of the Glass-Steagall Act, which prohibit Bankshares from owning subsidiaries that are engaged principally in the issue, flotation, underwriting, public sale or distribution of securities. The interpretation, scope and application of the provisions of the Glass-Steagall Act currently are being considered and reviewed by regulators and legislators, and the interpretation and application of those provisions have been challenged in the federal courts. Bankshares does not presently engage in securities-related activities in any material respect. NBB and BTC General. NBB is a national banking association incorporated under the laws of the United States and is subject to examination by the Office of the Comptroller of the Currency (the OCC). Deposits in NBB are insured by the FDIC up to a maximum amount (generally $100,000 per depositor, subject to aggregation rules). -10- 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, such banks are prohibited from engaging in certain tie- in-arrangements in connection with any extension of credit or the providing of any property of service. The Virginia State Corporation Commission and the Federal Reserve Board conduct regular examinations of BTC reviewing the adequacy of the loan loss reserves, quality of the loans and investments, propriety of management practices, compliance with laws and regulations and other aspects of the bank's operations. In addition to these regular examinations, Virginia chartered banks must furnish to the Federal Reserve Board quarterly reports containing detailed financial statements and schedules. Community Reinvestment Act. NBB and BTC are subject to the provisions of the Community Reinvestment Act of 1977 (the CRA), which requires the appropriate federal bank regulatory agency, in connection with its regular examination of a bank, to assess the bank's record in meeting the credit needs of the community served by the bank, including low and moderate-income neighborhoods. The banking regulators recently have substantially revised the implementing CRA regulations. Under the new 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 new 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 new regulations place added importance on a bank's product delivery system, particularly branch localities. The new regulations require banks, other than small banks, to comply with significantly increased data collection requirements. The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required for any bank which has applied to, among other things, establish a new branch office that will accept deposits, relocate an existing office, or merge, consolidate with or acquire the assets or assume the liabilities of a federally regulated financial institution. It is likely that banks' compliance with the CRA, as well as other so-called fair lending laws, will face heightened government scrutiny and that costs associated with compliance will increase. -11- NBB and BTC received CRA ratings of "Outstanding" and "Satisfactory" respectively, in their last examinations by their primary federal bank regulators. Branching. In 1986, the Virginia Banking Act was amended to remove the geographic restrictions governing the establishment of branch banking offices. Subject to the approval of the appropriate federal and state bank regulatory authorities, BTC as a state bank, may establish a branch office anywhere in Virginia. National banks, like NBB, are required by the National Bank Act to adhere to branch banking laws applicable to state banks in the states in which they are located. Under current Virginia law, NBB may open branch offices throughout Virginia with the prior approval of the OCC. In addition, with prior approval of one or more of the Federal Reserve Board, the Virginia Commission, the OCC and the FDIC, NBB will be able to acquire existing banking operations in Virginia. On September 29, 1994, President Clinton signed into law the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the Interstate Act). The Interstate Act, which became effective September 29, 1995, allows bank holding companies to acquire banks in any state, without regard to state law, except that if the state has a minimum requirement for the amount of time a bank must be in existence, that law must be preserved. Under the Virginia Banking Act, a Virginia bank or all of the subsidiaries of Virginia holding companies sought to be acquired must have been in continuous operation for more than two years before the date of such proposed acquisition. The Interstate Act permits banks to acquire out-of-state branches through interstate mergers, beginning June 1, 1997. States can opt-in to interstate branching earlier, or opt-out before June 1, 1997. De novo branching, where an out-of-state bank holding company sets up a new branch in another state, would require a state's specific approval. An acquisition or merger would not be permitted under the Interstate Act if the bank, including its insured depository affiliates, would control more than 10% of the total amount of deposits of insured depository institutions in the United States, or would control 30% or more of the total amount of deposits of insured depository institutions in any state. Virginia has, by statute, elected to opt-in fully to interstate branching under the Interstate Act, effective July 1, 1995. Under the Virginia statute, Virginia state banks may, with the approval of the Virginia State Corporation Commission, establish and maintain a de novo branch or acquire one or more branches in a state other than Virginia, either separately or as part of a merger. Procedures also are established to allow out-of-state domiciled banks to establish or acquire branches in Virginia, provided the "home" state of the bank permits Virginia banks to establish or acquire branches within its borders. The activities of such branches would be subject to the same laws as Virginia domiciled banks, unless such activities are prohibited by the law of the state where the bank is organized. The Virginia State Corporation Commission would have the authority to examine and supervise out-of-state state banks to ensure that the branch is operating in a safe and sound manner and in compliance with the laws of Virginia. The Virginia statute authorizes the Bureau of Financial Institutions to enter into cooperative agreements with other state and federal regulators for the examination and supervision of out-of-state state banks with Virginia operations, or Virginia domiciled banks with operations in other states. Likewise, national banks, with the approval of the OCC, may branch into and out of the state of Virginia. Any Virginia branch of an out-of-state national bank is subject to Virginia law (enforced by the OCC) with respect to intrastate branching, consumer protection, fair lending and community -12- reinvestment as if it were a branch of a Virginia bank, unless preempted by federal law. The Interstate Act will permit banks and bank holding companies throughout the United States to enter Virginia markets through the acquisition of Virginia institutions and will make it easier for Virginia bank holding companies and Virginia state and national banks to acquire institutions and to establish branches in other states. Competition in market areas served by the Company may increase as a result of the Interstate Act and the Virginia interstate banking statutes. Deposit Insurance. The FDIC establishes rates for the payment of premiums by federally insured financial institutions. A Bank Insurance Fund (the BIF) is maintained for commercial banks, with insurance premiums from the industry used to offset losses from insurance payouts when banks fail. Beginning in 1993, insured depository institutions like NBB and BTC paid for deposit insurance under a risk-based premium system. Both NBB and BTC qualified for the minimum annual premium rate of $2,000 per year in 1996. Beginning in 1997, all banks, including NBB and BTC, will be subject to a higher FDIC assessment which will fund interest payments for bank issues to resolve problems associated with the savings and loan industry. This assessment will continue until 2018-2019. The assessment will vary over the period from 1.29 cents to 2.43 cents per $100 of deposits. Government Policies. The operations of NBB and BTC are affected not only by general economic conditions, but also by the policies of various regulatory authorities. In particular, the Federal Reserve Board regulates money and credit and interest rates in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of loans, investments and deposits and affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve Board monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future. Limits on Dividends and Other Payments. As a national bank, NBB, may not pay dividends from its capital; all dividends must be paid out of net profits then on hand, after deducting expenses, losses, bad debts, accrued dividends on preferred stock, if any, and taxes. In addition, a national bank is prohibited from declaring a dividend on its shares of common stock until its surplus equals its stated capital, unless there has been transferred to surplus no less than one-tenth of the bank's net profits of (i) the preceding two consecutive half- year periods (in the case of an annual dividend) or (ii) the preceding half-year period (in the case of a quarterly or semi-annual dividend). The approval of the OCC is required if the total of all dividends declared by a national bank in any calendar year exceeds the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus or to fund the retirement of preferred stock. The OCC has promulgated regulations that became effective on December 13, 1990, which significantly affect the level of allowable dividend payments for national banks. The effect is to make the calculation of national banks' dividend-paying capacity consistent with generally accepted accounting principles. The allowance for loan and lease losses will not be considered an element of "undivided profits then on hand" and provisions to the allowance are treated as expenses and therefore not part of "net profits." Accordingly, a national bank with an allowance greater than its statutory bad debts may not include the excess in calculating undivided profits for dividend purposes. Further, a national bank may be able to use a portion of its earned capital surplus account as "undivided profits then on hand," depending on the -13- composition of that account. As a state member bank subject to the regulations of the Federal Reserve Board, BTC must obtain the approval of the Federal Reserve Board for any dividend if the total of all dividends declared in any calendar year would exceed the total of its net profits, as defined by the Federal Reserve Board, for that year, combined with its retained net profits for the preceding two years. In addition, a state member bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts. For this purpose, bad debts are generally defined to include the principal amount of loans which are in arrears with respect to interest by six months or more, unless such loans are fully secured and in the process of collection. Moreover, for purposes of this limitation, a state member bank is not permitted to add the balance in its allowance for loan losses account to its undivided profits then on hand; however, it may net the sum of its bad debts as so defined against the balance in its allowance for loan losses account and deduct from undivided profits only bad debts as so defined in excess of that account. In addition, the Federal Reserve Board is authorized to determine, under certain circumstances relating to the financial condition of a state member bank, that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The payment of dividends that depletes a bank's capital base could be deemed to constitute such an unsafe or unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings. Virginia law also imposes restrictions on the ability of BTC to pay dividends. A Virginia state bank is permitted to declare a dividend out of its "net undivided profits", after providing for all expenses, losses, interest and taxes accrued or due by the bank. In addition, a deficit in capital originally paid in must be restored to its initial level, and no dividend can be paid which could impair the bank's paid in capital. The Bureau of Financial Institutions further has authority to limit the payment of dividends by a Virginia bank if it determines the limitation is in the public interest and is necessary to ensure the bank's financial soundness. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) provides that no insured depository institution may make any capital distribution (which would include a cash dividend) if, after making the distribution, the institution would not satisfy one or more of its minimum capital requirements. Capital Requirements. The Federal Reserve Board has adopted risk-based capital guidelines in final form which are applicable to Bankshares and BTC. The Federal Reserve Board guidelines redefine the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of risk-weighted assets. The minimum ratio of qualified total capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8.0%. At least half of the total capital must be comprised of Tier 1 capital for a minimum ratio of Tier 1 Capital to risk-weighted assets of 4.0%. The remainder may consist of a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The OCC has adopted similar regulations applicable to NBB. In addition, the Federal Reserve Board has established minimum leverage ratio (Tier 1 capital to total assets less intangibles) guidelines that are applicable to Bankshares and BTC. The OCC has adopted similar regulations applicable to -14- NBB. These guidelines provide for a minimum ratio of 3.0% for banks that meet certain specified criteria, including that they have the highest regulatory CAMEL rating and are not anticipating or experiencing significant growth and have well-diversified risk. All other banks will be required to maintain an additional cushion of at least 100 to 200 basis points, based upon their particular circumstances and risk profiles. The guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. Bank regulators from time to time have indicated a desire to raise capital requirements applicable to banking organizations beyond current levels. In addition, the number of risks which may be included in risk-based capital restrictions, as well as the measurement of these risks, is likely to change, resulting in increased capital requirements for banks. Bankshares, NBB and BTC are unable to predict whether higher capital ratios would be imposed and, if so, at what levels and on what schedule. Legislative Developments The difficulties encountered nationwide by financial institutions during 1990 and 1991 prompted federal legislation designed to reform the banking industry and to promote the viability of the industry and of the deposit insurance system. FDICIA, which became effective on December 19, 1991, bolsters the deposit insurance fund, tightens bank regulation and trims the scope of federal deposit insurance as summarized below. FDIC Funding. The legislation bolsters the bank deposit insurance fund with $70 billion in borrowing authority and increases to $30 billion from $5 billion the amount the FDIC can borrow from the U.S. Treasury to cover the cost of bank failures. The loans, plus interest, would be repaid by premiums that banks pay on domestic deposits over the next fifteen years. Prompt Corrective Action. Among other things, FDICIA requires the federal banking agencies to take "prompt corrective action" in respect to banks that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." If a bank does not meet all of the minimum capital ratios necessary to be considered adequately capitalized, it will be considered undercapitalized, significantly undercapitalized or critically undercapitalized, depending on the amount of the shortfall in its capital. 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 -15- implement an acceptable capital restoration plan, it can be subject to more severe sanctions, including an order to sell sufficient voting stock to become adequately capitalized. More severe sanctions and remedial actions can be mandated by the regulators if an institution is considered significantly or critically undercapitalized. In addition, FDICIA requires regulators to draft a new set of non-capital measures of bank safety, such as loan underwriting standards and minimum earnings levels. The legislation also requires regulators to perform annual on- site bank examinations, places limits on real estate lending by banks and tightens auditing requirements. In April 1995, the regulators adopted safety and soundness standards as required by FDICIA in the following areas: (i) operational and managerial; (ii) asset quality earnings and stock valuation; and (iii) employee compensation. Deposit Insurance. FDICIA reduces the scope of federal deposit insurance. The most significant change ended the "too big to fail" doctrine, under which the government protects all deposits in most banks, including those exceeding the $100,000 insurance limit. The FDIC's ability to reimburse uninsured deposits--those over $100,000 and foreign deposits--has been sharply limited. Since December 1993, the Federal Reserve Board's ability to finance undercapitalized banks with extended loans from its discount window has been restricted. In addition, only the best capitalized banks will be able to offer insured brokered deposits without FDIC permission or to insure accounts established under employee pension plans. As of September 29, 1996, "The Depository Insurance Fund Act of 1996" became law. This legislation provided for a one time assessment on banks that had previously acquired certain deposits from savings and loan institutions. Neither NBB or BTC were subject to that special assessment. Beginning in 1997, all banks will be subject to increased assessments that are designed to finally resolve problems associated with the savings and loan industry. Other legislative and regulatory proposals regarding changes in banking and the regulation of banks, thrifts and other financial institutions are periodically considered by the executive branch of the federal government, Congress and various state governments, including Virginia. New proposals, could significantly change the regulation of banks and the financial services industry. It cannot be predicted what might be proposed or adopted on how these proposals would affect the Company. Other Business Concerns The banking industry is particularly sensitive to interest rate fluctuations, as the spread between the rates which must be paid on deposits and those which may be charged on loans is an important component of profit. In addition, the interest which can be earned on a bank's invested funds has a significant effect on profits. Rising interest rates typically reduce the demand for new loans, particularly the real estate loans which represent a significant portion of NBB's and BTC's loan demand, as well as certain NBB loans in which BTC participates. -16- STATISTICAL DISCLOSURE BY NATIONAL BANKSHARES, INC. AND SUBSIDIARY (BANKSHARES) I. DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY; INTEREST ---------------------------------------------------------------------- RATES AND INTEREST DIFFERENTIAL ------------------------------- A. AVERAGE BALANCE SHEETS The following table presents, for the years indicated, condensed daily average balance sheet information. ($ in thousands) December 31, ASSETS 1996 1995 1994 ------ ---- ---- ---- Cash and due from banks $ 11,493 10,189 9,108 Federal funds sold 8,903 12,105 11,245 Securities available for sale: Taxable 65,992 41,695 40,023 Nontaxable 6,679 930 --- Securities held to maturity: Taxable 79,599 105,701 111,091 Nontaxable 25,133 35,668 34,251 Mortgage loans held for sale 850 723 995 Loans, net 177,419 159,920 152,976 Other assets 11,977 11,475 10,273 -------- ------- ------- Total assets $388,045 378,406 369,962 ======== ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Noninterest-bearing demand deposits $ 41,997 38,833 36,724 Interest-bearing demand deposits 76,017 77,545 77,182 Savings deposits 49,783 54,698 67,905 Time deposits 168,141 159,185 143,356 -------- ------- ------- Total deposits 335,938 330,261 325,167 Short-term borrowings 433 593 891 Other liabilities 2,215 1,826 1,502 -------- ------- ------- Total liabilities 335,586 332,680 327,560 Stockholders' equity 49,459 45,726 42,402 -------- ------- ------- Total liabilities and stockholders' equity $388,045 378,406 369,962 ======== ======= ======= -17- B. ANALYSIS OF NET INTEREST EARNINGS The following table shows the major categories of interest-earning assets and interest-bearing liabilities, the interest earned or paid, the average yield or rate on the daily average balance outstanding, net interest income and net yield on average interest-earning assets for the years indicated.
December 31, 1996 December 31, 1995 December 31, 1994 Average Average Average Average Yield/ Average Yield/ Average Yield/ ($ in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate ------- -------- ------- ------- -------- ------- ------- -------- ------- Interest-earning assets: Loans, net (1)(2)(3) $178,269 17,339 9.73% 160,643 15,897 9.90% 153,971 13,857 9.00% Taxable securities 145,591 8,877 6.10% 147,396 9,723 6.60% 151,114 9,966 6.60% Nontaxable securities (1) 31,812 2,971 9.34% 36,598 2,856 7.80% 34,251 2,910 8.50% Federal funds sold 8,903 567 6.37% 12,105 704 5.82% 11,245 450 4.00% -------- ------- ------- ------- ------- ------- Total interest- earning assets $364,575 29,754 8.16% 356,742 29,180 8.18% 350,581 27,183 7.75% ======== ======= ======= ======= ======= ======= Interest-bearing liabilities: Interest-bearing demand deposits $ 76,017 2,182 2.87% 77,545 2,353 3.03% 77,182 1,975 2.56% Savings deposits 49,783 1,646 3.31% 54,698 1,798 3.29% 67,905 2,613 3.85% Time deposits 168,141 9,181 5.46% 159,185 8,517 5.35% 143,356 6,060 4.23% Short-term borrowings 433 27 6.24% 593 35 5.90% 891 36 4.04% Long-term debt --- --- --- --- --- --- --- --- --- -------- ------- ------- ------- ------- ------- Total interest- bearing liabilities $294,374 13,036 4.43% 292,021 12,703 4.35% 289,334 10,684 3.69% ======== ======= ======= ======= ======= ======= Net interest income and interest rate spread 16,718 3.73% 16,477 3.83% 16,499 4.06% ======= ======= ======= Net yield on average interest-earning assets 4.59% 4.62% 4.71% (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 $374 in 1996, $305 in 1995 and $274 in 1994 are included in total interest income. (3) Nonaccrual loans are included in average balances for yield computations.
-18- C. ANALYSIS OF CHANGES IN INTEREST INCOME AND INTEREST EXPENSE The Company's primary source of revenue is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid on deposits and other funds. The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities and by changes in yields earned on interest-earning assets and rates paid on interest-bearing liabilities. The following table sets forth, for the years indicated, a summary of the changes in interest income and interest expense resulting from changes in average asset and liability balances (volume) and changes in average interest rates (rate).
1996 Over 1995 1995 Over 1994 Changes Due To Changes Due To Net Dollar Net Dollar ($ in thousands) Rates(2) Volume(2) Change Rates(2) Volume(2) Change -------- --------- ---------- -------- --------- ---------- Interest income:(1) Loans $ (276) 1,718 1,442 1,421 619 2,040 Taxable securities (728) (118) (846) 2 (245) (243) Nontaxable securities 518 (403) 115 (246) 192 (54) Federal funds sold 62 (199) (137) 217 37 254 ------ ------ ------ ------ ------ ------ Increase(decrease) in income on interest- earning assets $ (424) 998 574 1,394 603 1,997 ------ ------ ------ ------ ------ ------ Interest expense: Interest-bearing demand deposits $ (125) (46) (171) 369 9 378 Savings deposits 10 (162) (152) (349) (466) (815) Time deposits 178 486 664 1,736 721 2,457 Short-term borrowings 2 (10) (8) 13 (14) (1) ------ ------ ------ ------ ------ ------ Increase(decrease) in expense of interest- bearing liabilities $ 65 268 333 1,769 250 2,019 ------ ------ ------ ------ ------ ------ Increase (decrease) in net interest income $ (489) 730 241 (375) 353 (22) ====== ====== ====== ====== ====== ====== (1) Taxable equivalent basis using a Federal income tax rate of 34%. (2) Variances caused by the change in rate times the change in volume have been allocated to rate and volume changes proportional to the relationship of the absolute dollar amounts of the change in each.
-19- ANALYSIS OF INTEREST RATE SENSITIVITY The table below sets forth, as of December 31, 1996, the distribution of repricing opportunities of the Company's interest-earning assets and interest-bearing liabilities, the interest rate sensitivity gap (i.e., interest rate sensitive assets less interest rate sensitive liabilities), the cumulative interest rate sensitivity gap ratio (i.e., interest rate sensitivity gap divided by total interest-earning assets) and the cumulative interest rate sensitivity gap ratio. The table sets forth the time periods during which interest-earning assets and interest-bearing liabilities will mature or may reprice in accordance with their contracted terms. Certain shortcomings are inherent in the method of analysis presented in the following table. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees and at different times to changes in market interest rates. Also, loan prepayments and early withdrawals of certificates of deposit could cause the interest sensitivities to vary from those which appear on the table. An interest rate sensitivity gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would generally tend to affect adversely net interest income while a positive gap would generally tend to result in an increase in net interest income. During a period of declining interest rates, a negative gap would generally tend to result in increased net interest income, while a positive gap would generally tend to affect adversely net interest income. The Company's future earnings may be adversely affected by a sharp upturn in interest rates as Bankshares is liability sensitive for a period extending beyond one year. In a falling rate environment earnings might benefit to a certain degree from this position, because assets at higher rate levels would reprice downward at a slower rate than interest sensitive liabilities. Over the one to five year period, the Company's cumulative interest-sensitivity position reflects an asset sensitive position. This would mean the Company would benefit initially from falling rates but would be adversely affected by rising rates. This would depend, however, on the length of time rates were rising and falling and the length of time rates remained stable at the level ultimately reached. -20- An interest-sensitivity table showing all major interest sensitive asset and liability categories for the time intervals indicated and cumulative "gaps" for each interval is set forth on the following table.
INTEREST RATE December 31, 1996 SENSITIVITY TABLE (1) Interest-sensitive (days) 1-5 >5 ($ in thousands) 1-90 91-180 181-365 Years Years Total ---- ------ ------- ----- ----- ----- Interest-earning assets: Commercial and industrial loans $ 20,528 5,928 14,293 29,064 17,585 87,398 Real estate mortgage loans 1,475 4,407 9,481 14,625 13,434 43,422 Real estate construction loans 6,295 --- --- --- --- 6,295 Loans to individuals 19,367 2,828 5,242 29,150 1,855 58,442 -------- ------- ------- ------- ------- ------- Total loans, net of unearned income (2) $ 47,665 13,163 29,016 72,839 32,874 195,557 -------- ------- ------- ------- ------- ------- Federal funds sold $ 1,910 --- --- --- --- 1,910 Securities available for sale 24,587 9,250 2,750 13,300 12,647 62,534 Securities held to maturity 21,265 16,800 7,175 38,548 24,922 108,710 Mortgage loans held for sale 516 --- --- --- --- 516 -------- ------- ------- ------- ------- ------- Total interest-earning assets $ 95,943 39,213 38,941 124,687 70,443 369,227 ======== ======= ======= ======= ======= ======= Interest-bearing liabilities: Interest-bearing demand deposits $ 73,804 --- --- --- --- 73,804 Savings deposits 48,164 --- --- --- --- 48,164 Time deposits 42,042 26,977 52,905 46,455 141 168,520 Other borrowings 627 --- --- --- --- 627 -------- ------- ------- ------- ------- --- ------- Total interest-bearing liabilities $164,637 26,977 52,905 46,455 141 291,115 ======== ======= ======= ======= ======= ======= Cumulative ratio of interest- sensitive assets to interest- sensitive liabilities 0.58 0.71 0.71 1.03 1.27 1.27 ======== ======= ======= ======= ======= ======= Cumulative interest-sensitivity gap $(68,694) (56,458) (70,422) 7,810 78,112 78,112 ======== ======= ======= ======= ======= ======= (1) The Company is sensitive to interest rate changes, as liabilities generally reprice or mature before interest-earning assets. The above gap table reflects the Company's rate-sensitive position at December 31, 1996, and is not necessarily reflective of its position throughout the year. The carrying amounts of interest-rate sensitive assets and liabilities are presented in the periods in which they reprice to market rates or mature and are summed to show the interest-rate sensitivity gap. (2) Excludes nonaccrual loans.
-21- II. INVESTMENT PORTFOLIO A. BOOK VALUE OF INVESTMENTS The amortized costs and fair values of securities available for sale as of December 31, 1996, 1995 and 1994 were as follows:
December 31, 1996 1995 1994 AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR ($ in thousands) COSTS VALUES COSTS VALUES COSTS VALUES --------- ------ --------- ------ --------- ------ Securities available for sale: U.S. Treasury $ 8,740 8,790 14,991 15,322 5,497 5,237 U.S. Government agencies and corporations 33,840 33,640 42,586 42,809 26,887 24,942 States and political subdivisions 8,868 8,619 7,613 7,567 --- --- Mortgage-backed securities (1) 4,568 4,452 4,748 4,645 4,802 4,402 Other securities 7,074 7,033 5,505 5,527 1,686 1,638 ------- ------ ------ ------ ------ ------ Total securities available for sale $62,910 62,534 75,443 75,870 38,872 36,219 ======= ====== ====== ====== ====== ====== The amortized costs of securities held to maturity as of December 31, 1996, 1995 and 1994 were as follows: December 31, ($ in thousands) 1996 1995 1994 ---- ---- ---- Securities held to maturity: U.S. Treasury $ 11,547 19,330 35,317 U.S. Government agencies and corporations 54,804 49,938 66,192 States and political subdivisions 34,144 36,428 38,482 Mortgage-backed securities (1) 767 961 1,147 Other securities 7,448 5,108 6,874 -------- ------- ------- Total securities held to maturity $108,710 111,765 148,012 ======== ======= ======= (1) The majority of Mortgage-backed Securities and Collateralized Mortgage Obligations held at December 31, 1996 were backed by U.S. agencies. Certain holdings are required to be periodically subjected to the Financial Institution Examination Council's (FFIEC) high risk mortgage security test. These tests address possible fluctuations in the average life and price sensitivity which are the primary risks associated with this type of security. Such tests are usually subject to regulatory review. Except for U.S. Government securities, the Company has no securities with any issuer that exceeds 10% of stockholders' equity.
-22- B. MATURITIES AND ASSOCIATED YIELDS The following table presents the maturities for those securities available for sale and held to maturity as of December 31, 1996 and weighted average yield for each range of maturities.
Maturities and Yields December 31, 1996 ($ in thousands except for % data) < 1 Year 1-5 Years 5-10 Years > 10 Years None Total -------- --------- ---------- ---------- ---- ----- Available for Sale ------------------ U.S. Treasury $ 2,006 3,339 3,445 --- --- $ 8,790 6.99% 6.87% 6.06% --- --- 6.58% U.S. Agencies 3,442 16,344 13,363 491 --- 33,640 5.02% 5.99% 7.01% 7.41% --- 6.32% Mortgage-backed securities 315 28 2,896 1,213 --- 4,452 6.06% 7.24% 5.99% 5.86% --- 5.97% Taxable Securities --- --- 1,557 806 --- 2,363 --- --- 6.67% 7.63% --- 6.98% Nontaxable Securities --- 351 4,906 999 --- 6,256 --- 6.15% 6.95% 7.20% --- 6.95% Corporate 1,001 2,214 1,487 1,523 --- 6,225 5.58% 6.39% 6.79% 7.07% --- 6.53% Other securities --- --- --- --- 808 808 --- --- --- --- 7.03% 7.03% ------ ------ ------ ------ ------ ------- Total 6,764 22,276 27,654 5,032 808 62,534 5.73% 6.16% 6.74% 6.91% 7.03% 6.24% ====== ====== ====== ====== ====== ======= Held To Maturity ---------------- U.S. Treasury 5,003 4,022 2,522 --- --- 11,547 6.08% 4.91% 5.58% --- --- 5.56% U.S. Agencies 10,598 32,732 10,974 500 --- 54,804 5.15% 6.02% 6.73% 8.07% --- 6.02% Mortgage-backed securities --- 394 373 --- --- 767 --- 8.00% 7.97% --- --- 7.99% Taxable Securities 210 605 1,329 495 --- 2,639 8.47% 6.48% 6.97% 7.45% --- 7.07% Nontaxable Securities 2,571 13,519 13,110 2,305 --- 31,505 9.00% 7.67% 7.67% 8.30% --- 7.79% Corporate 251 3,527 1,961 460 --- 6,199 8.05% 6.49% 7.15% 7.45% --- 6.83% Other securities 148 694 210 197 --- 1,249 7.52% 5.87% 9.41% 8.99% --- 7.16% ------ ------ ------ ------ ------ ------- Total 18,781 55,493 30,479 3,957 --- 108,710 6.02% 6.39% 7.08% 8.10% --- 6.45% ====== ====== ====== ====== ====== ======= (1) Rates shown represent weighted average yield on a fully taxable basis.
-23- 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, 1996. A. TYPES OF LOANS December 31, ($ in thousands) 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Commercial and industrial loans $ 87,519 59,609 59,213 67,359 69,984 Real estate mortgage loans 43,917 45,589 44,447 40,236 42,771 Real estate construction loans 6,295 6,007 5,643 3,967 4,062 Loans to individuals 60,991 56,920 52,031 43,084 37,349 -------- ------- ------- ------- ------- Total loans 198,722 168,125 161,334 154,646 154,166 Less unearned income (2,549) (2,307) (2,494) (1,907) (1,284) -------- ------- ------- ------- ------- Total loans, net of unearned income 196,173 165,818 158,840 152,739 152,882 Less allowance for loans losses (2,575) (2,625) (2,551) (2,583) (2,327) -------- ------- ------- ------- ------- Total loans, net $193,598 163,193 156,289 150,156 150,555 ======== ======= ======= ======= ======= B. MATURITIES AND INTEREST RATE SENSITIVITIES December 31, 1996 After ($ in thousands) <1 Year 1-5 Years 5 Years Total ------- --------- ------- ----- Commercial and industrial $41,255 29,366 16,898 87,519 Real estate construction 6,295 --- --- 6,295 Less loans with predetermined interest rates (8,640) (9,616) (14,443) (32,699) ------- ------- ------- ------- Loans with adjustable rates $38,910 19,750 2,455 61,115 ======= ======= ======= ======= -24- C. RISK ELEMENTS 1. Nonaccrual, Past Due and Restructured Loans The following table presents aggregate amounts for nonaccrual loans, restructured loans, other real estate owned, net and accruing loans which are contractually past due ninety days or more as to interest or principal payments. December 31, ($ in thousands) 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Nonaccrual loans: Commercial and industrial $ 121 270 --- 710 483 Real estate mortgage 495 418 390 1,123 884 Real estate construction --- --- --- --- --- Loans to individuals --- 30 30 31 23 ------ ----- ----- ----- ----- $ 616 718 420 1,864 1,390 ------ ----- ----- ----- ----- Restructured loans: Commercial and industrial --- --- 229 598 --- ------ ----- ----- ----- ----- Total nonperforming loans $ 616 718 649 2,462 1,390 Other real estate owned, net 474 762 1,150 225 837 ------ ----- ----- ----- Total nonperforming assets $1,090 1,480 1,799 2,687 2,227 ====== ===== ===== ===== ===== Accruing loans past due 90 days or more: Commercial and industrial $ 14 11 4 45 144 Real estate mortgage 252 250 219 198 377 Real estate construction --- --- 87 243 237 Loans to individuals 192 313 180 128 144 ------ ----- ----- ----- ----- $ 458 574 490 614 902 ====== ===== ===== ===== ===== The effect of nonaccrual and restructured loans on interest income is presented below: ($ in thousands) 1996 1995 1994 ---- ---- ---- Scheduled interest: Nonaccrual loans $ 68 59 38 Restructured loans --- --- 19 ---- ---- ---- Total scheduled interest $ 68 59 57 ---- ---- ---- Recorded interest: Nonaccrual loans $ 24 5 1 Restructured loans --- --- 9 ---- ---- ---- Total recorded interest $ 24 5 10 ==== ==== ==== -25- Interest is recognized on the cash basis for all loans carried in nonaccrual status. Loans generally are placed in nonaccrual status when the collection of principal or interest is ninety days or more past due, unless the obligation is both well-secured and in the process of collection. 2. Potential Problem Loans At December 31, 1996, the recorded investment in loans which have been identified as impaired loans totaled $725,000. Of this amount, $354,000 related to loans with no valuation allowance and $371,000 related to loans with a corresponding valuation allowance of $290,000. For the year-ended December 31, 1996, the average recorded investment in impaired loans was approximately $800,000 and the total interest income recognized on impaired loans was $33,000 of which $23,000 was recognized on a cash basis. At December 31, 1995, the recorded investment in loans which have been identified as impaired loans totaled $837,000. Of this amount, $133,000 related to loans with no valuation allowance and $704,000 related to loans with a corresponding valuation allowance of $419,000. For the year ended December 31, 1995, the average recorded investment in impaired loans was approximately $906,000, and the total interest income recognized on impaired loans was $47,000 of which $5,000 was recognized on a cash basis. The balance of impaired loans at January 1, 1995 totaled approximately $812,000. The initial adoption of SFAS No. 114 did not require an increase to the Company's allowance for loan losses. The impact of SFAS No. 114, as amended by SFAS No. 118, was immaterial to the Company's consolidated financial statements as of and for the year ended December 31, 1995. 3. Foreign Outstandings At December 31, 1996, 1995 and 1994, there were no foreign outstandings. 4. Loan Concentrations The Company does a general banking business, serving the commercial, agricultural and personal banking needs of its customers. NBB's trade territory, commonly referred to as the New River Valley, consists of Montgomery and Giles Counties, Virginia and portions of adjacent counties. NBB's operating results are closely correlated with the economic trends within this area which are, in turn, influenced by the area's three largest employers, Virginia Polytechnic Institute and State University, Montgomery County Schools and Hoechst-Celanese. Other industries include a wide variety of manufacturing, retail and service concerns. Most of BTC's business originates from the communities of Tazewell and Bluefield and other communities in Tazewell County, Virginia and in Mercer County, West Virginia. BTC's service area has largely depended on the coal mining industry and farming for its economic base. In recent years, coal companies have mechanized and reduced the number of persons engaged in the -26- production of coal. There are still a number of support industries for the coal mining business that continue to provide employment in the area. Additionally, several new businesses have been established in the area and Bluefield, West Virginia has begun to emerge as a regional medical center. The ultimate collectibility of the loan portfolios and the recovery of the carrying amounts of repossessed property are susceptible to changes in the market conditions of these areas. At December 31, 1996 and 1995, approximately $71 million and $52 million, respectively, of the loan portfolio were concentrated in commercial real estate. This represents approximately 36% and 34% of the loan portfolio at December 31, 1996 and 1995, respectively. Included in commercial real estate at December 31, 1996 and 1995 was approximately $49 million and $25 million, respectively, in loans for college housing and professional office buildings. Loans for the purpose of acquiring residential real estate were approximately $60 million and $56 million at December 31, 1996 and 1995, respectively. This represents approximately 31% and 34% of the loan portfolio at December 31, 1996 and 1995, respectively. Loans primarily for the purpose of purchasing automobiles were approximately $29 million and $25 million at December 31, 1996 and 1995, respectively. This represents approximately 15% of the loan portfolio at December 31, 1996 and 1995. The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property and with loan amounts established based on certain percentage limitations of the property's total stated or appraised value. Credit approval is primarily a function of collateral and the evaluation of the creditworthiness of the individual borrower or project based on available financial information. -27- IV. SUMMARY OF LOAN LOSS EXPERIENCE ------------------------------- A. ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES The following tabulation shows average loan balances at the end of each period; changes in the allowance for loan losses arising from loans charged off and recoveries on loans previously charged off by loan category; and additions to the allowance which have been charged to operating expense:
December 31, ($ in thousands) 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Average loans outstanding $177,419 159,920 152,976 149,027 153,487 ======== ======= ======= ======= ======= Balance at beginning of year 2,625 2,551 2,583 2,327 2,121 Charge-offs: Commercial and industrial loans 95 23 72 231 441 Real estate mortgage loans 11 9 192 285 198 Real estate construction loans --- --- 53 --- --- Loans to individuals 400 259 322 246 406 -------- ------- ------- ------- ------- Total loans charged off 506 291 639 762 1,045 -------- ------- ------- ------- ------- Recoveries: Commercial and industrial loans 4 10 7 10 17 Real estate mortgage loans 64 16 4 5 --- Real estate construction loans --- --- --- --- --- Loans to individuals 57 57 43 50 26 -------- ------- ------- ------- ------- Total recoveries 125 83 54 65 43 -------- ------- ------- ------- ------- Net loans charged off 381 208 585 697 1,002 -------- ------- ------- ------- ------- Additions charged to operations 331 282 553 953 1,208 -------- ------- ------- ------- ------- Balance at end of year 2,575 2,625 2,551 2,583 2,327 ======== ======= ======= ======= ======= Net charge-offs to average loans outstanding 0.21% 0.13% 0.38% 0.47% 0.65% ======== ======= ======= ======= ======= 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.
-28- 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, 1996 1995 1994 1993 1992 Percent Percent Percent Percent Percent of of of of of Loans in Loans in Loans in Loans in Loans in Each Each Each Each Each Category Category Category Category Category ($ in Allowance to Total Allowance to Total Allowance to Total Allowance to Total Allowance to Total thousands) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans --------- -------- --------- -------- --------- -------- --------- -------- --------- -------- Commercial and industrial loans $ 403 44.04% 411 35.46% 679 36.70% 860 43.56% 873 45.40% Real estate mortgage loans 305 22.10% 363 27.12% 364 27.55% 373 26.02% 416 27.74% Real estate construction loans 51 3.17% 100 3.57% 37 3.50% 54 2.56% 50 2.63% Loans to individuals 504 30.69% 271 33.85% 569 32.25% 685 27.86% 567 24.23% Unallocated 1,312 1,480 902 611 421 ------ ------ ------ ------ ------ $2,575 100.00% 2,625 100.00% 2,551 100.00% 2,583 100.00% 2,327 100.00% ======= ====== ====== ====== ======
-29- V. DEPOSITS -------- A. AVERAGE AMOUNTS OF DEPOSITS AND AVERAGE RATES PAID Average amounts and average rates paid on deposit categories in excess of 10% of average total deposits are presented below: December 31, 1996 1995 1994 Average Average Average Average Rates Average Rates Average Rates ($ in thousands) Amounts Paid Amounts Paid Amounts Paid ------- ------- ------- ------- ------- ------- Noninterest-bearing demand deposits $ 41,997 --- 38,833 --- 36,724 --- Interest-bearing demand deposits 76,017 2.87% 77,545 3.03% 77,182 2.56% Savings deposits 49,783 3.31% 54,698 3.29% 67,905 3.85% Time deposits 168,141 5.46% 159,185 5.35% 143,356 4.23% -------- ------- ------- Average total deposits $335,938 4.43% 330,261 4.35% 325,167 3.69% ======== ======= ======= B. TIME DEPOSITS OF $100,000 OR MORE The following table sets forth time certificates of deposit and other time deposits of $100,000 or more: DECEMBER 31, 1996 Over 3 Over 6 3 Months Months Months Through 6 Through 12 Over 12 ($ in thousands) or Less Months Months Months Total ------- --------- ---------- ------- ----- Certificates of deposit $11,314 3,431 12,682 6,322 33,749 Other time deposits 292 105 --- 3,268 3,665 ------- ------ ------- ------ ------ Total time deposits of $100,000 or more $11,606 3,536 12,682 9,590 37,414 ======= ====== ======= ====== ====== -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, 1996 1995 1994 ---- ---- ---- Return on average assets 1.58% 1.46% 1.43% Return on average equity 12.37% 12.08% 12.51% Dividend payout ratio 37.55% 37.32% 37.13% Average equity to average assets 12.75% 12.08% 11.46% Item 2. Properties - ------------------- Bankshares' headquarters, including the Main Office of NBB, are located at 100 South Main Street, Blacksburg, Virginia. In addition to the Main Office location, NBB owns six branch offices: two in the Town of Blacksburg; one in the Town of Christiansburg; one in Montgomery County; one in the Town of Pearisburg; and the sixth in the Town of Pembroke. An additional branch in the Rich Creek area of Giles County is expected to open in the second quarter of 1997. NBB leases office space near the Main Office which is occupied by NBB's trust, marketing, audit, compliance and credit review departments. An additional property was acquired in 1996 to provide for additional office space, reducing the need for leased properties. Bank of Tazewell County owns the land and building of six of its seven offices. The bank leases the land and building for its seventh office. The Main Office is located at Main Street, Tazewell, Virginia. Three additional branches are located in Tazewell, one in North Tazewell and two are located in Bluefield, Virginia. Management believes that its existing facilities are adequate to meet present needs and any anticipated growth. NBB owns all its computer and data processing hardware and is a licensee of the software it utilizes. BTC also owns all of its computer and data processing hardware and is a licensee of the software it utilizes. This allows each bank to perform its data processing functions in-house. Management anticipates that with the constantly changing technological environment that significant future capital expenditures will be necessary. Item 3. Legal Proceedings - -------------------------- Bankshares, NBB nor BTC are currently involved in any material pending legal proceedings, other than routine litigation incidental to NBB's and BTC's banking business. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ There were no matters submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1996. -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 8, 1997. 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 52 President and Chief 1986 Executive Officer, National Bankshares, Inc.; and President and Chief Executive Officer of The National Bank of Blacksburg since 1983. F. Brad Denardo 44 Corporate Officer, National 1989 Bankshares, Inc.; and Executive Vice President since 1989 and Senior Vice President - Loans since 1985 of The National Bank of Blacksburg. Marilyn B. Buhyoff 48 Secretary & Counsel, 1989 National Bankshares, Inc.; and Senior Vice President - Administration since 1992, Vice President/Administra- tion since 1990 and Personnel Officer since 1987 of The National Bank of Blacksburg. Joan C. Nelson 46 Treasurer, National 1993 Bankshares, Inc.; and Cashier since 1993, Senior Vice President/ Operations since 1989 and Vice President/Operations since 1986 of the National Bank of Blacksburg. The executive officers listed above have served Bankshares and/or its subsidiaries in the aforementioned executive capacity for the past five years. -32- PART II ------- Item 5. Market for Registrant's Common Equity and Related Stockholder Matters - ---------------------------------------------------------- There is no established trading market for the stock of National Bankshares, Inc. As of March 14, 1997, the total number of holders of the Registrant's common stock was 1,184. Information concerning Market Price and Dividend Data is set forth under "Common Stock Information and Dividends" on page 13 of Bankshares' 1996 Annual Report to Stockholders and is incorporated herein by reference. Item 6. Selected Financial Data - -------------------------------- The table entitled "Selected Consolidated Financial Data" on page 7 of Bankshares' 1996 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 8 through 17 of Bankshares' 1996 Annual Report to Stockholders is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The following consolidated financial statements of the Registrant and the Independent Auditors' Report set forth on pages 19 through 43 of Bankshares' 1996 Annual Report to Stockholders are incorporated herein by reference: 1. Independent Auditors' Report 2. Consolidated Balance Sheets - December 31, 1996 and 1995 3. Consolidated Statements of Income - Years Ended December 31, 1996, 1995 and 1994 4. Consolidated Statements of Changes in Stockholders' Equity - Years Ended December 31, 1996, 1995 and 1994 5. Consolidated Statements of Cash Flows - Years Ended December 31, 1996, 1995 and 1994 6. Notes to Consolidated Financial Statements - December 31, 1996, 1995 and 1994 -33- 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, 1996 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, 1997, which information is incorporated herein by reference. Item 11. Executive Compensation - -------------------------------- The information set forth under "Executive Compensation" on pages 5 through 9 of Bankshares' Proxy Statement dated March 14, 1997 is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------ The information set forth under "Voting Securities and Stock Ownership" on page 1 and under "Election of Directors" on pages 2 through 4 of Bankshares' Proxy Statement dated March 14, 1997 is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------- The information contained under "Certain Transactions With Officers and Directors" on page 11 through 12 of Bankshares' Proxy Statement dated March 14, 1997 is incorporated herein by reference. -34- 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: 1996 Annual Report To Stockholders Page(s)* 1. Financial Statements: -------------------- Independent Auditors' Report 19 Consolidated Balance Sheets - December 31, 1996 and 1995 20 Consolidated Statements of Income - Years ended December 31, 1996, 1995 and 1994 21 Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 1996, 1995 and 1994 22 Consolidated Statements of Cash Flows - Years ended December 31, 1996, 1995 and 1994 23 Notes to Consolidated Financial Statements - December 31, 1996, 1995 and 1994 24-43 2. Financial Statement Schedules: ----------------------------- Independent Auditor's Report of Cook & Associates, LLP covering the financial statements of Bank of Tazewell County as of and for the years ended December 31, 1995 and 1994, is filed as an Exhibit and is incorporated by reference herein. Exhibit 99 * Incorporated by reference from the indicated pages of the 1996 Annual Report to Stockholders. -35- 3. Exhibits: -------- PAGE NO. IN EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM ----------- ----------- ----------------- 3(i) Articles of Incorporation, as (incorporated amended, of National herein by Bankshares, Inc. reference to Exhibit 3(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 3(ii) Bylaws, as amended, of National 41 Bankshares, Inc. 4(i) Specimen copy of certificate (incorporated for National Bankshares, Inc. herein by common stock, $2.50 par value reference to Exhibit 4(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 4(i) Article Four of the Articles of (incorporated Incorporation of National herein by Bankshares, Inc. included in reference to Exhibit No. 3(a)) Exhibit 4(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 10(ii)(B) Computer software license (incorporated agreement dated June 18, 1990, herein by by and between Information reference to Technology, Inc. and The Exhibit 10(e) of National Bank of Blacksburg the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) Employment Agreement dated (incorporated January 1, 1992, by and between herein by National Bankshares, Inc. and reference to James G. Rakes Exhibit 10(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) Capital Accumulation Plan (incorporated (included in Exhibit No. 10(a)) herein by reference to Exhibit 10(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) -36- PAGE NO. IN EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM ----------- ----------- ----------------- *10(iii)(A) Employee Lease Agreement dated (incorporated May 7, 1992, by and between herein by National Bankshares, Inc. and reference to The National Bank of Blacksburg Exhibit 10(c) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) 13(i) 1996 Annual Report to 53 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 107 Bankshares, Inc. 27 Financial Data Schedule 108 99 Independent Auditor's Report of 109 Cook & Associates, LLP on financial statements of Bank of Tazewell County as of and for the years ended December 31, 1995 and 1994 * Indicates a management contract or compensatory plan required to be filed herein. (b) Reports on Form 8-K filed during the last quarter of the period covered by this report: ------------------------------------------------------------------------ None. (c) Exhibits required by Item 601 of Regulation S-K: ----------------------------------------------- See Item 14(a)3 above. (d) Financial Statement Schedules required by Regulation S-X: -------------------------------------------------------- See Item 14(a)2 above. -37- SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, National Bankshares, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NATIONAL BANKSHARES, INC. BY: /s/James G. Rakes ------------------------------ James G. Rakes, President and Chief Executive Officer DATE: March 28, 1997 ------------------------------ BY: /s/Joan C. Nelson ------------------------------ Joan C. Nelson Treasurer DATE: March 28, 1997 ------------------------------ Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the date indicated. NAME DATE TITLE ---- ---- ----- /s/C. L. Boatwright March 28, 1997 Director and Vice ------------------------ -------------- Chairman of the Board C. L. BOATWRIGHT /s/T. C. Bowen, Jr. March 28, 1997 Director ------------------------ -------------- T. C. BOWEN, JR. /s/A. A. Crouse March 28, 1997 Director ------------------------ -------------- A. A. CROUSE /s/R. E. Christopher, Jr. March 27, 1997 Director and Chairman of ------------------------ -------------- the Board R. E. CHRISTOPHER, JR. /s/R. E. Dodson March 28, 1997 Director ------------------------ -------------- R. E. DODSON Director ------------------------ -------------- P. A. DUNCAN /s/W. T. Peery March 28, 1997 Director ------------------------ -------------- W. T. PEERY /s/J. G. Rakes March 28, 1997 President and Chief ------------------------ -------------- Executive Officer - J. G. RAKES National Bankshares, Inc. /s/J. R. Stewart March 27, 1997 Director ------------------------ -------------- J. R. STEWART -38- INDEX TO EXHIBITS ----------------- PAGE NO. IN EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM ----------- ----------- ----------------- 3(i) Articles of Incorporation, as (incorporated amended, of National Bankshares, herein by Inc. reference to Exhibit 3(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 3(ii) Bylaws, as amended of National 41 Bankshares, Inc. 4(i) Specimen copy of certificate for (incorporated National Bankshares, Inc. common herein by stock, $2.50 par value reference to Exhibit 4(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 4(i) Article Fourth of the Articles (incorporated of Incorporation of National herein by Bankshares, Inc. included in reference to Exhibit No. 3(a)) Exhibit 4(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1993) 10(ii)(B) Computer software license (incorporated agreement dated June 18, 1990, herein by by and between Information reference to Technology, Inc. and The Exhibit 10(e) of National Bank of Blacksburg the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) Employment Agreement dated (incorporated January 1, 1992, by and between herein by National Bankshares, Inc. and reference to James G. Rakes Exhibit 10(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) -39- PAGE NO. IN EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM ----------- ----------- ----------------- *10(iii)(A) Capital Accumulation Plan (incorporated (included in Exhibit No. 10(a)) herein by reference to Exhibit 10(b) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) *10(iii)(A) Employee Lease Agreement dated (incorporated May 7, 1992, by and between herein by National Bankshares, Inc. and reference to The National Bank of Blacksburg Exhibit 10(c) of the Annual Report on Form 10K for fiscal year ended December 31, 1992) 13(i) 1996 Annual Report to 53 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 107 Bankshares, Inc. 27 Financial Data Schedule 108 99 Independent Auditor's Report of 109 Cook & Associates, LLP on financial statements of Bank of Tazewell County as of and for the years ended December 31, 1995 and 1994 * Indicates a management contract or compensatory plan required to be filed herein. -40- EX-3.(II) 2 AMENDED BYLAWS EXHIBIT NO. 3(ii) - ----------------- AMENDED AND RESTATED BYLAWS OF NATIONAL BANKSHARES, INC. BLACKSBURG, VIRGINIA Adopted November 24, 1993 Amended May 29, 1996 -41- ARTICLE I. SHAREHOLDERS SECTION 1.1. Annual Meeting. -------------- The annual meeting of the shareholders to elect directors and for the transaction of such other business as may properly come before the meeting shall be held on the second Tuesday in April of each year or, if such date falls on a legal holiday, the next business day. SECTION 1.2. Special Meetings. ---------------- Special meetings of shareholders may be called by the Chairman of the Board of Directors, the President or by a majority of the Board of Directors. Business transacted at all special meetings shall be confined to the purpose(s) stated in the notice. SECTION 1.3. Place of Meeting. ---------------- The Board of Directors (the "Board") may designate any place inside or outside Virginia for any annual or special meeting of the shareholders. If no designation is made, the meeting will be at the principal office of the Corporation. SECTION 1.4. Notice of Meeting. ----------------- Except as otherwise required by the Virginia Stock Corporation Act, as now in effect or hereafter from time to time amended (the "Act"), written notice stating the time and location of the meeting, and, in case of a special meeting, the purpose(s) of the meeting, shall be delivered not less than ten nor more than sixty days before the meeting date, either personally or by mail, to each shareholder of record entitled to vote at such meeting. If mailed, the notice will be deemed to be delivered when deposited in the United States mail, postage prepaid, addressed to the shareholder at his address as it appears on the stock transfer books of the Corporation. SECTION 1.5. Closing of Transfer Books or Fixing of Record Date. -------------------------------------------------- For the purpose of determining shareholders entitled to notice of or vote at any shareholders' meeting, or any adjournment thereof, or entitled to receive payment of any dividend, or in order to determine shareholders for any other proper purpose, the Board may close the stock transfer books for a stated period not to exceed seventy days. If the stock transfer books are closed to determine shareholders entitled to notice of or vote at a shareholders' meeting, such books shall be closed for at least ten days immediately preceding such meeting. In lieu of closing the stock transfer books, the Board may fix in advance a date as the record date for a determination of shareholders, such date to be not more than seventy days, and in case of a shareholders' meeting, not less than ten days, prior to the date on which the particular action requiring a determination of shareholders is to be taken. If the stock transfer books are not closed and no record date is fixed for the determination of -42- shareholders entitled to notice of or vote at a shareholders' meeting, or shareholders entitled to receive payment of a dividend, the day before the notice of the meeting is mailed or the date on which the resolution of the Board declaring such dividend is adopted, as the case may be, shall be the record date for the determination of shareholders. Any determination of shareholders entitled to vote at a shareholders' meeting made as provided in this Section shall apply to any adjournment thereof, unless the Board fixes a new record date, which it shall do if the meeting is adjourned to a date more than 120 days after the date fixed for the original meeting. SECTION 1.6. Presiding Officer and the Secretary. ----------------------------------- The Chairman or the President, or, in their absence, an officer designated by the Board, shall preside at all shareholder meetings, and the Secretary shall serve as secretary. Otherwise, a chairman or secretary shall be elected by a majority vote of the shareholders present to act in the absence of those officers. SECTION 1.7. Voting Lists. ------------ The Secretary or other person having charge of the stock transfer books of the Corporation shall make, at least ten days before each shareholders' meeting, a complete list of the shareholders entitled to vote at such meeting, or any adjournment thereof, with the address of and the number of shares held by each, which list, for a period of ten days prior to such meeting, shall be kept on file at the registered office of the Corporation and shall be subject to inspection by any shareholder at any time during usual business hours, subject to any limitations on such right provided by the Act or other provisions of law. Such list shall also be produced and kept open at the time and place of the meeting for inspection by any shareholder during the whole time of the meeting for the purposes thereof. The original stock transfer book is "prima facie" evidence as to the shareholders who are entitled to examine such list or transfer books or to vote at any shareholders' meeting. SECTION 1.8. Quorum. ------ Unless otherwise provided in the Corporation's Articles of Incorporation (the "Articles"), a majority of the outstanding shares of the Corporation entitled to vote, represented in person or by proxy, shall constitute a quorum at a shareholders' meeting. If less than a quorum is present at a meeting, a majority of the shares so represented may adjourn the meeting from time to time without further notice. At such adjourned meeting at which a quorum is present or represented, any business may be transacted which might have been transacted at the original meeting. The affirmative vote of the majority of the shares represented at the meeting and entitled to vote on the subject matter shall be the act of the shareholders, unless the vote of a greater number is required by the Act or the Articles, and except that in the election of directors those receiving the greatest number of votes shall be deemed elected, even though not receiving a majority. -43- SECTION 1.9. Proxies. ------- At all meetings of shareholders, a shareholder may vote by proxy executed in writing by the shareholder or by his duly authorized attorney in fact. Such proxy shall be filed with the Secretary before or at the meeting. No proxy shall be valid after eleven months from the date of its execution, unless otherwise provided in the proxy. SECTION 1.10. Action by Shareholders Without a Meeting. ---------------------------------------- Any action required to be taken at a meeting of the shareholders of the Corporation, or any action which may be taken at a meeting of the shareholders, may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the shareholders entitled to vote with respect to the subject matter thereof. SECTION 1.11. Shareholder Proposals or Nominations. ------------------------------------ No business shall be transacted at any meeting of shareholders, except such business as shall be (a) specified in the notice of meeting given as provided in Section 1.4 of this Article I; (b) otherwise brought before the meeting by or at the direction of the Board; or (c) otherwise brought before the meeting by a shareholder of record of the Corporation entitled to vote at the meeting in compliance with the procedure set forth in this Section 1.11. For business to be brought before a meeting by a shareholder pursuant to (c) above, the shareholder must have given timely notice in writing to the President of the Corporation. To be timely, a shareholder's notice shall be delivered to, or mailed and received at, the principal executive offices of the Corporation not less than sixty days nor more than ninety days prior to the meeting; provided, however, in the event that less than seventy days' notice or prior public disclosure of the date of the meeting is given or made to shareholders, notice by the shareholder to be timely must be so received not later than the close of business on the tenth day following the day on which such notice of the date of the meeting or such public disclosure was made. Notice shall be deemed to have been given more than seventy days in advance of an annual meeting of shareholders if the annual meeting is called on the date indicated by Section 1.1 of this Article I without regard to when public disclosure thereof is made. Notice of actions to be brought before a meeting pursuant to (c) above shall set forth, as to each matter the shareholder proposes to bring before the meeting; (a) a brief description of the business desired to be brought before the meeting and the reasons for bringing such business before the meeting; and (b) as to the shareholder giving the notice, (i) the name and address, as they appear on the Corporation's books, of such shareholder, (ii) the classes and number of shares of the Corporation which are owned of record or beneficially by such shareholder, and (iii) any material interest of such shareholder in such business other than his interest as a shareholder of the Corporation. Notwithstanding anything in these Bylaws to the contrary, no business shall be conducted on a shareholder proposal or nomination except in accordance with the provisions set forth in this Section 1.11. The requirements of this Section are in addition to any other requirements established by law and do not impair the effect of the requirements of Section 1.2 of these Bylaws relating to business permitted to be transacted at special shareholders' meetings. The -44- Chairman of the meeting shall, if the facts warrant, determine and declare to the meeting that any business was not properly brought before the meeting in accordance with the provision prescribed by these ByLaws and, if he should so determine, he shall so declare to the meeting and any such business not so properly brought before the meeting shall not be transacted. ARTICLE II. BOARD OF DIRECTORS SECTION 2.1. General Powers. -------------- The business and affairs of the Corporation shall be managed and administered by the Board of Directors. Except as limited by the Act, all corporate powers shall be vested in and exercised by the Board. SECTION 2.2. Number, Tenure and Qualifications. --------------------------------- The number of directors of the Corporation shall be nine. The number of directors may be increased or decreased from time to time by amendment of these Bylaws within the variable range established by the Articles. At each annual meeting of shareholders, the number of directors equal to the number of the class whose term expires at the time of such meeting shall be elected to hold office until the third succeeding annual meeting and until their successors shall have been elected and qualify. Directors reaching the age of 73 shall be ineligible for renomination to the Board of Directors of the Corporation at the expiration of the term of office during which the director becomes 73 years of age; provided, however, that the foregoing clause shall not apply to Charles L. Boatwright, T.C. Bowen, Jr., A. A. Crouse, R. E. Dodson, and William T. Peery. SECTION 2.3 Regular Meetings. ---------------- A meeting of the Board shall be held immediately after each annual meeting of shareholders without notice other than that given by these Bylaws, at which meeting there shall be elected at least a Chairman of the Board (the "Chairman"), a President, a Secretary and a Treasurer, who shall hold such offices until the first meeting of the Board following the next annual meeting of shareholders and until their successors shall be elected and qualify or until their earlier resignation or removal. Regular meetings of the Board shall be held as provided by resolution of the Board. SECTION 2.4. Special Meetings. ---------------- Special meetings of the Board may be called by or at the request of the Chairman, the President or by a majority of the Board. The person or persons calling a special meeting of the Board may fix any place inside or outside Virginia as the place for holding that special meeting. -45- SECTION 2.5. Action by Directors Without a Meeting; Telephonic Attendance. ------------------------------------------------------------ Any action of the board, or of any committee of the Board, may be taken without a meeting if a consent in writing, setting forth the action so taken, shall be signed by all of the directors, or by all of the members of the committee, as the case may be. Directors may participate in meetings of the Board and committees of the Board by, and such meetings may be conducted through, the use of any means of communication by which all directors participating may simultaneously hear each other during the meeting. Directors so participating are deemed to be present in person at the meeting and will be counted in determining whether a quorum is present. SECTION 2.6. Notice. ------ Notice of any special meeting (which notice need not state the purpose of or business to be conducted at the meeting) shall be given by written notice delivered personally or mailed to each director at his business address, or by telephone, facsimile or telegram. If notice is by personal delivery, facsimile or telephone, the delivery, facsimile transmission or telephone call shall be at least two days prior to the special meeting. If notice is given by mail or telegram, such notice shall be deposited in the United States mail, postage prepaid, and addressed to each director at his business address or delivered to the telegraph company, as the case may be, at least five days prior to the special meeting. SECTION 2.7. Quorum. ------ Except as may otherwise be provided in the Articles or in these Bylaws, a majority of the full Board or of the full membership of any committee thereof shall constitute a quorum for the transaction of business at any meeting of the Board or such committee, as the case may be. If less than such majority is present at a meeting, a majority of directors present may adjourn the meeting from time to time without further notice. SECTION 2.8. Committees. ---------- By resolution, the Board shall designate from among Board members an Executive Committee, which shall exercise all of the authority of the Board except as limited by law, the Articles or the Board itself. The Executive Committee may take no action described in Subsections (i), (ii), (iii), (iv), or (v) of Subsection 2.9(b) of these Bylaws. Such action may only be taken by the Board of Directors as described in such Subsections. The Board may designate from among its members other committees for such purposes and with such powers as the Board may determine. All committees shall keep regular minutes of their meetings and shall report their actions to the Board at its next regular meeting. -46- SECTION 2.9. Manner of Acting. ---------------- (a) The act of the majority of the directors present at a meeting at which a quorum is present shall be the act of the Board or any committee thereof, unless the Articles or these Bylaws require the vote of a greater number of directors. (b) Notwithstanding the foregoing or any other provision in these bylaws, the affirmative vote of six (6) out of nine (9) directors shall be required to approve any of the following actions: (i) Authorization for the Corporation as sole shareholder of Bank of Tazewell County to vote in the election of any person to serve on the board of directors of Bank of Tazewell County or in the removal as a director of any person serving on the board of directors of Bank of Tazewell County except that action by the Corporation as sole shareholder of the Bank of Tazewell County may be authorized by the Board of this Corporation as if this subsection 2.9(b) were not a part of the Corporation's Bylaws in the event that the Corporation's Board of Directors determines as a part of its authorization for removal or a court of competent jurisdiction or regulatory authority having jurisdiction over the Bank of Tazewell County determines that such director(s) of the Bank of Tazewell County being removed have committed a violation of law applicable to his or their duties as director(s) which has a material adverse financial effect on Bank of Tazewell County or have engaged in conduct as director(s) for which he or they would not be entitled to indemnification under the Articles of Bank of Tazewell County as amended; (ii) Authorization for the Corporation as sole shareholder of the Bank of Tazewell County to vote on any proposed amendment to the articles of incorporation or bylaws of the Bank of Tazewell County; (iii) Authorization for the Corporation as sole shareholder of the Bank of Tazewell County to vote on the merger, consolidation or sale of all or substantially all of the assets of the Bank of Tazewell County. (iv) A recommendation to the shareholders of the Corporation to merge, consolidate or sell all or substantially all of the assets of the Corporation, where such recommendation is required by law; and (v) A modification prior to January 1, 2001 to any of the following provisions of the Bylaws added to such Bylaw by these amendment; (1) the first sentence of Section 2.2; (2) the last paragraph of Section 2.2; (3) the second sentence of Section 2.8; and/or (4) subsection 2.9(b)(i) through (iv) -47- On and after January 1, 2001 subsections 2.9(b)(i) through (iv) may be amended or repealed by the Directors of the Corporation as if this subsection 2.9(b)(v) had not been adopted and as of January 1, 2001 this subsection 2.9(b)(v) shall automatically and without further action cease to be of force and effect. SECTION 2.10 Vacancies. --------- Any vacancy occurring in the Board, including a vacancy resulting from an increase by not more than two in the number of directors, may be filled by the affirmative vote of a majority of the remaining directors, though less than a quorum of the Board. If a vacancy is filled by the shareholders, a vacant office held by a director elected by a voting group of shareholders shall be filled by vote of only the holders of that voting group. SECTION 2.11. Compensation. ------------ Payment to the directors for the expense, if any, of attendance at meetings of the Board, and of a fixed sum for attendance at meetings of the Board or a stated salary as director may be authorized by Board resolution. Members of special or standing committees may be authorized by Board resolution to receive compensation for attending meetings. SECTION 2.12. Honorary Directors. ------------------ The Board shall not appoint any Honorary Director, Honorary Chairman, Honorary President, or Honorary Officer. ARTICLE III. OFFICERS SECTION 3.1. Generally. --------- Any one or more offices may be held by the same person. SECTION 3.2. Chairman. -------- The Board shall appoint, from one of its members, a Chairman to serve in said capacity at the pleasure of the Board. He shall preside at all meetings of the Board and shall be an ex-officio member of all committees of the Board. The Board may also designate a Vice Chairman to serve as and perform all duties of the Chairman in the Chairman's absence. -48- SECTION 3.3. President. --------- The Board shall appoint a President of the Corporation to serve at the pleasure of the Board. The President shall supervise the carrying out of the policies adopted or approved by the Board and shall be the Chief Executive Officer of the Corporation. He shall have general executive powers, as well as the specific powers conferred by these Bylaws. He shall also have and may exercise such further powers and duties as from time to time may be conferred upon or assigned to him by the Board. SECTION 3.4. Secretary. --------- The Board shall appoint a Secretary to serve at the pleasure of the Board. The Secretary shall: (a) keep the minutes of the shareholders', Board and Committee meetings in one or more books provided for that purpose; (b) see that all notices are duly given in accordance with the provisions of these Bylaws and as required by law; (c) be custodian of the corporate records and the Corporation's seal and see that the Corporation's seal is affixed to all documents for which it is required; (d) sign with the President or other designated officer stock certificates of the Corporation issued as authorized by resolution of the Board; (e) have general charge of the stock transfer books and shareholder list of the Corporation; and (f) in general perform all duties incident to the office of Secretary and such other duties as may from time to time be assigned to him by the President or the Board. SECTION 3.5. Treasurer. --------- The Board shall appoint a Treasurer, and if required by the Board, the Treasurer shall give a bond for the faithful discharge of his duties in such sum and with such surety or sureties as the Board shall determine. He shall: (a) have charge and custody of and be responsible for all funds and securities of the Corporation; (b) receive and give receipts for monies due and payable to the Corporation from any source whatsoever, and deposit all such monies in the name of the Corporation in such banks, trust companies or other depositories as shall be selected by the Board; and (c) in general perform all of the duties incident to the office of Treasurer and such other duties as from time to time may be assigned to him by the President or by the Board. SECTION 3.6. Other Officers. -------------- The Board may appoint such other officers as it deems appropriate to transacting the business of the Corporation. Such officers shall exercise such powers and perform such duties as pertain to their offices or are assigned to them by the President or the Board. The Board may by resolution authorize any duly appointed officer to appoint one or more officers or assistant officers. -49- SECTION 3.7. Removal. ------- Any officer or agent elected or appointed by the Board may be removed by the Board at any time, with or without cause, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Any officer or agent appointed by another officer may be removed at any time, with or without cause, by the Board or by such appointing officer. SECTION 3.8. Vacancies. --------- The Board may fill any vacancy occurring in the offices of the Corporation at any regular meeting of the Board or at a special meeting of the Board called for that purpose. An officer elected to fill a vacancy shall be elected for the unexpired term of his predecessor in office. ARTICLE IV. STOCK CERTIFICATES AND THEIR TRANSFER SECTION 4.1. Certificate for Shares. ---------------------- The Board will determine the form of certificates representing shares of the Corporation. Such certificates shall bear the signature (or a facsimile thereof if such certificates are countersigned by an appropriate party in accordance with the Act) of the President or a Vice President and the Secretary or an Assistant Secretary and shall bear the corporate seal or a facsimile thereof. All stock certificates shall be consecutively numbered or otherwise identified. The name and address of the person to whom the shares represented thereby are issued, and the number of shares and date of issue, shall be entered on the stock transfer books of the Corporation. All certificates surrendered to the Corporation for transfer shall be canceled, and no new certificates will be issued until the former certificate for a like number of shares has been surrendered and canceled, except that a replacement for a lost, destroyed or mutilated certificate may be issued upon such terms and indemnity to the Corporation as the Board prescribes. No stock certificate will be issued, and no dividend payment will be made, for fractional shares of common stock. SECTION 4.2. Transfer of Shares. ------------------ Transfer of shares shall be made only on the stock transfer books of the Corporation by the holder of record or by his legal representative, who must furnish evidence of authority satisfactory to the Corporation, and on surrender for cancellation of the certificate for such shares. The Corporation may treat the holder of record of any share or shares of stock as the holder in fact thereof and accordingly is not bound to recognize any equitable or other claim to or interest in such shares on the part of any other person, whether or not it shall have notice thereof, except as expressly provided by the laws of the Commonwealth of Virginia. -50- ARTICLE V. CONTRACTS, LOANS, CHECKS, DEPOSITS AND INVESTMENTS SECTION 5.1. Contracts. --------- The Board may authorize any officer(s) or agent(s) to enter into any contract or execute and deliver any instrument in the name and on behalf of the Corporation, either generally or confined to specific instances. SECTION 5.2. Loans. ----- No loan shall be contracted on behalf of the Corporation and no evidences of indebtedness shall be issued in its name unless authorized by a resolution of the Board, either generally or confined to specific instances. SECTION 5.3. Checks, Drafts, etc. -------------------- All checks, drafts or other orders for the payment of money, notes or other evidences of indebtedness issued in the name of the Corporation shall be signed by those officer(s) or agent(s) of the Corporation designated in, and in the manner determined by, resolution of the Board. SECTION 5.4. Deposits. -------- All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in banks, trust companies or other depositories selected by the Board. ARTICLE VI. SEAL The Board of Directors shall provide a seal which shall be circular in form and shall have inscribed thereon the name of the Corporation, state of incorporation and the words "Corporate Seal." ARTICLE VII. BYLAWS Unless otherwise provided in the Articles, these Bylaws may be amended, altered or repealed and new Bylaws adopted upon a vote of two-thirds of the directors present and voting at a meeting at which a quorum is present, provided that notice of the proposed amendment, alteration or repeal shall be given in writing delivered personally to each director at his business address, or by telephone, facsimile, or telegram. If notice is by personal delivery, facsimile or telephone, the delivery, facsimile or telephone call shall be at least two days prior to the meetings at which such amendment, alternation or repeal is to be considered. If notice is given by mail or telegram, such notice shall be deposited in the United States mail, postage prepaid, and addressed to each director at his business address or delivered to the telephone company, as the case may be, at least five days prior to the meeting at which such amendment, alteration or repeal is to be considered. -51- ARTICLE VIII. WAIVER OF NOTICE Whenever any notice is required to be given to any shareholder or director of the Corporation under the provisions of these Bylaws, the Articles or the Act, a waiver thereof in writing, signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be deemed equivalent to the giving of such notice. Attendance at or participation in any shareholders' meeting by a shareholder, or at any Board or Board committee meeting by a director, waives any required notice unless objection is timely made as provided by the Act. (SEAL) _______________________________ Secretary -52- EX-13 3 1996 ANNUAL REPORT NATIONAL BANKSHARES 1996 Annual Report -53- Contents -------- In the Community 2 ------------------------------------------------ To Our Stockholders 6 ------------------------------------------------ Selected Consolidated Financial Data 7 ------------------------------------------------ Management's Discussion and Analysis 8 ------------------------------------------------ Statement of Management's Responsibility 20 ------------------------------------------------ Independent Auditors' Report 21 ------------------------------------------------ Consolidated Financial Statements 22 ------------------------------------------------ Notes to Consolidated Financial Statements 28 ------------------------------------------------ Corporate Information 52 ------------------------------------------------ -54- NBB The National Bank "For a Future You Can Bank On...Bank on Us!" It's not just a slogan, it's The National Bank's commitment to be there for you and your family. It also reflects our promise to remain true to our hometown roots. This is not a commitment we take lightly. It's one we've made to generations of New River Valley residents. The National Bank has been a local fixture for over a century, through good times and bad. We intend to work hard to continue the tradition of offering our neighbors a full range of financial services with a personal touch. PHOTOGRAPH OF MAIN OFFICE MANAGER SERVING REFRESHMENTS TO CUSTOMERS DURING 4TH OF JULY CELEBRATION. PHOTOGRAPH OF NBB HOSTING 1996 ANNUAL COMMUNITY BREAKFAST. We understand what makes a community bank different. We know that our customers deserve exceptional service. They expect a personal greeting and a friendly smile. They want to develop long term relationships with our banking and trust professionals, and they look for honest advice from bankers who will be with them for the long haul. Our customers want their bank to keep up with the times and to offer new and more convenient ways for them to manage their finances. They would also like The National Bank to take an active and visible role in their hometown. PHOTOGRAPH OF "PENNIES FROM HEAVEN" HELD AT HETHWOOD BRANCH FOR KIPPS ELEMENTARY STUDENTS. -55- PHOTOGRAPH OF CHRISTMAS WITH HEAD START PHOTOGRAPH OF PEMBROKE HERITAGE FESTIVAL NBB is proud to be a part of the community. The bank and its employees contribute time, talent and resources to a large number of important activities. Every year we consult with community leaders and seek their advice on how The National Bank can most effectively serve our locality. NBB's bankers work with school children, and they volunteer with senior citizens. They generously share their expertise with groups promoting economic development at the regional and local levels. We like to participate, both as a company and as individuals, in community festivals and celebrations. The New River Valley is our home, and we believe that it is important to give something back to the citizens who have rewarded us with their support and confidence for almost 106 years. PHOTOGRAPH OF WILDERNESS TRAIL FESTIVAL PHOTOGRAPH OF RICH CREEK AUTUMN FEST The National Bank--For a Future You Can Bank On... Bank On Us! -56- Bank of Tazewell County We are excited about the future of Bank of Tazewell County and its affiliation with National Bankshares, Inc. Since this is the first year that BTC will appear as a part of National Bankshares' Annual Report, a brief description of BTC might be fitting. PHOTOGRAPH OF R.E. DODSON AND ALONZO CROUSE PHOTOGRAPH OF MAIN STREET FESTIVAL BTC began in 1889 as "The Clinch Valley Bank", with roots in Tazewell, Virginia. In 1893 the name was changed to "Bank of Clinch Valley". In 1929 Bank of Clinch Valley merged with "Farmers National Bank", also located in Tazewell, to form the "Farmers Bank of Clinch Valley". In 1964 the Farmers Bank of Clinch Valley merged with the Bank of Graham, Bluefield, Virginia, establishing the "Bank of Tazewell County". Bank of Graham was organized in 1890 and had operated continuously in Bluefield, Virginia in the eastern section of Tazewell County since that date. On May 31, 1996, in what is believed to be the most significant development in its history, BTC became a wholly owned subsidiary of National Bankshares, Inc. PHOTOGRAPH OF DAYCARE AND PRESCHOOL STUDENTS AT BTC ON HALLOWEEN BTC has always prided itself on its mission of satisfying the banking needs of its customers in the areas where it operates. We are particularly gratified that because of the affiliation with Bankshares, we will be able to enlarge the scope of services offered. We are currently cooperating with the highly skilled staff of Bankshares in working out the details of a Visa/MasterCard credit card, secondary market mortgage loans and home equity lines. These are just a few of the increased services the merger will allow BTC to provide. -57- PHOTOGRAPH OF KIDZOWN PLAYGROUND Our history has been built on a philosophy of safety and soundness, service to our customers, and the goal of being a good corporate citizen. We support and participate in numerous activities and projects that make the communities in which we do our banking very desirable areas in which to live and rear our families. PHOTOGRAPH OF A GINGERBREAD HOUSE DISPLAY PHOTOGRAPH OF 1996 CHRISTMAS PARADE Finally, we would like to express our appreciation to all who have made BTC what it is today. The cornerstone of any business is the strength of its people, whether they are shareholders, customers or bank personnel. We face the future with the optimism and confidence that will enable us to embrace a vision of success equal to or greater than our previous accomplishments. PHOTOGRAPH OF THE TAZEWELL COUNTY FAIR Bank of Tazewell County---We''ll Be There To Serve You All The Days Of Your Life. -58- National Bankshares To Our Stockholders: This past year proved to be momentous for National Bankshares, Inc. At the same time the holding company was celebrating its tenth anniversary, we were completing our first major expansion, a merger with Bank of Tazewell County. We learned many things from this endeavor. We found that it takes stacks of paper and numerous regulatory approvals before banking firms can combine. We now know that mergers require a major commitment of time from directors, employees and consultants. Most significantly, we discovered the importance of working with the right merger partner. We were extremely fortunate to have the Tazewell bank affiliate with us, where we dealt with individuals of integrity and goodwill throughout the long and complex process. In the several months since the completion of the merger, directors, officers and employees of National Bankshares, The National Bank and Bank of Tazewell County have worked together and come to know each other better. There are many more similarities than differences among us. Both banks have deep roots in the localities they serve. They are true community banks, committed to providing high quality, personalized service to customers. NBB and BTC each has a dedicated board of directors and a staff of experienced bankers. Looking to the future, we plan to build on the strengths which both banks bring to National Bankshares. It is gratifying to report positive financial results to you at the end of the first year of combined operations. When you review this Annual Report, you will notice that 1996 net income reached over $6.1 million, 10.71% higher than the combined totals of Bankshares and BTC in 1995. A solid 18.63% increase in net loans, growth of 13.06% in noninterest income and a 5.16% reduction in noninterest expense contributed to increased earnings. National Bankshares ended 1996 with total assets of $388.9 million. As National Bankshares, Inc. embarks on its first full year with more than one subsidiary, we felt that it would be a fitting time to introduce a new corporate logo. We hope you will agree that this design, which depicts "...energy and the dynamic image of a rising sun..", is an appropriate symbol for a corporation that has a positive view of growth and change, but also an appreciation for the importance of enduring fundamentals. This is also a good opportunity to thank you, our stockholders, for your continued support and to restate our commitment to build and operate an exceptional community bank holding company. James G. Rakes President and PICTURE OF Chief Executive Officer JAMES G. RAKES -59- National Bankshares, Inc. and Subsidiaries Selected Consolidated Financial Data $ In thousands, except per share data. Years ended December 31, 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Selected Interest income $ 28,647 28,094 26,062 25,827 28,304 Income Interest expense 13,036 12,703 10,684 10,752 13,965 Statement Net interest income 15,611 15,391 15,378 15,075 14,339 Data: Provision for loan losses 331 282 553 953 1,208 Noninterest income 2,693 2,382 2,047 2,399 1,360 Noninterest expense 9,515 10,033 9,725 9,002 8,396 Income taxes 2,341 1,933 1,844 1,903 1,376 Net income 6,117 5,525 5,303 5,644 4,719 Per Share Net income $ 1.61 1.46 1.40 1.49 1.25 Data: Cash dividends declared 0.62 0.57 0.52 0.45 0.39 Book value per share(1) 13.56 12.70 11.25 10.81 9.81 Selected Loans, net $193,598 163,193 156,289 150,156 150,555 Balance Total securities 171,244 187,635 184,231 174,964 164,842 Sheet Total assets 388,850 380,915 373,132 357,773 352,977 Data at Total deposits 334,584 330,313 327,686 314,001 312,840 End Stockholders' equity 49,801 48,154 42,658 40,951 37,106 of Year: Selected Loans, net $177,419 160,643 152,976 149,027 153,487 Balance Total securities 177,403 183,994 185,365 154,740 161,406 Sheet Total assets 388,045 378,406 369,962 349,747 353,673 Daily Total deposits 335,938 330,261 325,167 307,645 314,518 Averages: Stockholders' equity(1) 49,459 45,726 42,402 39,435 35,552 Selected Return on average assets 1.58 1.46 1.43 1.61 1.33 Ratios: Return on average equity(1) 12.37 12.08 12.51 14.31 13.27 Dividend payout ratio 37.55 37.32 37.13 32.18 34.29 Average equity to average assets(1) 12.75 12.08 11.46 11.28 10.05 (1) Includes amount related to common stock subject to ESOP put option. The effect is immaterial. Average Equity to Average Assets Graph 1992 1993 1994 1995 1996 ----- ----- ----- ----- ----- 10.05% 11.28% 11.46% 12.08% 12.75% (Dollars) Cash Dividends Per Share Graph 1992 1993 1994 1995 1996 ----- ----- ----- ----- ----- 0.39 0.45 0.52 0.57 0.62 -60- Management's Discussion and Analysis ($ In millions) Net Income Graph 1992 1993 1994 1995 1996 ----- ----- ----- ----- ----- $ 4.7 5.6 5.3 5.5 6.1 Net Interest Income Graph 1992 1993 1994 1995 1996 ----- ----- ----- ----- ----- $ 14.3 15.1 15.4 15.4 15.6 ($ In thousands, except per share data.) PERFORMANCE SUMMARY 1996 v. 1995 Net income in 1996 for National Bankshares, Inc. (Bankshares) and its wholly owned subsidiaries, The National Bank of Blacksburg (NBB) and Bank of Tazewell County (BTC), (the Company) was $6,117, an increase of $592 or 10.71%. This produced a return on average assets and average equity of 1.58% and 12.37%, respectively. Net income for 1995 was $5,525 which resulted in a return on average assets of 1.46% and a return on average equity of 12.08%. Earnings per share for 1996 was $1.61, which represents an increase of $.15 per share over 1995. NET INTEREST INCOME Net interest income for 1996 was $15,611, an increase of $220 or 1.43% when compared with 1995. This increase was primarily due to an increase in interest-earning assets which rose by $7,785 or 2.15%. The net yield on interest-earning assets for 1996 was 4.59%, a four basis point decrease from 1995 caused by a slight decline in the yield on interest-earning assets. The cost to fund interest-earning assets was 3.57% in 1996 and 3.56% in 1995. During 1996, management's strategy was to fund increases in the loan portfolio through liquidity generated principally from the securities portfolio. While the Company experienced a good degree of success in this endeavor, a substantial portion of the growth took place in the highly rate- competitive commercial loan area. This limited the effect of the loan growth on the yield on interest-earning assets and net interest income. The Company continues to have excess liquidity which will permit it to increase the loan portfolio through the use of existing funds. INTEREST RATE SENSITIVITY The Company has systems and procedures in place to monitor interest rate sensitivity and modifies its asset and liability management strategies in response to changing economic conditions. The Company is sensitive to rising interest rate changes as liabilities generally reprice or mature more quickly than interest-earning assets. Future earnings may be adversely affected by a sharp upturn in interest rates as the Company is liability sensitive for a period extending beyond one year. In a falling rate environment earnings would benefit to some extent from this position as assets at higher rate levels would generally reprice downward at a slower rate than interest sensitive liabilities. -61- Beyond one year, the Company's cumulative interest sensitive position reflects a slightly liability sensitive position indicating that the adverse effect of rising rates or benefit from falling rates would dissipate in the one to five year time period. The impact of rising rates is dependent, however, upon the magnitude, the length of the rising or falling rate trend and the period of time rates remain stable at a given level. Management typically adjusts its asset/liability strategies during times of rising and falling rates to minimize or maximize the impact of changing rate scenarios. PROVISION AND ALLOWANCE FOR LOAN LOSSES The adequacy of the allowance for loan losses is based on management's judgement and analysis of current and historical loss experience, risk characteristics of the loan portfolio, concentrations of credit and asset quality, as well as other internal and external factors such as general economic conditions. An internal credit review department performs pre-credit reviews of large credits and provides management with an early warning of asset quality deterioration. Changing trends in the loan mix are also evaluated in determining the adequacy of the allowance for loan losses. Loan loss and other industry indicators related to asset quality are presented in the following table. Loan Loss Data ($ In thousands) 1996 1995 ------ ------ Provision for loan losses $ 331 282 Net charge-offs to average net loans 0.21% 0.13% Allowance for loan losses to loans, net of unearned income and deferred fees 1.31% 1.58% Allowance for loan losses to nonperforming loans 418.02% 365.60% Allowance for loan losses to nonperforming assets 236.24% 177.37% Nonperforming assets to loans, net of unearned income, plus other real estate owned 0.55% 0.89% Nonaccrual loans $ 616 718 Restructured loans --- --- Other real estate owned, net 474 762 ------- ------- Total nonperforming assets $ 1,090 1,480 ------- ------- Accruing loans past due 90 days or more $ 458 574 ------- ------- Nonperforming loans include nonaccrual and restructured loans. Nonperforming loans do not include accruing loans past due 90 days or more. Nonperforming assets shown in the above table have decreased by $390 or 26.35% from 1995 and represent the continuation of a declining trend. Net charge-offs for 1996 were .21% up slightly from 1995 when that ratio was .13%. While the Company did experience a small increase in net charge- offs, overall the trend of improving assets quality continues. The provision for loan losses, which was up $49 or 17.38%, was made to not only cover current year net charge-offs, but to prevent excessive deterioration of the ratio of the allowance for loan losses to loans, net of unearned income. -62- Management's Discussion and Analysis While continual efforts are made to improve overall asset quality, management is unable to estimate when and under what exact terms problem credits will be resolved. With the information available to it, management does not anticipate any significant deterioration in asset quality and expects the positive trend to continue. However, changing economic conditions, the timing and extent of such and the ultimate impact on the Company's asset quality is not within management's ability to predict with any degree of precision. At December 31, 1996, the recorded investment in loans which have been identified as impaired, in accordance with SFAS No. 114, totaled $725. Of this amount, $354 related to loans with no valuation allowance, and $371 related to loans with a corresponding valuation allowance of $290. For the year ended December 31, 1996, the average recorded investment in impaired loans was approximately $800, and the total interest income recognized on impaired loans was $33, of which $23 was recognized on a cash basis. NONINTEREST INCOME Noninterest income for 1996 was $2,693 up $311 or 13.06% from 1995. Service charges on deposit accounts were up $190 or 19.13% from the previous year. The level of these charges is driven by demand deposit volume, service charge rates in effect, waiver policy, types of accounts opened and the willingness of account holders to bear penalty charges such as overdraft fees. While management can exert direct influence over some of the above variables, it can do so only in varying degrees with others. Increases for 1996 were largely attributable to volume. Other service charges and fees are composed of safe deposit box rent, charges associated with letters of credit and other miscellaneous items. These charges were up $41 or 17.98% over 1995. Trust income in 1996 rose by $123 or 25.63% over 1995. Factors affecting this increase include an increase in estate settlement income and the retention of managed assets after the closing of estates. Due to its nature, estate business volume and the related income is not within management's ability to predict. Management accordingly cannot determine if such income levels are sustainable. Credit card income is composed of numerous types of fees and charges, including overlimit charges, annual fees, and merchant discount. Credit card income for 1996 was $511 up $61 or 13.56% over 1995. Given the highly competitive market which limits the amount of charges set, volume increases are the principal means used by the Company to enhance revenues. Net gains from securities activities were down $85 or 46.70% from 1995. Gains and losses can occur as a result of portfolio restructuring, called securities and certain market adjustments. The majority of the gains for 1996 consisted of market adjustments to an allowance set up to cover potential losses on certain bonds held by BTC. The amount of these bonds not covered by reserves is not material to the Company's consolidated financial statements, hence is not expected to have a material effect on future operating results. NONINTEREST EXPENSE Noninterest expenses for 1996 were $9,515 compared to $10,033 in 1995, which represents a $518 or 5.16% decrease. Salaries and fringe benefits expense for 1996 increased $244 or 4.85% over 1995. This increase was largely due to a $177 increase in net pension cost, routine merit adjustments, promotions and other normal compensation related items. Occupancy and furniture and fixtures expense experienced a slight decrease in 1996 of 3.91%, however, expenses in this area are expected to increase in -63- National Bankshares, Inc. and Subsidiaries 1997 due to the scheduled opening of a new branch facility in the second quarter. The cost of Federal Deposit Insurance continued to decline significantly in 1996 by $375 or 98.94% from 1995. With the Bank Insurance Fund reaching mandated levels, banks in general became eligible in 1995 for refunds on premiums previously paid and for reduced premiums in future periods. The Company expects future premiums to be nominal in amount, based on information currently available. Net costs of other real estate owned decreased sharply by $190 or 97.44% from 1995 due primarily to a $119 reduction in the provision for losses on other real estate owned in 1996. Efforts to market the remaining properties continue, however, the exact timing, terms and conditions of sale of such properties remains unknown. The other operating expense category decreased by $251 or 9.65% from 1995 and was due primarily to a $111 reduction in expenses associated with the merger, from $268 in 1995 to $157 in 1996, and a reduction in charitable contributions of $70. Other operating expenses in 1995 included a contribution to a community development corporation which was not incurred in 1996. INCOME TAXES Higher taxable income in 1996 resulted in a $408 increase in income tax expense when compared to 1995. Tax exempt interest income continues to be the primary difference between the "expected" and reported income tax expense. The Company's effective tax rate for 1996 and 1995 was 27.68% and 25.92%, respectively. The increase in the effective tax rate for 1996 was due primarily to the level of tax exempt interest income being comparable to 1995. The Company has determined that a valuation allowance for the gross deferred tax assets is not necessary due to the fact that realization of the entire amount of gross deferred tax assets can be supported by the amount of taxes paid during the carryback period under current tax laws. EFFECTS OF INFLATION The Company's consolidated statements of income generally reflect the effects of inflation. Since interest rates, loan demand and deposit levels are related to inflation, the resulting changes are included in net income. The most significant item which does not reflect the effects of inflation is depreciation expense, because historical dollar values used to determine this expense do not reflect the effect of inflation on the market value of depreciable assets after their acquisition. BALANCE SHEET Total assets at year-end 1996 were $388,850 which represents an increase of $7,935 or 2.08% over the previous year. Excluding corporate acquisitions, deposits are the Company's primary method of achieving growth. In both 1996 and 1995, the Company experienced excess liquidity, therefore management's strategy has been to stress the absorption of those funds before pursuing external sources. Accordingly, rates paid to attract deposits have moderated which in turn produces a lower level of deposit growth. In 1996, deposits grew by a nominal $4,271 or 1.29%. Total Assets Graph (Millions) 1992 1993 1994 1995 1996 ----- ----- ----- ----- ----- $353.0 357.8 373.1 380.9 388.9 -64- Management's Discussion and Analysis LOANS Loans, net of unearned income and deferred fees grew by $30,355 or 18.31% in 1996. Commercial loans which grew by $27,910 or 46.82% accounted for the largest portion of increase. Loans to individuals increased by $4,071 and represented a 7.15% increase over 1995. The Company routinely engages in the origination and sale of mortgage loans in the secondary market. During 1996, the Company originated $17,907 in mortgage loans and sold $18,271, respectively. Management, as a part of its strategic plan, will continue to pursue loan growth as long as the market can provide such growth without compromising underwriting standards. SECURITIES Overall bank owned securities declined by $16,391 or 8.74%. The largest portion of the decrease took place in the available for sale portfolio which declined by $13,336 or 17.58%. Funds were in turn used to fund loan growth. The Company's investment policy stresses safety with a program of purchasing high quality securities such as U.S. Treasury and U.S. Government agency issues, state, county, and municipal bonds, corporate bonds, mortgage- backed securities and other bank qualified investments. The Company has classified all of its investment securities as either held to maturity or available for sale, as the Company does not engage in trading activities. Investment strategies are adjusted in response to market conditions and available investment vehicles. At December 31, 1996, the Company had no investment concentrations in any single issue (excluding U.S. Government) that exceeded ten percent of capital. DEPOSITS Total deposits at year-end 1996 were $334,584 which represents only a nominal increase from 1995. Noninterest-bearing demand deposits grew $4,280, an increase of 10.75%. Savings deposits declined by $2,384 or 4.72%. This decline was offset by increases in interest-bearing demand deposits and the majority of the funds shifted to the higher earning time deposits category. Limited growth in the deposit area is expected to continue until excess liquidity in the securities portfolio is absorbed and a need for external funding arises. LIQUIDITY Liquidity is the ability to provide sufficient cash flow to meet financial commitments and to fund additional loan demands 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 1996 and 1995. Management is not aware of any trends, commitments or events that will result in or that are reasonably likely to result in a material increase or decrease in liquidity. Net cash from operating activities of $7,968 in 1996 increased $1,604 from 1995 and was primarily attributable to the increase in net income and the change in the mortgage loans held for sale category which fluctuates based upon loan demand and the timing of loan sales in the secondary market. Cash flows from investing activities continue to reflect the shifting of securities to the loan portfolio and securities held to maturity to available for sale. Net cash flows provided by operating activities, federal funds sold, securities and financing activities for 1996 of $7,968, $5,815, $15,541 and $1,930, respectively, were used principally to fund the net increase in loans of $31,633. -65- National Bankshares, Inc. and Subsidiaries CAPITAL RESOURCES Total stockholders' equity increased $1,647 from 1995 to 1996, with net income, less cash dividends on common stock of $2,297, and common stock subject to ESOP put option of $1,643 recorded outside stockholders' equity at December 31, 1996, accounting primarily for the increase. Net unrealized gains (losses) on securities available for sale, net of income taxes, were ($248) at December 31, 1996, and $282 at December 31, 1995. These unrealized net gains and losses are recorded as a separate component of stockholders' equity and will continue to be subject to change in future years due to fluctuations in fair values, sales, purchases, maturities and calls of securities classified as available for sale. Stockholders' Equity Graph (Millions) 1992 1993 1994 1995 1996 ----- ----- ----- ----- ----- $ 37.1 41.0 42.7 48.2 49.8 Book Value Graph (Dollars) 1992 1993 1994 1995 1996 ----- ----- ----- ----- ----- $ 9.81 10.81 11.25 12.70 13.56 In November 1996, the Company entered into contracts for the construction of a new branch facility totaling $342. Construction is expected to be completed in Spring 1997. Total remaining commitments under the construction and related equipment purchases contracts as of December 31, 1996, approximated $178. There are no other material commitments for capital expenditures as of December 31, 1996. In addition, there are no expected material changes in the mix or relative cost of capital resources. The Company has operated from a consistently strong capital position. The ratio of total stockholders' equity to total assets was 12.81% at year-end 1996 compared to 12.64% at year-end 1995. Banks are required to apply percentages to various assets, including off-balance sheet assets, to reflect their perceived risk. Regulatory defined capital is divided by risk-weighted assets in determining the bank's risk-based capital ratio. No regulatory authorities have advised National Bankshares, Inc., The National Bank of Blacksburg or Bank of Tazewell County 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 11 of the Notes to Consolidated Financial Statements for additional information. FUTURE ACCOUNTING CONSIDERATIONS In June 1996, the Financial Accounting Standards Board issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. This Statement provides accounting and reporting standards for -66- Management's Discussion and Analysis transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Management of the Company does not expect that adoption of SFAS No. 125 will have a material impact on the Company's financial position, results of operations or liquidity. MERGER On June 1, 1996, Bankshares issued 1,888,209 shares of its common stock in a one-for-one exchange for all the outstanding common stock of Bank of Tazewell County, Tazewell, Virginia. This business combination has been accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements for the periods prior to the combination have been restated to include the accounts and results of operations of Bank of Tazewell County. There were no adjustments of a material amount resulting from Bank of Tazewell County's adoption of Bankshares' accounting policies. In May, 1996, Bankshares declared a stock split of .11129 per share effected in the form of a stock dividend to the holders of Bankshares common stock just prior to the merger effective date to facilitate the one-for-one common stock exchange ratio. All stockholders' equity accounts, share and per share data have been adjusted retroactively to reflect the stock split. The Bank of Tazewell County is well capitalized with excess liquidity, and should provide the Company with an expanded market place. COMMON STOCK INFORMATION AND DIVIDENDS National Bankshares, Inc.'s common stock is traded on a limited basis in the over-the-counter market and is not listed on any exchange or quoted on NASDAQ. Local brokerage firms are familiar with and active in trading in the common stock of National Bankshares, Inc. As of December 31, 1996, there were 1,184 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 1996 and 1995. Prices do not necessarily reflect the prices which would have prevailed had there been an active trading market, nor do they reflect unreported trades, which may have been at lower or higher prices. Common Stock Market Prices ----------------------------------------------------------------- Dividend 1996 1995 Per Share High Low High Low 1996 1995 ------ ------ ------ ------ ------ ------ First Quarter $26.50 24.00 23.50 21.50 -- -- Second Quarter 26.25 24.50 25.00 22.00 .30 .27 Third Quarter 27.00 24.50 25.00 23.00 -- -- Fourth Quarter 26.50 25.00 25.50 24.00 .32 .30 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 the Notes to Consolidated Financial Statements. -67- National Bankshares, Inc. and Subsidiaries PERFORMANCE SUMMARY 1995 v. 1994 The Company's net income for 1995 was $5,525, an increase of $222 or 4.19%. This produced a return on average assets and equity of 1.46% and 12.08%, respectively. Net income for 1994 was $5,303 which resulted in a return on average assets of 1.43% and a return on average equity of 12.51%. While these results reflect a slight improvement in the return on average assets, the return on average equity declined. That decline was caused by the continued high level of profitability coupled with a dividend payout ratio of 37.32%. Earnings per share for 1995 was $1.46, up $.06 per share from 1994. NET INTEREST INCOME Net interest income for 1995 was $15,391 compared to $15,378 in 1994, a nominal increase. The net yield on interest-earning assets for 1995 was 4.63%, slightly lower than in 1994 at which time the net yield was 4.71%. In April 1994, the Company acquired the deposits of the Pembroke Office of the First Union National Bank of Virginia which increased its deposits approximately $14,514. This addition produced excess liquidity which was initially absorbed by the securities portfolio. With the excess liquidity position, the Company was allowed to take a less aggressive stance in attracting external funds. The full absorption of excess liquidity created by the acquisition of the Pembroke Office deposits and nominal deposit growth is expected to continue. This acquisition, in combination with the rising rate environment, produced the slight decline in the net yield on interest-earning assets. PROVISION AND ALLOWANCE FOR LOAN LOSSES Loan loss and other industry indicators related to asset quality are presented in the following table. Loan Loss Data ($ In thousands) 1995 1994 ------ ------ Provision for loan losses $ 282 553 Net charge-offs to average net loans 0.13% 0.38% Allowance for loan losses to loans, net of unearned income and deferred fees 1.58% 1.61% Allowance for loan losses to nonperforming loans 365.60% 393.07% Allowance for loan losses to nonperforming assets 177.37% 141.80% Nonperforming assets to loans, net of unearned income, plus other real estate owned 0.89% 1.12% Nonaccrual loans $ 718 420 Restructured loans --- 229 Other real estate owned, net 762 1,150 ------- ------ Total nonperforming assets $ 1,480 1,799 ------- ------ Accruing loans past due 90 days or more $ 574 490 ------- ------ -68- Management's Discussion and Analysis Nonperforming loans include nonaccrual and restructured loans. Nonperforming loans and nonperforming assets do not include accruing loans past due 90 days or more. Nonperforming assets totaled $1,480 at December 31, 1995 which represents a $319 or 17.73% decrease from December 31, 1994. In 1994, other real estate owned increased by $884 as nonaccrual real estate loans moved into foreclosure. Nonaccrual loans, which totaled $420 in 1994, increased $298 in 1995. The majority of this increase related to one impaired loan at the Company's BTC subsidiary. While continual efforts are made to improve overall asset quality, management is unable to estimate when and under what exact terms problem assets will be resolved. Effective January 1, 1995, Bankshares adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan", as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures." At December 31, 1995, the recorded investment in loans which have been identified as impaired loans, in accordance with SFAS No. 114, totaled $837. Of this amount, $133 related to loans with no valuation allowance, and $704 related to loans with a corresponding valuation allowance of $419. For the year ended December 31, 1995, the average recorded investment in the impaired loans was approximately $906 and the total interest income recognized on impaired loans was $47, of which $5 was recognized on a cash basis. The balance of impaired loans at January 1, 1995, totaled approximately $812. The initial adoption of SFAS No. 114 did not require an increase to the Company's allowance for loan losses. The impact of SFAS No. 114, as amended by SFAS No. 118, was immaterial to the Company's consolidated financial statements as of and for the year ended December 31, 1995. NONINTEREST INCOME Noninterest income for 1995 was $2,382, up $335 or 16.37% from 1994. Income from service charges on deposits is largely dictated by demand deposit volume, service charge rates, waiver policy and the willingness of account holders to bear penalty charges such as overdraft and insufficient funds fees. While management can exert direct influence over some of these variables, it can do so only in varying degrees with others. All of the above factors contributed to the increase in this category of $82 or 9.00%. Other service charges and fees is composed of fees associated with safe deposit box rent, letters of credit and other services. The miscellaneous nature of this category makes it subject to fluctuations. In 1995 this category declined by $18 or 7.32%. Trust income for 1995 was down from 1994 by $35 or 6.80%. Trust income may fluctuate depending on the volume of business, particularly estate account settlements. A continued financial relationship with heirs after an estate closing can build business volume, but is unpredictable. Market factors also affect the level of income earned. Credit card income continues to show improvement. For 1995, credit card income was up $95 or 26.76% over the previous year. Credit card income includes various fees and charges, primarily annual fees and merchant discount. Because of the highly competitive nature of this product, the Company must offer fees at market levels in order to retain cardholders. Given this inability to adjust fees, the Company generally relies on increased volume to generate additional revenues. Net securities gains for 1995 were $182, as opposed to a net loss of $14 in 1994. The increase in net gains was due principally to calls of securities. -69- National Bankshares, Inc. and Subsidiaries NONINTEREST EXPENSE Noninterest expense for 1995 was $10,033 compared to $9,725 in 1994. This represents a $308 increase or 3.17%. Salaries and employee benefits increased $117 or 2.38%. This increase was due to routine merit adjustments, promotions and other normal compensation related items, offset by a decrease of $75 in net pension cost. The cost of Federal Deposit Insurance declined sharply by $334 or 46.84% from 1994. With the Bank Insurance Fund reaching mandated levels, banks in general became eligible in 1995 for refunds on premiums previously paid and for reduced premiums in future periods. Net costs related to the liquidation and holding of other real estate owned rose $158 in 1995 due primarily to a $124 increase in the provision for losses on other real estate owned in 1995 to reduce the carrying amount of certain properties to their net realizable values. The other operating expense category increased by $302 or 13.13% from 1994 and was due primarily to expenses associated with the merger in the amount of $268 incurred in 1995, and a contribution to a community development corporation expensed in 1995. A substantial portion of the Company's involvement in the community development corporation will be recovered through future tax deductions and tax credits over a ten year period. INCOME TAXES Higher taxable income in 1995 resulted in a $89 or 4.83% increase in income tax expense when compared to 1994. Tax exempt interest income continues to be the primary difference between the "expected" and reported income tax expense. The Company's effective tax rate for 1995 and 1994 was 25.92% and 25.80%, respectively. The Company has determined that a valuation allowance for the gross deferred tax assets is not necessary due to the fact that realization of the entire amount of gross deferred tax assets can be supported by the amount of taxes paid during the carryback period under current tax laws. EFFECTS OF INFLATION The Company's consolidated statements of income generally reflect the effects of inflation. Since interest rates, loan demand and deposit levels are related to inflation, the resulting changes are included in net income. The most significant item which does not reflect the effects of inflation is depreciation expense, because historical dollar values used to determine this expense do not reflect the effect of inflation on the market value of depreciable assets after their acquisition. BALANCE SHEET Total assets at year-end 1995 totaled $380,915, an increase of $7,783 or 2.09% over 1994. Average assets for 1995 totaled $378,406 an increase of $8,444 or 2.28% over 1994. Loans, net outstanding at year-end 1995 were $163,193, an increase of 4.42% from the same point in time in 1994. This growth was funded by a shift from securities to loans, increased internally generated capital and a nominal growth in deposits. The use of excess internal liquidity to fund loan growth allowed the Company to place less emphasis on the procurement of external funds in the market place and avoid the associated cost of such activities. LOANS Loans, net of unearned interest and deferred fees, at December 31, 1995 were $165,818. This represents an increase of $6,978 or 4.39% over 1994 year end. Management continues in its efforts to add to the loan portfolio as long as such growth can be accomplished without compromising underwriting standards. -70- Management's Discussion and Analysis SECURITIES In late 1995, the Financial Accounting Standards Board granted financial institutions a one time opportunity to transfer securities from held to maturity to available for sale. Conditions of this transfer provided that institutions opting to make this shift could do so without bringing into question their ability and positive intent to hold to maturity their remaining held to maturity securities. The Company utilized this one time opportunity to shift approximately $30,156 in securities held to maturity to the available for sale category on December 1, 1995. The year-end balances for securities available for sale were $75,870 and $36,219 in 1995 and 1994, respectively, and the year-end balances for securities held to maturity were $111,765 and $148,012 in 1995 and 1994, respectively. Year-end 1995 balances reflect more clearly the shift of investments associated with the one time transfer of $30,156 described above and the general decline in securities held to maturity due to calls and maturities. The Company's investment policy stresses safety with a program of purchasing high quality securities such as U.S. Treasury and U.S. Government agency issues, state, county, and municipal bonds, corporate bonds, mortgage- backed securities and other bank qualified investments. The Company has classified all of its investment securities as either held to maturity or available for sale, as the Company does not engage in trading activities. Investment strategies are adjusted in response to market conditions and available investment vehicles. At December 31, 1995, the Company had no investment concentrations in any single issue (excluding U.S. Government) that exceeded ten percent of capital. DEPOSITS Average total deposits at December 31, 1995, totaled $330,261 compared to $325,167 in 1994, an increase of $5,094 or 1.57%. The low growth rate was in part due to the Company's excess liquidity position and its ability to meet funding needs. 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 1995 and 1994. Management is not aware of any trends, commitments or events that will result in or that are reasonably likely to result in a material increase or decrease in liquidity. Net cash from operating activities of $6,364 in 1995 decreased $1,357 from 1994 and was primarily attributable to the change in the mortgage loans held for sale category which fluctuates based upon loan demand and the timing of loan sales in the secondary market. CAPITAL RESOURCES Total stockholders' equity increased $5,496 from 1994 to 1995, with net income, less cash dividends on common stock of $2,062, accounting primarily for the increase. Net unrealized gains (losses) on securities available for sale, net of income taxes, were $282 at December 31, 1995 and ($1,751) at December 31, 1994. These unrealized net gains and losses are recorded as a separate component of stockholders' equity and will continue to be subject to change in future years due to fluctuations in fair values, sales, purchases, maturities and calls of securities classified as available for sale. -71- National Bankshares, Inc. and Subsidiaries The Company has operated from a consistently strong capital position. The ratio of total stockholders' equity to total assets was 12.64% at year-end 1995. Banks are required to apply percentages to various assets, including off-balance sheet assets, to reflect their perceived risk. Regulatory defined capital is divided by risk-weighted assets in determining the bank's risk-based capital ratio. No regulatory authorities have advised National Bankshares, Inc. or its subsidiaries, The National Bank of Blacksburg or Bank of Tazewell County, of any specific leverage ratios applicable to them. Bankshares' and its subsidiaries' capital adequacy ratios exceed regulatory requirements and provide added flexibility to take advantage of business opportunities as they arise. See note 11 of the Notes to Consolidated Financial Statements for additional information. -72- Statement of Management's Responsibility Management is responsible for the preparation, content and integrity of the consolidated financial statements, related notes and all other information included in this annual report. The financial data has been prepared in accordance with generally accepted accounting principles and, management believes, fairly and consistently presents Bankshares' financial position and results of operations. Bankshares maintains a system of internal controls which provides reasonable assurances that assets are protected and that accounting records are reliable for the preparation of consolidated financial statements. The Audit Committee of the Board of Directors is comprised entirely of outside directors. Bankshares' internal auditor reports to the committee. On a periodic basis, the committee meets with the internal auditor, independent auditors and management to discuss matters relating to the quality of internal control, financial reporting and audit scope. Both the internal auditor and independent auditors have access to the Audit Committee, without management present if desired, to freely discuss their evaluation of Bankshares' system of internal controls and any other matters. James G. Rakes Joan C. Nelson President and Treasurer Chief Executive Officer -73- Independent Auditors' Report The Board of Directors and Stockholders National Bankshares, Inc.: We have audited the accompanying consolidated balance sheets of National Bankshares, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We did not audit the financial statements of Bank of Tazewell County, a wholly owned subsidiary, which statements reflect total assets constituting 46.6 percent and 46.5 percent and total interest income constituting 42.8 percent and 44.1 percent in 1995 and 1994, respectively, of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Bank of Tazewell County for 1995 and 1994, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Bankshares, Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1996 in conformity with generally accepted accounting principles. As discussed in notes 1(D) and 5 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan", as amended by Statement of Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures", as of January 1, 1995. As discussed in notes 1(C) and 3 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities", as of January 1, 1994. KPMG Peat Marwick LLP Roanoke, Virginia February 17, 1997 -74- National Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets $ In thousands except share and per share data, 1996 1995 December 31, 1996 and 1995 ------ ------ Assets Cash and due from banks (notes 2 and 16) $ 10,080 10,055 Federal funds sold (note 16) 1,910 7,725 Securities available for sale (notes 3 and 16) 62,534 75,870 Securities held to maturity (fair value $108,755 in 1996 and $112,778 in 1995) 108,710 111,765 Mortgage loans held for sale (notes 14, 15 and 16) 516 880 Loans (notes 4, 5, 15 and 16): Real estate construction loans 6,295 6,007 Real estate mortgage loans 43,917 45,589 Commercial and industrial loans 87,519 59,609 Loans to individuals 60,991 56,920 -------- -------- Total loans 198,722 168,125 Less unearned income and deferred fees (2,549) (2,307) -------- -------- Loans, net of unearned income and deferred fees 196,173 165,818 Less allowance for loan losses (note 5) (2,575) (2,625) -------- -------- Loans, net 193,598 163,193 -------- -------- Bank premises and equipment, net (note 6) 5,037 4,679 Accrued interest receivable 3,510 3,621 Other real estate owned, net (note 5) 474 762 Other assets (note 9) 2,481 2,365 -------- -------- Total assets $388,850 380,915 ======== ======== Liabilities Noninterest-bearing demand deposits $ 44,096 39,816 and Interest-bearing demand deposits 73,804 73,101 Stockholders' Savings deposits 48,164 50,548 Equity Time deposits (note 7) 168,520 166,848 -------- -------- Total deposits (note 16) 334,584 330,313 -------- -------- Other borrowed funds (note 16) 627 161 Accrued interest payable 700 744 Other liabilities (note 8) 1,495 1,543 -------- -------- Total liabilities 337,406 332,761 -------- -------- Common stock subject to ESOP put option (note 8) 1,643 --- -75- Stockholders' equity (notes 9, 10, 11 and 17): Preferred stock of no par value. Authorized 5,000,000 shares; none issued and outstanding --- --- Common stock of $2.50 par value. Authorized 5,000,000 shares; issued and outstanding 3,792,833 shares 9,482 9,482 Retained earnings 42,210 38,390 Net unrealized gains (losses) on securities available for sale (248) 282 Common stock subject to ESOP put option (64,796 shares at $25.35 per share) (note 8) (1,643) --- -------- -------- Total stockholders' equity 49,801 48,154 Commitments and contingent liabilities (notes 6, 8 and 14) -------- -------- Total liabilities and stockholders' equity $388,850 380,915 ======== ======== See accompanying notes to consolidated financial statements. -76- National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income $ In thousands, except per share data. Years ended December 31, 1996, 1995 and 1994 1996 1995 1994 ------ ------ ------ Interest Interest and fees on loans $ 17,232 15,761 13,764 Income Interest on federal funds sold 567 704 450 Interest on securities - taxable 8,877 9,723 9,966 Interest on securities - nontaxable 1,971 1,906 1,882 -------- ------- ------- Total interest income 28,647 28,094 26,062 -------- ------- ------- Interest Interest on time deposits of Expense $100,000 or more (note 7) 2,070 1,898 1,364 Interest on other deposits 10,939 10,770 9,284 Interest on borrowed funds 27 35 36 -------- ------- ------- Total interest expense 13,036 12,703 10,684 -------- ------- ------- Net interest income 15,611 15,391 15,378 Provision for loan losses (note 5) 331 282 553 -------- ------- ------- Net interest income after provision for loan losses 15,280 15,109 14,825 -------- ------- ------- Noninterest Service charges on deposit accounts 1,183 993 911 Income Other service charges and fees 269 228 246 Credit card fees 511 450 355 Trust income 603 480 515 Other income 30 49 34 Realized securities gains (losses), net (note 3) 97 182 (14) -------- ------- ------- Total noninterest income 2,693 2,382 2,047 -------- ------- ------- Noninterest Salaries and employee benefits (note 8) 5,278 5,034 4,917 Expense Occupancy and furniture and fixtures 884 920 936 Data processing and ATM 497 462 462 FDIC assessment 4 379 713 Credit card processing 466 411 340 Goodwill amortization 30 30 20 Net costs of other real estate owned 5 195 37 Other operating expense 2,351 2,602 2,300 -------- ------- ------- Total noninterest expense 9,515 10,033 9,725 -------- ------- ------- Income before income tax expense 8,458 7,458 7,147 Income tax expense (note 9) 2,341 1,933 1,844 -------- ------- ------- Net income $ 6,117 5,525 5,303 ======== ======= ======= Net income per share $ 1.61 1.46 1.40 ======== ======= ======= See accompanying notes to consolidated financial statements. -77- National Bankshares, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity
Net Unrealized Common Gains (Losses) Stock on Securities Subject to $ in thousands except share and per share data. Common Retained Available ESOP Put Years ended December 31, 1996, 1995 and 1994. Stock Surplus Earnings For Sale Option Total -------- ------- -------- -------------- ---------- ------- Balances, December 31, 1993 as previously reported $ 4,274 1,112 12,868 --- --- 18,254 .11129 for one stock split 190,472 additional shares issued 476 (476) --- --- --- --- Adjustment in connection with pooling-of- interests 4,721 (711) 18,725 (38) --- 22,697 ------- ------ ------- ------ ------ ------ Balances, December 31, 1993 as restated 9,471 (75) 31,593 (38) --- 40,951 Cumulative effect of change in accounting for securities available for sale at January 1, 1994, net of income taxes of $141 --- --- --- 273 --- 273 Net Income --- --- 5,303 --- --- 5,303 Net proceeds from issuance of common stock (4,480 shares) (note 10) 11 75 --- --- --- 86 Cash dividends ($.52 per share) --- --- (993) --- --- (993) Cash dividends of BTC declared prior to merger --- --- (976) --- --- (976) Change in net unrealized gains (losses) on securities available for sale, net of income tax benefit of $1,023 --- --- --- (1,986) --- (1,986) ------- ------ ------- ------ ------ ------ Balances, December 31, 1994 as restated 9,482 --- 34,927 (1,751) --- 42,658 Net income --- --- 5,525 --- --- 5,525 Cash dividends ($.57 per share) --- --- (1,080) --- --- (1,080) Cash dividends of BTC declared prior to merger --- --- (982) --- --- (982) Change in net unrealized gains (losses) on securities available for sale, net of income taxes of $1,047 --- --- --- 2,033 --- 2,033 ------- ------ ------- ------ ------ ------ Balances, December 31, 1995 as restated 9,482 --- 38,390 282 --- 48,154 Net income --- --- 6,117 --- --- 6,117 Cash dividends ($.62 per share) --- --- (1,787) --- --- (1,787) Cash dividends of BTC declared prior to merger --- --- (510) --- --- (510) Change in net unrealized gains (losses) on securities available for sale, net of income tax benefit of $273 --- --- --- (530) --- (530) Common stock subject to ESOP put option --- --- --- --- (1,643) (1,643) ------- ------ ------- ------ ------ ------ Balances, December 31, 1996 $ 9,482 --- 42,210 (248) (1,643) 49,801 ======= ====== ======= ====== ====== ====== See accompanying notes to consolidated financial statements.
-78- National Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows $ In thousands. Years ended December 31, 1996, 1995 1996 1995 1994 and 1994 ------ ------ ------ Cash Flows Net income $ 6,117 5,525 5,303 from Adjustments to reconcile net income to net Operating cash provided by operating activities: Activities Provision for loan losses 331 282 553 (Note 13) Recovery of bond losses (89) --- --- Provision for deferred income taxes (4) (120) (32) Depreciation of bank premises and equipment 517 535 544 Amortization of intangibles 121 145 123 Amortization of premiums and accretion of discounts, net 52 (32) 69 (Gains) losses on bank premises and equipment disposals 7 (9) --- (Gains) losses on sales and calls of securities available for sale, net (3) (2) 27 Gains on calls of securities held to maturity, net (5) (180) (13) Net (increase) decrease in mortgage loans held for sale 364 (488) 1,360 (Gains) losses and write-downs on other real estate owned (9) 168 8 (Increase) decrease in: Accrued interest receivable 111 88 (242) Other assets 40 129 (343) Increase (decrease) in: Accrued interest payable (44) 170 40 Other liabilities 462 153 324 ------- ------- ------- Net cash provided by operating activities 7,968 6,364 7,721 ------- ------- ------- Cash Flows Net (increase) decrease in federal funds from sold 5,815 (100) 6,270 Investing Proceeds from sales of securities Activities available for sale 1,000 1,867 --- (Notes 3 Proceeds from calls and maturities of and 13) securities available for sale 21,938 8,134 9,964 Proceeds from calls and maturities of securities held to maturity 35,569 28,592 30,865 Purchases of securities available for sale (10,397) (16,432) (16,068) Purchases of securities held to maturity (32,477) (22,271) (36,707) Purchases of loan participations (1,704) --- (1,000) Collections of loan participations 2,448 1,928 510 Net increase in loans made to customers (31,633) (9,197) (7,213) Proceeds from disposal of other real estate owned 325 220 91 Recoveries on loans charged off 125 83 54 Bank premises and equipment expenditures Proceeds from sale of bank premises and (882) (492) (1,112) equipment --- 9 1 ------- ------- ------- Net cash used in investing activities (9,873) (7,659) (14,345) ------- ------- ------- -79- Cash Flows Deposits assumed, net of premium paid --- --- 13,159 from Net increase in time deposits 1,672 18,179 8,471 Financing Net increase (decrease) in other deposits 2,599 (15,552) (9,300) Activities Net proceeds from issuance of common stock --- --- 86 (Note 13) Net increase (decrease) in other borrowed funds 466 (630) (397) Cash dividends paid (2,807) (2,056) (1,969) ------- ------- ------- Net cash provided by (used in) financing activities 1,930 (59) 10,050 ------- ------- ------- Net increase (decrease) in cash and due from banks 25 (1,354) 3,426 Cash and due from banks at beginning of year 10,055 11,409 7,983 ------- ------- ------- Cash and due from banks at end of year $10,080 10,055 11,409 ======= ======= ======= See accompanying notes to consolidated financial statements. -80- Notes to Consolidated Financial Statements $ In thousands, except share and per share data.December 31, 1996, 1995 and 1994 Note 1: Summary of Significant Accounting Policies The accounting and reporting policies of National Bankshares, Inc. (Bankshares) and its wholly owned subsidiaries, The National Bank of Blacksburg (NBB) and Bank of Tazewell County (BTC), conform to generally accepted accounting principles and general practices within the banking industry (see note 17 for merger with BTC). In preparing the consolidated financial statements, management is required to make certain estimates, assumptions and loan evaluations that affect its consolidated financial statements for the period. Actual results could vary significantly from those estimates. Changing economic conditions, adverse economic prospects for borrowers, as well as regulatory agency action as a result of an examination, could cause NBB and BTC to recognize additions to the allowance for loan losses and may also affect the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. The following is a summary of the more significant accounting policies. (A) Consolidation The consolidated financial statements include the accounts of National Bankshares, Inc. and its wholly owned subsidiaries (the Company). All significant intercompany balances and transactions have been eliminated. (B) Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand and due from banks. (C) Securities Effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and accordingly, has recorded the effect of this adoption in the accompanying consolidated financial statements for the year ended December 31, 1994. Securities available for sale are reported at fair value, with unrealized gains and losses excluded from net income and reported, net of income taxes, in a separate component of stockholders' equity. Securities held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts on a basis which approximates the level yield method. The Company does not engage in securities trading. Gains and losses on securities are accounted for on the completed transaction basis by the specific identification method. A decline in the fair value of any available for sale or held to maturity security below cost that is deemed other than temporary is charged to income resulting in the establishment of a new cost basis for the security. (D) Loans Loans are stated at the amount of funds disbursed plus the applicable amount, if any, of unearned interest and other charges less payments received. Income on installment loans, including impaired installment loans that have not been placed in nonaccrual status, is recognized on methods which approximate the level yield method. Interest on all other loans, including impaired other loans that have not been placed in nonaccrual status, is accrued based on the balance outstanding times the applicable interest rate. Interest is recognized on the cash basis for all loans carried in nonaccrual status. Loans generally are placed in nonaccrual status when the collection of principal or interest is 90 days or more past due, unless the obligation is both well-secured and in the process of collection. Loan origination and commitment fees and certain direct costs are being deferred, and the net amount amortized as an adjustment to the related loan's yield. These amounts are being amortized over the contractual life of the related loans. -81- National Bankshares, Inc. and Subsidiaries Effective January 1, 1995, the Company adopted the provisions of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan", as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures". SFAS No. 114, as amended by SFAS No. 118, requires that impaired loans within the scope of the statements be presented in the financial statements at the present value of expected future cash flows or at the fair value of the loan's collateral if the loan is deemed "collateral dependent." A valuation allowance is required to the extent that the measure of the impaired loans is less than the recorded investment. SFAS No. 114 does not apply to large groups of small-balance homogeneous loans such as residential real estate mortgage, consumer installment, home equity and bank card loans, which are collectively evaluated for impairment. SFAS No. 118 allows a creditor to use existing methods for recognizing interest income on an impaired loan. Mortgage loans held for sale are carried at the lower of cost or fair value. (E) Allowance for Loan Losses The allowance for loan losses is a valuation allowance consisting of the cumulative effect of the provision for loan losses, plus any amounts recovered on loans previously charged off, minus loans charged off. The provision for loan losses charged to expense is the amount necessary in management's judgement to maintain the allowance for loan losses at a level it believes adequate to absorb losses in the collection of its loans. (F) Bank Premises and Equipment Bank premises and equipment are stated at cost, net of accumulated depreciation. Depreciation is charged to expense over the estimated useful lives of the assets on the straight-line basis. Depreciable lives include 40 years for premises and 3-10 years for furniture and equipment. Costs of maintenance and repairs are charged to expense as incurred and improvements are capitalized. (G) Other Real Estate Owned Other real estate, acquired through foreclosure or deed in lieu of foreclosure, is carried at the lower of the recorded investment or its fair value, less estimated costs to sell (net realizable value). When the property is acquired, any excess of the loan balance over net realizable value is charged to the allowance for loan losses. Increases or decreases in the net realizable value of such properties are credited or charged to income by adjusting the valuation allowance for other real estate owned. Net costs of maintaining or operating foreclosed properties are expensed as incurred. (H) Intangible Assets Included in other assets are deposit intangibles of $666 and $757 at December 31, 1996 and 1995, respectively, and goodwill of $367 and $397 at December 31, 1996 and 1995, respectively. Deposit intangibles are being amortized on a straight-line basis over a ten-year period and goodwill is being amortized on a straight-line basis over a fifteen-year period. (I) 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. (J) Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates -82- Notes to Consolidated Financial Statements expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (K) Trust Assets and Income Assets (other than cash deposits) held by the Trust Departments in a fiduciary or agency capacity for customers are not included in the consolidated financial statements since such items are not assets of the Company. Trust income is recognized on the accrual basis. (L) Net Income Per Share Net income per share is based upon the weighted average number of common shares outstanding (3,792,833 shares in 1996 and 1995 and 3,788,859 shares in 1994). (M) Off-Balance Sheet Financial Instruments In the ordinary course of business, the Company has entered into off-balance sheet financial instruments consisting of commitments to extend credit and standby letters of credit. Such financial instruments are recorded in the financial statements when they become payable. (N) Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value: (1) Cash and Due from Banks The carrying amount is a reasonable estimate of fair value. (2) Federal Funds Sold The carrying amount is a reasonable estimate of fair value. (3) 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. (4) 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 operating expenses and prepayments. The estimate of maturity is based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. Fair value for significant nonperforming loans is based on estimated cash flows which are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and specific borrower information. (5) Deposits The fair value of demand and savings deposits is the amount payable on demand. The fair value of fixed maturity time deposits and certificates of deposit is estimated using the rates currently offered for deposits with similar remaining maturities. (6) Other Borrowed Funds Other borrowed funds represents treasury tax and loan deposits. The carrying amount is a reasonable estimate of fair value because the deposits are generally repaid within 1 to 120 days from the transaction date. -83- National Bankshares, Inc. and Subsidiaries (7) Commitments to Extend Credit and Standby Letters of Credit T h e 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, 1996 and 1995, and as such, the related fair values have not been estimated. (O) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of The Company adopted the provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", on January 1, 1996. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of this Statement did not have a material impact on the Company's financial position, results of operations or liquidity. (P) Reclassifications Certain reclassifications have been made to prior years' consolidated financial statements to place them on a basis comparable with the 1996 consolidated financial statements. Note 2: Restrictions on Cash To comply with Federal Reserve regulations, the Company is required to maintain certain average reserve balances. The daily average reserve requirements were $2,914 and $2,530 for the weeks including December 31, 1996 and 1995, respectively. Note 3: Securities As discussed in note 1(C), effective January 1, 1994, the Company adopted the provisions of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities". The cumulative effect of this change in accounting at January 1, 1994, was to increase securities available for sale by $414, decrease the net deferred tax asset by $141 and increase stockholders' equity by $273. The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities available for sale by major security type as of December 31, 1996 and 1995 are as follows: December 31, 1996 Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- ------ Available for sale: U.S. Treasury $ 8,740 116 (66) 8,790 U.S. Government agencies and corporations 33,840 149 (349) 33,640 States and political subdivisions 8,688 86 (155) 8,619 Mortgage-backed securities 4,568 12 (128) 4,452 Other securities 7,074 25 (66) 7,033 -------- ------ ------ ------- Total securities available for sale $ 62,910 388 (764) 62,534 ======== ====== ====== ======= -84- Notes to Consolidated Financial Statements December 31, 1995 Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- ------ Available for sale: U.S. Treasury $ 14,991 352 (21) 15,322 U.S. Government agencies and corporations 42,586 476 (253) 42,809 States and political subdivisions 7,613 3 (49) 7,567 Mortgage-backed securities 4,748 8 (111) 4,645 Other securities 5,505 42 (20) 5,527 -------- ------ ------ ------- Total securities available for sale $ 75,443 881 (454) 75,870 ======== ====== ====== ======= The amortized costs and fair values of single maturity securities available for sale at December 31, 1996, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities included in these totals are allocated based upon estimated cash flows at December 31, 1996. December 31, 1996 Amortized Fair ($ In thousands) Costs Values --------- -------- Due in one year or less $ 6,768 6,764 Due after one year through five years 22,325 22,276 Due after five years through ten years 27,872 27,654 Due after ten years 5,144 5,032 No maturity 801 808 -------- ------- $ 62,910 62,534 ======== ======= The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities held to maturity by major security type as of December 31, 1996 and 1995 are as follows: December 31, 1996 Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- ------ Held to maturity: U.S. Treasury $ 11,547 36 (148) 11,435 U.S. Government agencies and corporations 54,804 215 (604) 54,415 States and political subdivisions 34,144 530 (105) 34,569 Mortgage-backed securities 767 29 --- 796 Other securities 7,448 103 (11) 7,540 -------- ------ ------ ------- Total securities held to maturity $108,710 913 (868) 108,755 ======== ====== ====== ======= -85- National Bankshares, Inc. and Subsidiaries December 31, 1995 Gross Gross Amortized Unrealized Unrealized Fair ($ In thousands) Costs Gains Losses Values --------- ---------- ---------- ------ Held to maturity: U.S. Treasury $ 19,330 167 (32) 19,465 U.S. Government agencies and corporations 49,938 188 (16) 50,110 States and political subdivisions 36,428 802 (202) 37,028 Mortgage-backed securities 961 31 --- 992 Other securities 5,108 81 (6) 5,183 -------- ------ ------ ------- Total securities held to maturity $111,765 1,269 (256) 112,778 ======== ====== ====== ======= The amortized costs and fair values of single maturity securities held to maturity at December 31, 1996, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities included in these totals are allocated based upon estimated cash flows at December 31, 1996. December 31, 1996 Amortized Fair ($ In thousands) Costs Values --------- ------ Due in one year or less $ 18,781 18,820 Due after one year through five years 55,493 55,480 Due after five years through ten years 30,479 30,414 Due after ten years 3,957 4,041 -------- ------- $108,710 108,755 ======== ======= There were no sales of securities held to maturity during 1996, 1995 or 1994. The carrying value of securities pledged to secure public and trust deposits, and for other purposes as required or permitted by law, was $18,446 at December 31, 1996 and $16,262 at December 31, 1995. On November 15, 1995, the Financial Accounting Standards Board issued a Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." This Special Report contained a unique provision that allowed entities to, concurrent with the initial adoption of the implementation guidance but no later than December 31, 1995, reassess the appropriateness of the classifications of all securities held at the time. In connection with this one-time reassessment, the Company transferred securities classified as held to maturity with amortized costs of approximately $30,156 to available for sale securities, increased by the related unrealized gain in the amount of approximately $643 on December 1, 1995. Entities opting to make such a transfer could do so without bringing into question their ability and positive intent to hold the remaining held to maturity portfolio until maturity. -86- Notes to Consolidated Financial Statements Note 4: Loans to Officers and Directors In the normal course of business, loans have been made to executive officers and directors of Bankshares and its subsidiaries. As of December 31, 1996 and 1995, there were direct loans to executive officers and directors of $2,567 and $3,332, respectively. In addition, there were loans of $2,145 and $2,550 at December 31, 1996 and 1995, respectively, which were endorsed by directors and/or executive officers or had been made to companies in which directors and/or executive officers had an equity interest. The following schedule summarizes amounts receivable from executive officers and directors of Bankshares and its subsidiaries, and their immediate families or associates: Year ended December 31, ($ In thousands) 1996 ------------ Aggregate balance, beginning of year $ 5,882 Additions 3,449 Collections (4,619) ------- Aggregate balance, end of year $ 4,712 ======= Note 5: Nonperforming Assets, Past Due Loans, Impaired Loans and Allowance for Loan Losses Nonperforming assets consist of the following: December 31, ($ In thousands) 1996 1995 1994 ------ ------ ------ Nonaccrual loans $ 616 718 420 Restructured loans --- --- 229 ------- ------ ------ Total nonperforming loans 616 718 649 Other real estate owned, net 474 762 1,150 ------- ------ ------ Total nonperforming assets $ 1,090 1,480 1,799 ------- ------ ------ Accruing loans past due 90 days or more $ 458 574 490 ======= ====== ====== There were no material commitments to lend additional funds to customers whose loans were classified as nonperforming at December 31, 1996. -87- National Bankshares, Inc. and Subsidiaries The following table shows the interest that would have been earned on nonaccrual and restructured loans if they had been current in accordance with their original terms and the recorded interest that was earned and included in income on these loans: Years ended December 31, ($ In thousands) 1996 1995 1994 ------ ------ ------ Scheduled interest: Nonaccrual loans $ 68 59 38 Restructured loans --- --- 19 ------- ------ ------ Total scheduled interest $ 68 59 57 ======= ====== ====== Recorded interest: Nonaccrual loans $ 24 5 1 Restructured loans --- --- 9 ------- ------ ------ Total recorded interest $ 24 5 10 ======= ====== ====== Changes in the valuation allowance for other real estate owned are as follows: Years ended December 31, ($ In thousands) 1996 1995 1994 ------ ------ ------ Balances, beginning of year $ 91 49 409 Provision for other real estate owned 5 124 --- Write-offs --- (82) (360) ------- ------ ------ Balances, end of year $ 96 91 49 ======= ====== ====== As discussed in note 1(D), effective January 1, 1995, the Company adopted the provisions of SFAS No. 114, as amended by SFAS No. 118. At December 31, 1996, the recorded investment in loans which have been identified as impaired loans, in accordance with SFAS No. 114, totaled $725. Of this amount, $354 related to loans with no valuation allowance and $371 related to loans with a corresponding valuation allowance of $290. At December 31, 1995, the recorded investment in loans which have been identified as impaired loans totaled $837. Of this amount, $133 related to loans with no valuation allowance and $704 related to loans with a corresponding valuation allowance of $419. For the year ended December 31, 1996, the average recorded investment in impaired loans was approximately $800, and the total interest income recognized on impaired loans was $33 of which $23 was recognized on a cash basis. For the year ended December 31, 1995, the average recorded investment in impaired loans was approximately $906, and the total interest income recognized on impaired loans was $47 of which $5 was recognized on a cash basis. The balance of -88- Notes to Consolidated Financial Statements impaired loans at January 1, 1995 totaled approximately $812. The initial adoption of SFAS No. 114 did not require an increase to the Company's allowance for loan losses. The impact of SFAS No. 114, as amended by SFAS No. 118, was immaterial to the Company's consolidated financial statements as of and for the year ended December 31, 1995. Changes in the allowance for loan losses are as follows: Years ended December 31, ($ In thousands) 1996 1995 1994 ------ ------ ------ Balances, beginning of year $ 2,625 2,551 2,583 Provision for loan losses 331 282 553 Recoveries 125 83 54 Loans charged off (506) (291) (639) ------- ------ ------ Balances, end of year $ 2,575 2,625 2,551 ======= ====== ====== Note 6: Bank Premises and Equipment Bank premises and equipment stated at cost, less accumulated depreciation, are as follows: December 31, ($ In thousands) 1996 1995 ------ ------ Premises $ 5,787 5,511 Furniture and equipment 3,936 3,764 Construction-in-progress 249 30 ------- ------ 9,972 9,305 Less accumulated depreciation (4,935) (4,626) ------- ------ Total bank premises and equipment $ 5,037 4,679 ======= ====== The Company leases a branch facility as well as certain other office space under noncancellable operating leases that expire over the next seven years. The future minimum lease payments under these leases (with initial or remaining lease terms in excess of one year) as of December 31, 1996 are: Years ending December 31, Amount ------ 1997 $ 83 1998 60 1999 36 2000 13 2001 13 Later years through 2003 23 ---- $228 ==== -89- National Bankshares, Inc. and Subsidiaries Note 7: Time Deposits Included in time deposits are certificates of deposit and other time deposits of $100 or more in the aggregate amounts of $37,414 at December 31, 1996 and $35,127 at December 31, 1995. At December 31, 1996, the scheduled maturities of time deposits are as follows: $120,448 in 1997; $19,701 in 1998; $3,137 in 1999; $24,530 in 2000; $563 in 2001; and $141 thereafter. Note 8: Employee Benefit Plans NBB has a Retirement Accumulation Plan qualifying under IRS Code Section 401(k). Eligible participants in the plan can contribute up to 10% of their total annual compensation to the plan. Employee contributions are matched by NBB based on a percentage of an employee's total annual compensation contributed to the plan. For the years ended December 31, 1996, 1995 and 1994, NBB contributed $83, $78 and $76, respectively, to the plan. Bankshares has a nonleveraged Employee Stock Ownership Plan (ESOP) which enables employees with one year of service who have attained the age of 21 prior to the plan's January 1 and July 1 enrollment dates to own Bankshares common stock. Contributions to the ESOP are determined annually by the Board of Directors. Contribution expense amounted to $200, $163 and $145 for the years ended December 31, 1996, 1995 and 1994, respectively. Dividends on ESOP shares are charged to retained earnings. As of December 31, 1996, the number of allocated shares held by the ESOP was 47,560 and the number of unallocated shares was 17,236. All shares held by the ESOP are treated as outstanding in computing the Company's net income per share. Bankshares or the ESOP has the right of first refusal for any shares distributed to a participant in the event the participant elects to sell the shares. Upon reaching age 55 with ten years of plan participation, a vested participant has the right to diversify 50% of his or her allocated ESOP shares and Bankshares or the ESOP, with the agreement of the Trustee, would be obligated to purchase those shares. The ESOP contains a put option which allows a withdrawing participant to require Bankshares or the ESOP, if the plan administrator agrees, to purchase his or her allocated shares if the shares are not readily tradeable on an established market at the time of its distribution. Accordingly, at December 31, 1996, 64,796 shares of stock held by the ESOP, at their estimated fair value, which is based on the most recent available independent valuation, is recorded outside of stockholders' equity. Bankshares does not anticipate any material cash requirements in each of the next five years relating to the ESOP. The Company also sponsors two separate noncontributory defined benefit pension plans which cover substantially all of its employees. The pension plans' benefit formulas generally base payments to retired employees upon their length of service and a percentage of qualifying compensation during their final years of employment. The NBB pension plan's assets are invested principally in U.S. Government agency obligations (53%), mutual funds (22%), and equity securities (18%). The BTC pension plan's assets are invested principally in BTC certificates of deposit (29%), U.S. Government agency obligations (26%), U.S. Treasury securities (25%), and money market funds (18%). -90- Notes to Consolidated Financial Statements The plans' funded status at December 31, 1996 and 1995 is as follows: December 31, ($ In thousands) 1996 1995 ------ ------ Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $3,148 in 1996 and $3,110 in 1995 $ 3,252 3,210 ======== ======= Projected benefit obligation for service rendered to date (5,160) (5,094) Plan assets at fair value 3,950 3,498 -------- ------- Projected benefit obligation in excess of plan assets (1,210) (1,596) Unrecognized net transition asset (228) (251) Unrecognized net loss from past experience different from that assumed 989 1,438 Prior service cost not yet recognized in net pension cost 246 262 -------- ------- Net accrued pension cost (includes accrued pension cost of $346 in 1996 and $276 in 1995 included in other liabilities, and prepaid pension cost of $143 in 1996 and $129 in 1995 included in other assets) $ (203) (147) ======== ======= Net pension cost includes the following (income) expense components: Years ended December 31, ($ In thousands) 1996 1995 1994 ------ ------ ------ Service cost-benefits earned during the year $ 327 223 273 Interest cost on projected benefit obligation 353 288 281 Actual return on plan assets (185) (304) (13) Net amortization and deferral (92) 19 (240) ------- ------ ------ Net pension cost $ 403 226 301 ======= ====== ====== Assumptions used in accounting for the pension plans as of December 31, 1996, 1995 and 1994 are as follows: NBB BTC 1996 1995 1994 1996 1995 1994 ---- ---- ---- ---- ---- ---- Weighted average discount rate 7.75% 7% 8.5% 7% 7% 8% Expected long-term rate of return 9% 9% 9% 9% 7.5% 8% Rate of increase in future compensation 5% 5% 5% 5% 5% 5% -91- National Bankshares, Inc. and Subsidiaries Note 9: Income Taxes Total income taxes were allocated as follows: Years ended December 31, ($ In thousands) 1996 1995 1994 ---- ---- ---- Income $ 2,341 1,933 1,844 Stockholders' equity, for net unrealized gains (losses) on securities available for sale recognized for financial reporting purposes (273) 1,047 (882) ------- ------ ------ Total income taxes $ 2,068 2,980 962 ======= ====== ====== The components of federal income tax expense attributable to income before income tax expense are as follows: Years ended December 31, ($ In thousands) 1996 1995 1994 ---- ---- ---- Current $ 2,345 2,053 1,876 Deferred (4) (120) (32) ------- ------ ------ Total income tax expense $ 2,341 1,933 1,844 ======= ====== ====== Taxes resulting from securities transactions amounted to a tax expense of $33 for the year ended December 31, 1996, $62 for the year ended December 31, 1995, and a tax benefit of $5 for the year ended December 31, 1994. The following is a reconciliation of the "expected" income tax expense, computed by applying the U.S. Federal income tax rate of 34% to income before income tax expense, with the reported income tax expense: Years ended December 31, ($ In thousands) 1996 1995 1994 ---- ---- ---- Expected income tax expense (34%) $ 2,876 2,536 2,430 Tax-exempt interest income (756) (744) (740) Nondeductible interest expense 99 88 75 Other, net 122 53 79 ------- ------ ------ Reported income tax expense $ 2,341 1,933 1,844 ======= ====== ====== -92- Notes to Consolidated Financial Statements The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1996 and 1995 are presented below: December 31, ($ In thousands) 1996 1995 ---- ---- Deferred tax assets: Loans, principally due to allowance for loan losses and unearned fee income $ 545 560 Other real estate owned, principally due to valuation allowance 33 33 Deferred compensation and other liabilities, due to accrual for financial reporting purpose 138 115 Deposit intangibles and goodwill 35 28 Nonaccrual interest on loans 23 19 Community development corporation related tax credit 30 34 Net unrealized losses on securities available for sale 128 --- ------ ------ Total gross deferred tax assets 932 789 Less valuation allowance --- --- ------ ------ Net deferred tax assets 932 789 ------ ------ Deferred tax liabilities: Bank premises and equipment, principally due to differences in depreciation (12) (20) Securities, due to differences in discount accretion (43) (30) Other assets (55) (49) Net unrealized gains on securities available for sale --- (145) ------ ------ Total gross deferred liabilities (110) (244) ------ ------ Net deferred tax asset included in other assets $ 822 545 ====== ====== The Company has determined that a valuation allowance for the gross deferred tax assets is not necessary at December 31, 1996 and 1995, due to the fact that the realization of the entire gross deferred tax assets can be supported by the amount of taxes paid during the carryback period available under current tax laws. -93- National Bankshares, Inc. and Subsidiaries Note 10: Common Stock Transactions During 1994, the ESOP purchased 4,480 shares of the common stock of Bankshares at a price of $19.35 per share. There was no stock purchased from Bankshares by the ESOP in 1996 and 1995. The net proceeds from the stock issuance in 1994 have been credited to common stock and surplus. 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, 1996, 1995 and 1994, dividends received from subsidiary banks were $1,901, $1,055 and $1,133, respectively. 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, 1996, retained net income which was free of such restriction amounted to approximately $7,572. Bankshares and its subsidiaries are subject to various regulatory capital requirements administered by the bank regulatory agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, Bankshares and its subsidiaries must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. Bankshares' and its subsidiaries' capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require Bankshares and its subsidiaries to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 1996, that Bankshares and its subsidiaries meet all capital adequacy requirements to which they are subject. As of December 31, 1996, the most recent notifications from the appropriate regulatory authorities categorized Bankshares and its subsidiaries as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized, Bankshares and its subsidiaries must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since those notifications that management believes have changed Bankshares' and its subsidiaries' category. -94- Notes to Consolidated Financial Statements Bankshares' and its subsidiaries' actual regulatory capital amounts and ratios are also presented in the following tables. To Be Well For Capital Capitalized Under Actual Adequacy Purposes Prompt Corrective Action Provisions ($ In thousands) Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- December 31, 1996: Total capital (to risk weighted assets) Bankshares consolidated $53,193 23.00% 18,497 8% n/a n/a NBB 26,175 16.29% 12,855 8% 16,069 10% BTC 27,007 38.30% 5,642 8% 7,052 10% Tier I capital (to risk weighted assets): Bankshares consolidated $50,618 21.89% 9,249 4% n/a n/a NBB 24,171 15.04% 6,428 4% 9,641 6% BTC 26,436 37.49% 2,821 4% 4,231 6% Tier I capital (to average assets): Bankshares consolidated $50,618 12.96% 15,620 4% n/a n/a NBB 24,171 11.20% 8,636 4% 10,795 5% BTC 26,436 15.14% 6,984 4% 8,730 5% To Be Well For Capital Capitalized Under Actual Adequacy Purposes Prompt Corrective Action Provisions ($ In thousands) Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- December 31, 1995: Total capital (to risk weighted assets) Bankshares consolidated $48,350 24.47% 15,799 8% n/a n/a NBB 22,272 16.21% 10,991 8% 13,739 10% BTC 25,991 43.24% 4,808 8% 6,011 10% Tier I capital (to risk weighted assets): Bankshares consolidated $46,083 23.33% 7,900 4% n/a n/a NBB 20,550 14.96% 5,496 4% 8,244 6% BTC 25,446 42.33% 2,404 4% 3,607 6% Tier I capital (to average assets): Bankshares consolidated $46,083 12.25% 15,051 4% n/a n/a NBB 20,550 10.27% 8,007 4% 10,009 5% BTC 25,446 14.45% 7,044 4% 881 5% -95- National Bankshares, Inc. and Subsidiaries Note 12: Parent Company Financial Information Condensed financial information of National Bankshares, Inc. (Parent) is presented below: Condensed Balance Sheets December 31, ($ In thousands) 1996 1995 ---- ---- Assets Cash due from subsidiaries $ 20 14 Investment in subsidiaries, at equity 51,434 48,067 Refundable income taxes due from subsidiaries 25 113 ------- ------- Total assets $51,479 48,194 ======= ======= Liabilities Other liabilities $ 35 40 and ------- ------- Stockholders' Common stock subject to ESOP put option Equity (note 8) 1,643 --- ------- ------- Stockholders' equity (notes 9, 10, 11 and 17): Preferred stock of no par value. Authorized 5,000,000 shares; none issued and outstanding --- --- Common stock of $2.50 par value. Authorized 5,000,000 shares; issued and outstanding 3,792,833 shares 9,482 9,482 Retained earnings 42,210 38,390 Net unrealized gains (losses) on securities available for sale (248) 282 Common stock subject to ESOP put option (64,796 shares at $25.35 per share)(note 8) (1,643) --- ------- ------- Total stockholders' equity 49,801 48,154 Commitments and contingent liabilities (notes 6, 8 and 14) ------- ------- Total liabilities and stockholders' equity $51,479 48,194 ======= ======= -96- Notes to Consolidated Financial Statements Condensed Statements of Income Years ended December 31, ($ In thousands) 1996 1995 1994 ---- ---- ---- Income Dividends from subsidiaries (note 11) $ 1,901 1,055 1,133 Expenses Other expenses 232 285 127 ------- ------- ------- Income before income tax benefit and equity in undistributed net income of subsidiaries 1,669 770 1,006 Applicable income tax benefit 41 97 43 ------- ------- ------- Income before equity in undistributed net income of subsidiaries 1,710 867 1,049 Equity in undistributed net income of subsidiaries 4,407 4,658 4,254 ------- ------- ------- Net income $ 6,117 5,525 5,303 ======= ======= ======= Condensed Statements of Cash Flows Years ended December 31, ($ In thousands) 1996 1995 1994 ---- ---- ---- Cash Flows Net income $ 6,117 5,525 5,303 from Adjustments to reconcile net income Operating to net cash provided by operating Activities activities: Equity in undistributed net income of subsidiaries (4,407) (4,658) (4,254) (Increase) decrease in other assets --- 3 (2) (Increase) decrease in refundable income taxes due from subsidiaries 88 162 (43) Increase (decrease) in other liabilities (5) (9) 20 ------- ------ ------ Net cash provided by operating activities 1,793 1,023 1,024 ------- ------ ------ Cash Flows Cash flows from financing activities: from Purchase of common stock of Financing subsidiaries --- --- (86) Activities Net proceeds from issuance of common stock --- --- 86 Dividends paid (1,787) (1,080) (993) ------- ------ ------ Net cash used in financing activities (1,787) (1,080) (993) ------- ------ ------ Net increase (decrease) in cash 6 (57) 31 Cash due from subsidiary at beginning of year 14 71 40 ------- ------ ------ Cash due from subsidiary at end of year $ 20 14 71 ======= ====== ====== -97- National Bankshares, Inc. and Subsidiaries Note 13: Supplemental Cash Flow Information The Company paid $13,080, $12,533 and $10,644 for interest and $1,839, $1,942 and $2,159 for income taxes, net of refunds, in 1996, 1995 and 1994, respectively. Noncash investing activities consisted of $506, $291 and $639 of loans charged against the allowance for loan losses in 1996, 1995 and 1994, respectively. Noncash investing activities also included $28 in 1996 and $26 in 1994 of loans transferred to other real estate owned. In addition, for the years ended December 31, 1996 , 1995 and 1994, noncash investing activities included changes in net unrealized gains (losses) on securities available for sale of ($803), $3,080 and ($2,595), respectively, changes in deferred tax assets included in other assets of $273, ($1,047) and $882, respectively, and changes in net unrealized gains (losses) on securities available for sale included in stockholders' equity of ($530), $2,033 and ($1,713), respectively. See note 3 for noncash transfers of securities. Note 14: Financial Instruments with Off-Balance Sheet Risk The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company may require collateral or other security to support the following financial instruments with credit risk: December 31, ($ In thousands) 1996 1995 ---- ---- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $ 32,087 32,378 ======== ====== Standby letters of credit $ 1,380 1,969 ======== ====== Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if required by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income- producing commercial properties. Extensions of credit arising from these commitments are predominantly variable rate in nature; the principal exception being construction loans which are at fixed rates, but have terms generally less than one year. -98- Notes to Consolidated Financial Statements 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 1996, the Company originated $17,907 and sold $18,271 to investors, compared to $15,515 originated and $15,027 sold in 1995. 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. Sold loans with potential recourse totaled approximately $18,271 at December 31, 1996. Note 15: Concentrations of Credit Risk The Company does a general banking business, serving the commercial, agricultural and personal banking needs of its customers. NBB's trade territory, commonly referred to as the New River Valley, consists of Montgomery and Giles Counties, Virginia and portions of adjacent counties. NBB's operating results are closely correlated with the economic trends within this area which are, in turn, influenced by the area's three largest employers, Virginia Polytechnic Institute and State University, Montgomery County Schools and Hoechst-Celanese. Other industries include a wide variety of manufacturing, retail and service concerns. Most of BTC's business originates from the communities of Tazewell and Bluefield and other communities in Tazewell County, Virginia and in Mercer County, West Virginia. BTC's service area has largely depended on the coal mining industry and farming for its economic base. In recent years, coal companies have mechanized and reduced the number of persons engaged in the production of coal. There are still a number of support industries for the coal mining business that continue to provide employment in the area. Additionally, several new businesses have been established in the area and Bluefield, West Virginia has begun to emerge as a regional medical center. The ultimate collectibility of the loan portfolios and the recovery of the carrying amounts of repossessed property are susceptible to changes in the market conditions of these areas. At December 31, 1996 and 1995, approximately $71 million and $52 million, respectively, of the loan portfolio were concentrated in commercial real estate. This represents approximately 36% and 34% of the loan portfolio at December 31, 1996 and 1995, respectively. Included in commercial real estate at December 31, 1996 and 1995 was approximately $49 million and $25 million, respectively, in loans for college housing and professional office buildings. Loans for the purpose of acquiring residential real estate were approximately $60 million and $56 million at December 31, 1996 and 1995, respectively. This represents approximately 31% and 34% of the loan portfolio at December 31, 1996 and 1995, respectively. Loans primarily for the purpose of purchasing automobiles were approximately $29 million and $25 million at December 31, 1996 and 1995, respectively. This represents approximately 15% of the loan portfolio at December 31, 1996 and 1995. -99- National Bankshares, Inc. and Subsidiaries The Company has established operating policies relating to the credit process and collateral in loan originations. Loans to purchase real and personal property are generally collateralized by the related property and with loan amounts established based on certain percentage limitations of the property's total stated or appraised value. Credit approval is primarily a function of collateral and the evaluation of the creditworthiness of the individual borrower or project based on available financial information. Note 16: Fair Value of Financial Instruments The estimated fair values of the Company's financial instruments at December 31, 1996 and 1995 are as follows: December 31, 1996 1995 Carrying Estimated Carrying Estimated ($ In thousands) Amount Fair Value Amount Fair Value -------- ---------- -------- ---------- Financial assets: Cash and due from banks $ 10,080 10,080 10,055 10,055 Federal funds sold 1,910 1,910 7,725 7,725 Securities 171,244 171,289 187,635 188,648 Mortgage loans held for sale 516 516 880 880 Loans, net 193,598 192,201 163,193 163,290 -------- ------- ------- ------- Total financial assets $377,348 375,996 369,488 370,598 ======== ======= ======= ======= Financial liabilities: Deposits $334,584 331,758 330,313 334,066 Other borrowed funds 627 627 161 161 -------- ------- ------- ------- Total financial liabilities $335,211 332,385 330,474 334,227 ======== ======= ======= ======= Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgements regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in assumptions could significantly affect these estimates. Fair value estimates are based on existing on-and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred tax assets and bank premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates. -100- Notes to Consolidated Financial Statements Note 17: Business Combination On June 1, 1996, Bankshares issued 1,888,209 shares of its common stock in a one-for-one exchange for all the outstanding common stock of Bank of Tazewell County, Tazewell, Virginia. This business combination has been accounted for as a pooling-of-interests and, accordingly, the consolidated financial statements for the periods prior to the combination have been restated to include the accounts and results of operations of Bank of Tazewell County. There were no adjustments of a material amount resulting from Bank of Tazewell County's adoption of Bankshares' accounting policies. In May, 1996, Bankshares declared a stock split of .11129 per share effected in the form of a stock dividend to the holders of Bankshares common stock just prior to the merger effective date to facilitate the one-for-one common stock exchange ratio. All stockholders' equity accounts, share and per share data have been adjusted retroactively to reflect the stock split. The results of operations previously reported by the separate enterprises and the combined amounts presented in the accompanying financial statements are summarized below: Six months ended June 30, Years ended December 31, ($ In thousands) 1996 1995 1994 ---- ---- ---- Revenues: National Bankshares, Inc. $ 9,286 17,848 16,169 Bank of Tazewell County 6,166 12,628 11,940 -------- ------ ------ Combined $ 15,452 30,476 28,109 ======== ====== ====== Net Income: National Bankshares, Inc. $ 1,883 3,256 2,916 Bank of Tazewell County 1,106 2,269 2,387 -------- ------ ------ Combined $ 2,989 5,525 5,303 ======== ====== ====== Note 18: Future Accounting Considerations In June 1996, the Financial Accounting Standards Board issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". SFAS No. 125 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996 and is to be applied prospectively. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. It distinguishes transfers of financial assets that are sales from transfers that are secured borrowings. Management of the Company does not expect that adoption of SFAS No. 125 will have a material impact on the Company's financial position, results of operations or liquidity. -101- The National Bank of Blacksburg Board of Directors Robert E. Christopher, Jr. Chairman of the Board PICTURE OF ROBERT Retired E. CHRISTOPHER, JR., CHARLES L. BOATWRIGHT Charles L. Boatwright AND JAMES G. RAKES Vice Chairman of the Board Physician James G. Rakes National Bankshares, Inc. The National Bank President and Chief Executive Officer James M. Shuler Companion Animal Clinic, Inc. President Virginia House of Delegates PICTURE OF Delegate JAMES M. SHULER, L. ALLEN BOWMAN AND L. Allen Bowman PAUL A. DUNCAN Litton Poly-Scientific Retiring President Paul A. Duncan Holiday Motor Corp. President Jeffrey R. Stewart Educational Consultant PICTURE OF JEFFREY R. STEWART, J. Lewis Webb, Jr. J. LEWIS WEBB, JR. AND Dentist PAUL P. WISMAN Paul P. Wisman Grundy National Bank Vice President of Investments Nicewonder Investments Manager of Assets The National Bank of Blacksburg Advisory Boards Montgomery County Advisory Board Dan A. Dodson, James L. Dowdy, W. Clinton Graves, James J. Owen, Arlene A. Saari, James C. Stewart, T. Cooper Via Giles Advisory Board Paul B. Collins, John H. Givens, Jr., Ross E. Martin, Kenneth L. Rakes, Scarlet B. Ratcliffe, H.M. Scanland, Jr., Buford Steele -102- Bank of Tazewell County Board of Directors Alonzo A. Crouse Bank of Tazewell County PICTURE OF Executive Vice President, ALONZO A. CROUSE, CARL Secretary and Cashier C. GILLESPIE AND R. E. DODSON Carl C. Gillespie Honorary Chairman of the Board Attorney R.E. Dodson Bank of Tazewell County President and Chief Executive Officer James A. Deskins Deskins Super Market, Inc. President PICTURE OF JAMES A. DESKINS, Ralph S. Bailey RALPH S. BAILEY AND Retired JAMES S. GILLESPIE, JR. James S. Gillespie, Jr. Jim Sam Gillespie Farm President E.P. Greever Retired PICTURE OF E.P. GREEVER, WILLIAM William T. Peery T. PEERY, CHARLES E. Cargo Oil Co., Inc. GREEN, III AND JACK H. President HARRY Charles E. Green, III Equitable Financial Services District Manager Jack H. Harry Harry's Enterprises, Inc. President J.M. Pope Retired PICTURE OF James G. Rakes J.M. POPE, JAMES G. National Bankshares, Inc. RAKES AND WILLIAM H. The National Bank VANDYKE President and Chief Executive Officer William H. VanDyke Candlewax Smokeless Fuel Co. Vice President T.C. Bowen, Jr. Chairman of the Board Attorney -103- National Bankshares, Inc. Board of Directors James G. Rakes National Bankshares, Inc. PICTURE OF The National Bank JAMES G. RAKES, ROBERT President and E. CHRISTOPHER, JR. AND Chief Executive Officer R.E. DODSON Robert E. Christopher, Jr. Chairman of the Board Retired R.E. Dodson Bank of Tazewell County President and Chief Executive Officer Alonzo A. Crouse Bank of Tazewell County Executive Vice President, PICTURE OF Secretary and Cashier ALONZO A. CROUSE, T.C. BOWEN, JR. AND T.C. Bowen, Jr. CHARLES L. Attorney BOATWRIGHT Charles L. Boatwright Vice Chairman of the Board Physician Paul A. Duncan Holiday Motor Corp. PICTURE OF President PAUL A. DUNCAN, WILLIAM T. PEERY AND JEFFREY R. William T. Peery STEWART Cargo Oil Co., Inc. President Jeffrey R. Stewart Educational Consultant -104- Corporate Information NATIONAL BANKSHARES, INC. OFFICERS James G. Rakes President and Chief Executive Officer Marilyn B. Buhyoff Secretary and Counsel F. Brad Denardo Corporate Officer Shelby M. Evans Corporate Compliance Officer Joan C. Nelson Treasurer David K. Skeens Corporate Auditor ANNUAL MEETING The Annual meeting of stockholders will be held on Tuesday, April 8, 1997 at 3:00 p.m. at the Best Western Red Lion Inn, 900 Plantation Road, Blacksburg, Virginia. REQUESTS FOR INFORMATION Analysts, investors and those seeking financial information should contact: James G. Rakes President and Chief Executive Officer 540/552/2011 or 800/552/4123 Those seeking general stockholder information should contact: Marilyn B. Buhyoff Secretary 540/552/2011 or 800/552/4123 FORM 10-K A form 10-K Report filed with the Securities and Exchange Commission is available to stockholders without charge upon written request to the Secretary of National Bankshares, Inc., 100 South Main Street, P.O. Box 90002, Blacksburg, VA 24062-9002 CORPORATE OFFICE REGISTERED AGENT National Bankshares, Inc. James G. Rakes 100 South Main Street 100 South Main Street Blacksburg, VA 24060 Blacksburg, VA 24060 P.O. Box 90002 P.O. Box 90002 Blacksburg, VA 24062-9002 Blacksburg, VA 24062-9002 -105- National Bankshares 100 South Main Street/P.O. Box 90002 Blacksburg, Virginia 24062 -106- EX-21 4 SUBSIDIARIES OF REGISTRANT EXHIBIT NO. 21(i) - ----------------- Subsidiaries of the Registrant 1. The National Bank of Blacksburg National Banking Association Chartered under the laws of the United States of America Doing business as The National Bank of Blacksburg and also as The National Bank 2. Bank of Tazewell County Incorporated under the laws of the State of Virginia Doing business as Bank of Tazewell County -107- EX-27 5 FINANCIAL DATA SCHEDULE
9 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE YEAR-END 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-K. 1,000 12-MOS DEC-31-1996 DEC-31-1996 10,080 0 1,910 0 62,534 108,710 108,755 196,173 2,575 388,850 334,584 627 3,838 0 0 0 9,482 40,319 388,850 17,232 10,848 567 28,647 13,009 13,036 15,611 331 97 9,515 8,458 8,458 0 0 6,117 1.61 1.61 4.59 616 458 0 725 2,625 506 125 2,575 2,575 0 1,312
EX-99 6 INDEPENDENT AUDITOR'S REPORT BTC EXHIBIT NO. 99 - -------------- Cook Associates, LLP Certified Public Accounts Members Division For CPA Firms AICPA And The Virginia Society Of Certified Public Accounts Originating Office P.O. Box 580 Richlands, Virginia INDEPENDENT AUDITOR'S REPORT To the Board of Directors Bank of Tazewell County Tazewell, Virginia We have audited the accompanying balance sheets of Bank of Tazewell County as of December 31, 1995 and 1994, and the related statements of income, changes in stockholders' equity, and cash flows for the years then ended. These financial statements are the responsibility of the Bank's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Bank of Tazewell County as of December 31, 1995 and 1994, and the results of its operations and its cash flows for the years then ended in conformity with generally accounting principles. As discussed in Note 1 and 11 to the financial statements, Bank of Tazewell County adopted the provisions of Statement of Financial Accounting Standards No.'s 114 and 118, "Accounting by Creditors for Impairment of a Loan" as of January 1, 1995. February 27, 1996 Cook Associates, LLP -109- -----END PRIVACY-ENHANCED MESSAGE-----