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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-Q
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Quarterly Report Pursuant to Section 13 or 15(d)
Of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2002
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Commission file number 0-15204
National Bankshares, Inc.
(Exact name of registrant as specified in its charter)
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State or other jurisdiction of incorporation or organization - Virginia
Internal Revenue Service - Employer Identification No. 54-1375874
101 Hubbard Street, P.O. Box 90002, Blacksburg, VA 24062-9002
(540) 951-6300
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such requirements
for the past 90 days.
Yes |X| No |_|
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 1, 2002
- -------------------------------- -----------------------------
Common Stock, $2.50 Par Value 3,511,377
(This report contains 25 pages)
1
26 NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-Q
Index
Page
Part I Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets, June 30, 2002 3-4
and December 31, 2001
Consolidated Statements of Income for the 5-6
Three Months Ended
June 30, 2002 and 2001
Consolidated Statements of Income for the 7-8
Six Months Ended
June 30, 2002 and 2001
Consolidated Statements of Changes in 9
Stockholders' Equity, Six Months Ended
June 30, 2002 and 2001
Consolidated Statements of Cash Flows, 10-11
Six Months Ended June 30, 2002 and 2001
Item 2 - Management's Discussion and Analysis of 16-22
Financial Condition and Results of Operations
Item 3 - Quantitative and Qualitative Disclosures about 23
Market Risk
Part II Other Information
Items 1 - 3 - Legal Proceedings; Changes in 24
Securities and Use of Proceeds;
Defaults Upon Senior Securities
Item 4 - Submission of Matters to a Vote of 24
Security Holders
Item 5 - Other Information 24
Item 6 - Exhibits and Reports on Form 8-K 24
Signatures 25
- ----------
2
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, 2002 and December 31, 2001
(Unaudited) (Audited)
June 30, December 31,
($000's except share and per share data) 2002 2001
================ ===============
Assets
Cash and due from banks $11,632 12,293
Interest-bearing deposits 3,972 15,510
Federal funds sold 4,229 1,080
Securities available for sale 97,014 88,667
Securities held to maturity (fair value
$96,367 in 2002 and $103,234 in 2001) 94,000 102,809
Mortgage loans held for sale 391 1,145
Loans:
Real estate construction loans 22,885 19,573
Real estate mortgage loans 80,525 77,339
Commercial and industrial loans 208,046 189,764
Loans to individuals 105,155 113,413
---------------- ---------------
Total loans 416,611 400,089
Less unearned income and deferred fees (1,522) (1,775)
--------------- ---------------
Loans, net of unearned income
and deferred fees 415,089 398,314
Less: allowance for loan losses (4,843) (4,272)
--------------- --------------
Loans, net 410,246 394,042
--------------- ---------------
Bank premises and equipment, net 9,907 10,132
Accrued interest receivable 5,206 4,917
Other real estate owned, net 301 211
Intangible assets 11,388 11,866
Other assets 1,537 1,951
--------------- ---------------
Total assets $ 649,823 644,623
================ ===============
Liabilities and stockholders' equity
Noninterest-bearing demand deposits $76,628 71,751
Interest-bearing demand deposits 147,039 134,230
Savings deposits 48,974 48,827
Time deposits 305,396 321,810
---------------- ---------------
Total deposits 578,037 576,618
---------------- ---------------
Other borrowed funds 321 203
Accrued interest payable 773 1,101
Other liabilities 1,214 1,440
---------------- ---------------
Total liabilities 580,345 579,362
---------------- ---------------
3
Stockholders' equity Preferred stock of
no par value.
Authorized 5,000,000 shares; none
issued and outstanding --- ---
Common stock of $2.50 par value.
Authorized 5,000,000 shares; issued and
outstanding 3,511,377 shares in 2002 and
3,511,377 shares in 2001 8,778 8,778
Retained earnings 58,952 55,917
Accumulated other comprehensive gain 1,748 566
---------------- ---------------
Total stockholders' equity 69,478 65,261
Commitments and contingent liabilities
---------------- ---------------
Total liabilities and
Stockholders' equity $ 649,823 644,623
================ ===============
See accompanying notes to the consolidated financial statements
4
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended June 30, 2002 and 2001
(Unaudited)
June 30, June 30,
($000's except share and per share data) 2002 2001
=============================================== ============= ==============
Interest income
- ---------------
Interest and fees on loans $ 8,107 $ 8,371
Interest on interest-bearing deposits 53 171
Interest on federal funds sold 10 196
Interest on securities - taxable 1,369 2,080
Interest on securities - nontaxable 1,106 864
============================================== ------------- ---------------
Total interest income 10,645 11,682
============================================== ------------- ---------------
Interest expense
- ----------------
Interest on time deposits $100,000 or more 867 1,223
Interest on other deposits 3,092 4,961
Interest on borrowed funds 1 1
============================================== ------------- ---------------
Total interest expense 3,960 6,185
============================================== ------------- ---------------
Net interest income 6,685 5,497
Provision for loan losses 546 332
============================================== ------------- ---------------
Net interest income after
provision for loan losses 6,139 5,165
============================================== ------------- ---------------
Noninterest income
- ------------------
Service charges on deposit accounts 569 575
Other service charges and fees 79 73
Credit card fees 378 335
Trust income 241 287
Other income 94 26
Realized securities gains, net 185 ---
------------- ---------------
Total noninterest income 1,546 1,296
============================================== ------------- ---------------
Noninterest expense
- -------------------
Salaries and employee benefits 2,216 2,047
Occupancy and furniture and fixtures 427 427
Data processing and ATM 302 348
Credit card processing 227 265
Intangibles and goodwill amortization 240 199
Net costs of other real estate owned 39 16
Other operating expenses 897 983
============================================== ------------- ---------------
Total noninterest expense 4,348 4,285
============================================== ------------- ---------------
Income before income tax expense 3,337 2,176
Income tax expense (790) (495)
============================================== ------------- ---------------
Net income $ 2,547 1,681
============================================== ============= ===============
Net income per share, basic and diluted $ 0.72 0.48
============= ===============
Weighted average number of common
shares outstanding 3,511,377 3,511,377
Dividends declared per share $ 0.46 0.43
============= ===============
See accompanying notes to consolidated financial statements.
5
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Six Months Ended June 30, 2002 and 2001
(Unaudited)
June 30, June 30,
($000's except share and per share data) 2002 2001
============================================ ============= ==============
Interest income
- ---------------
Interest and fees on loans $16,166 $16,603
Interest on interest-bearing deposits 98 375
Interest on federal funds sold 19 540
Interest on securities - taxable 2,772 4,067
Interest on securities - nontaxable 2,184 1,478
============================================ --------------- --------------
Total interest income 21,239 23,063
============================================ --------------- --------------
Interest expense
- ----------------
Interest on time deposits $100,000 or more 1,787 2,423
Interest on other deposits 6,436 9,756
Interest on borrowed funds 3 4
============================================ --------------- --------------
Total interest expense 8,226 12,183
============================================ --------------- --------------
Net interest income 13,013 10,880
============================================
Provision for loan losses 1,192 664
============================================ --------------- --------------
Net interest income after
provision for loan losses 11,821 10,216
============================================ --------------- --------------
Noninterest income
- ------------------
Service charges on deposit accounts 1,104 1,085
Other service charges and fees 134 145
Credit card fees 683 596
Trust income 480 565
Other income 349 126
Realized securities gains (losses), net 165 (26)
--------------- --------------
Total noninterest income 2,915 2,491
============================================ --------------- --------------
Noninterest expense
- -------------------
Salaries and employee benefits 4,443 3,966
Occupancy and furniture and fixtures 824 843
Data processing and ATM 586 709
Credit card processing 484 502
Intangibles and goodwill amortization 478 436
Net costs of other real estate owned 123 20
Other operating expenses 1,799 1,870
============================================ --------------- --------------
Total noninterest expense 8,737 8,346
============================================ --------------- --------------
Income before income tax expense 5,999 4,361
Income tax expense (1,348) (1,064)
============================================ ---------------- --------------
Net income $ 4,651 3,297
============================================ =============== ==============
Net income per share, basic and diluted $ 1.32 0.94
=============== ==============
Weighted average number of common
shares outstanding 3,511,377 3,511,383
Dividends declared per share $ 0.46 0.43
=============== ==============
See accompanying notes to consolidated financial statements.
6
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Six Months Ended June 30, 2002 and 2001
(Unaudited)
Accumulated
Other
($000's, except for per Common Retained Comprehensive Comprehensive
share data) Stock Earnings Income (Loss) Income Total
=========== ============= ================ ================ ============
Balances, December 31, 2000 $ 8,780 51,629 (575) --- 59,834
Net income --- 3,297 --- 3,297 3,297
Dividend ($0.43 per share) --- (1,510) --- --- (1,510)
Other comprehensive income,
net of tax:
Unrealized gains
on securities
available for sale, net
of income tax expense $690 --- --- --- 1,340 ---
Reclass adjustment net
of tax $9 --- --- --- 17 ---
---------------
Other comprehensive income --- --- 1,357 1,357 1,357
----------- ------------- ---------------- ---------------- ------------
Comprehensive income --- --- --- 4,654 ---
----------- ------------- ---------------- ---------------- ------------
Stock repurchase (1) (2) (6) --- --- (8)
----------- ------------- ----------------- --------------- ------------
Balances, June 30, 2001 $ 8,778 53,410 782 --- 62,970
=========== ============= ================= =============== ============
Balances, December 31, 2001 $ 8,778 55,917 566 65,261
Net income --- 4,651 --- 4,651 4,651
Dividend ($0.46 per share) --- (1,616) --- --- (1,616)
Other comprehensive income,
net of tax
Unrealized gains on
securities available for
sale, net of income tax
expense $661 --- --- --- 1,283 ---
Reclass adjustment net of
income tax $52 --- --- --- (101) ---
----------------
Other comprehensive income --- --- 1,182 1,182 1,182
----------- ------------- ---------------- ---------------- ------------
Comprehensive income --- --- --- 5,833 ---
----------- ------------- ---------------- ---------------- ------------
Stock repurchase --- --- --- --- ---
----------- -------------- --------------- ---------------- ------------
Balances, June 30,2002 $ 8,778 58,952 1,748 --- 69,478
=========== ============= ================ ================ ============
(1) Represents the repurchase of 500 shares at $16.25 per share.
See accompanying notes to consolidated financial statements.
7
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2002 and 2001
(Unaudited)
June 30, June 30,
($000's) 2002 2001
================ =================
Cash flows from operating activities
Net income $ 4,651 3,297
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 1,192 664
Depreciation of bank premises and equipment 499 558
Amortization of intangibles 478 435
Amortization of premiums and accretion of
discount, net 196 142
Gains on sales of bank premises and equipment --- (1)
(Gains)losses on sales and calls of securities
available for sale, net (153) 26
Gains on calls of securities held to (12) ---
maturity
Losses and write-downs on other real estate owned 94 4
(Increase) decrease in:
Mortgage loans held for sale 754 (254)
Accrued interest receivable (289) (408)
Other assets (195) (227)
Increase (decrease) in:
Accrued interest payable (328) 22
Other liabilities (226) (218)
----------------- -----------------
Net cash provided by operating
activities 6,661 4,040
---------------- -----------------
Cash flows from investing activities
Net (increase) decrease in federal funds sold (3,149) 17,973
Net decrease in interest-bearing
deposits 11,538 3,621
Proceeds from calls, maturities and principal payments of
securities available for sale 7,087 24,518
Proceeds from sales of securities available for
sale 404 ---
Proceeds from calls, maturities and principal payments of securities
held to maturity 8,715 8,937
Purchases of securities available for sale (13,984) (13,096)
Purchases of securities held to maturity --- (65,534)
Purchases of loan participations (3,200) (3,114)
Collections of loan participations 2,225 2,474
Purchase of loans from acquisition --- (9,255)
Net increase in loans to customers (16,717) (15,716)
Proceeds from disposal of other real estate owned 35 210
Recoveries on loans charged off 77 57
Purchase of bank premises and equipment (274) (668)
Proceeds from disposal of bank premises and equipment --- 16
---------------- ----------------
Net cash used in investing
activities (7,243) (49,577)
----------------- ----------------
8
Cash flows from financing activities
Deposits purchased net of premium paid --- 29,885
Net increase (decrease) in time deposits (16,414) 1,152
Net increase in other deposits 17,833 17,206
Net decrease in other borrowed funds 118 92
Dividends paid on common stock (1,616) (1,510)
Repurchase of common stock --- (8)
---------------- ------------------
Net cash provided by (used in) financing
activities (79) 46,817
---------------- -----------------
Net increase (decrease) in cash and due from banks (661) 1,280
Cash and due from banks at beginning of period 12,293 11,130
---------------- ------------------
Cash and due from banks at end of period $11,632 12,410
================ ==================
Supplemental disclosure of cash flow information
Cash paid for interest $ 8,554 12,161
================ ==================
Cash paid for income taxes $ 1,439 1,263
================ ==================
Loans charged to the allowance for loan losses $ 698 620
================ ==================
Loans transferred to other real estate owned $ 219 73
================ ==================
Unrealized gains on securities available for sale $ 1,791 2,056
================ ==================
See accompanying notes to consolidated financial statements.
9
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2002
(Unaudited)
Note (1)
The consolidated financial statements of National Bankshares, Inc.
(Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg
(NBB), Bank of Tazewell County (BTC) and National Bankshares Financial Services
Inc. (NBFS), (the Company), conform to accounting principles generally accepted
in the United States of America and to general practices within the banking
industry. The accompanying interim period consolidated financial statements are
unaudited; however, in the opinion of management, all adjustments consisting of
normal recurring adjustments which are necessary for a fair presentation of the
consolidated financial statements have been included. The results of operations
for the six months ended June 30, 2002 are not necessarily indicative of results
of operations for the full year or any other interim period. The interim period
consolidated financial statements and financial information included herein
should be read in conjunction with the notes to consolidated financial
statements included in the Company's 2001 Annual Report to Stockholders and
additional information supplied in the 2001 Form 10-K.
10
Note (2) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended
June 30, December 31,
2002 2001 2001
============== ============== ================
($000's, except for % data)
Balance at beginning of period $ 4,272 3,886 3,886
Provision for loan losses 1,192 664 1,408
Loans charged off (698) (620) (1,128)
Recoveries 77 57 106
-------------- -------------- ----------------
Balance at the end of period $ 4,843 3,987 4,272
============== ============== ================
Ratio of allowance for loan losses to the end
of period loans net of unearned income and
deferred fees 1.17% 1.04% 1.07%
=============== ============== ================
Ratio of net charge-offs (recoveries) to
average loans, net of unearned income and
deferred fees(1) .31% .31% .27%
=============== ============== ================
Ratio of allowance for loan losses to
nonperforming loans(2) 36.44% 2,345.29% 1,206.78%
=============== ============== ================
(1) Net charge-offs are on an annualized basis.
(2) The Company defines nonperforming loans as total nonaccrual and
restructured loans. Loans 90 days past due and still accruing are
excluded.
June 30, December 31,
2002 2001 2001
============= ============ ================
($000's, except for % data)
Nonperforming Assets
Nonaccrual loans $579 170 354
Restructured loans --- --- ---
------------- ------------ ----------------
Total nonperforming loans 579 170 354
Foreclosed property 301 399 211
------------- ------------ ----------------
Total nonperforming assets $880 569 565
============= ============ ================
Ratio of nonperforming assets to loans, net of
unearned income and deferred fees, plus other real
estate owned .21% .15% .14%
============= ============ ================
11
June 30, December 31,
2002 2001 2001
============= ============ ================
Accruing Loans Past Due 90 Days or More
Past due 90 days or more and
still accruing $876 1,400 980
============= ============ ================
Ratio of loans past due 90 days or
more to loans, net of unearned
income and deferred fees .21% .36% .25%
============= ============ ================
Impaired Loans
Total impaired loans $682 721 340
============= ============ ================
Impaired loans with a
valuation allowance $231 --- 65
Valuation allowance (110) --- (39)
------------- ------------ -----------------
Impaired loans net of allowance $121 --- 26
============= ============ ================
Impaired loans with no
valuation allowance $451 721 275
============= ============ ================
Average recorded investment
in impaired loans $486 591 671
============= ============ ================
Income recognized on impaired
loans $ 6 29 57
============= ============ ================
Amount of income recognized
on a cash basis --- --- ---
============= ============ ================
12
Note (3) Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for the sale by major security type as of
June 30, 2002 are as follows:
June 30, 2002
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Available for sale:
U.S. Treasury $ 5,247 210 --- 5,457
U.S. Government
agencies and
corporations 2,400 45 --- 2,445
State and political
subdivisions 58,358 1,410 48 59,720
Mortgage-backed
securities 11,801 404 2 12,203
Corporate debt
securities 13,227 224 15 13,436
Federal Reserve Bank stock 208 --- --- 208
Federal Home Loan
Bank stock 1,656 --- --- 1,656
Other securities 1,469 420 --- 1,889
----------------- ----------------- ----------------- ------------------
Total securities
available for sale $94,366 2,713 65 97,014
================= ================= ================= ==================
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of June
30, 2002 are as follows:
June 30, 2002
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Held to Maturity:
U.S. Government
agencies and
corporations $13,020 137 --- 13,157
State and political
subdivisions 46,900 1,085 34 47,951
Mortgage-backed
securities 11,260 234 13 11,481
Corporate securities 22,820 1,040 82 23,778
----------------- ----------------- ----------------- ------------------
Total securities
held to maturity $94,000 2,496 129 96,367
================= ================= ================= ==================
13
National Bankshares, Inc. and Subsidiaries
(In 000's, except for per share data)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The purpose of this discussion is to provide information about the
financial condition and results of operations of National Bankshares, Inc. and
its wholly-owned subsidiaries (the Company), which are not otherwise apparent
from the consolidated financial statements and other information included in
this report. Reference should be made to the financial statements and other
information included in this report as well as the 2001 Annual Report and Form
10-K for an understanding of the following discussion and analysis.
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. The Company's actual results could
differ materially from those set forth in the forward-looking statements.
Critical Accounting Policies
General
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States (GAAP). The
financial information contained within our statements is, to a significant
extent, financial information that is based on measures of the financial effects
of transactions and events that have already occurred. A variety of factors
could affect the ultimate value that is obtained either when earning income,
recognizing an expense, recovering an asset or relieving a liability. We use
historical loss factors as one factor in determining the inherent loss that may
be present in our loan portfolio. Actual losses could differ significantly from
the historical factors that we use. In addition, GAAP itself may change from one
previously acceptable method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that
losses be accrued when they are probable of occurring and estimatable and (ii)
SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that
losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
Our allowance for loan losses has three basic components: the formula
allowance, the specific allowance and the unallocated allowance. Each of these
components is determined based upon estimates that can and do change when the
actual events occur. The formula allowance uses a historical loss view as an
indicator of future losses and, as a result, could differ from the loss incurred
in the future. However, since this history is updated with the most recent loss
information, the errors that might otherwise occur are mitigated. The specific
allowance uses various techniques to arrive at an estimate of loss. Historical
loss information, expected cash flows and fair market value of collateral are
used to estimate these losses. The use of these values in inherently subjective
and our actual losses could be greater or less than the estimates. The
unallocated allowance captures losses that are attributable to various economic
events, industry or geographic sectors whose impact on the portfolio have
occurred but have yet to be recognized in either the formula or specific
allowance.
14
Core deposit intangibles
In July, 2001, the Financial Accounting Standards Board issued two
statements - Statement 141, Business Combinations, and Statement 142, Goodwill
and Other Intangible Assets, which could potentially impact the accounting for
goodwill and other intangible assets. Statement 141 eliminated the pooling
method of accounting for business combinations and required that intangible
assets that meet certain criteria be reported separately from goodwill.
Statement 142 eliminated the amortization of goodwill and other intangibles that
are determined to have an indefinite life. The Statement requires, at a minimum,
annual impairment tests for goodwill and other intangible assets that are
determined to have an indefinite life.
Subsequent to the effective date of SFAS 142 an apparent conflict with
SFAS 72 was raised as an issue, which allows certain intangibles arising from
Bank and Thrift acquisitions to be amortized over their estimated useful lives.
In late June of 2002, the Financial Accounting Standards Board announced
that existing core deposit intangibles would continue to be amortized under SFAS
No.72, subject to periodic impairment testing. Intangibles arising from future
transactions would be subject to the provisions of SFAS No.142.
Analysis of Financial Condition and Results of Operations for the Six Months
Ended June 30,2002
- --------------------------------------------------------------------------------
Net income for the six months ended June 30, 2002 was $4,651, which
represents an increase of $1,354 or 41.1% when compared to the same period in
2001. The annualized return on average assets for the six months ended June 30
2002 was 1.46% and 1.06% for June 30, 2001. The annualized return on average
equity was 13.86% for the period ended June 30, 2002 and 10.77% for June 30,
2001.
Earnings per share for the period ended June 30, 2002 was $1.32 and
$0.94 in 2001 for the same period.
Net Interest Income
Net interest income at the end of the second quarter of 2002 was
$13,013, an increase of $2,133 or 19.6%. Interest income decreased $1,824 or
7.9%, when the periods ended June 30, 2002 and 2001 are compared. Interest
expense decreased $3,957, or 32.5%, when the two periods are compared. The yield
on earning assets was 7.44%, decreasing 71 basis points from June 30, 2001. The
cost to fund earning assets for the period ended June 30, 2002 was 2.73% or a
142 basis point decrease from the same period in 2001. This resulted in a
increase in the net interest margin. As seen by this data, substantially lower
funding costs due to the low rate environment accounted for most of the
improvement.
Management believes that the current rate environment is unsustainable
over a long period of time without having an adverse effect on the general
economy. Accordingly, rate increases are expected by the end of 2002 or the
first part of 2003. While the Company's yield on earning assets would improve in
a higher rate scenerio, it would likely be offset by a greater increase in
funding costs in the near term. The ultimate impact on the Company's net
interest margin will be dependent on several factors. The timing of rate
increases and the extent of such will be a primary factor. However, the effect
of the rate increase could be mitigated by asset and liability management
practices.
15
Additional uncontrollable events that may effect the general economy
and rate levels include the ongoing terrorist threat, interruption of the
nation's oil supplies, and other potential side effects from problems in the
Middle East. Recent accounting scandals and their effect on the stock markets
may also have an adverse effect on the general economy. While management can
plan for various scenerios or rate environments it cannot predict the ultimate
outcome in the potentially volatile environment currently being experienced.
Provision and Allowance for Loan Losses
The ratio of the allowance for loan losses to loans net of unearned
income was 1.17% at June 30 2002. This compares to 1.04% at June 30, 2001. The
provision for the first six months of 2002 was $1,192, up $528 over the same
period the prior year.
While management continues to believe that overall credit quality
remains sound, net charge-offs are expected to be at slightly higher levels in
2002, due in part to an increasing loss exposure in the consumer loan portfolio.
With much of the growth in commercial loans the Company's exposure to losses
resulting from defaults in a small number of large size credits has also
increased. The ratio of the allowance for loan losses to loans at December 31,
2001 was 1.07%. The combined effect of loan growth and additional provisions in
2002 resulted in a nominal 10 basis point increase in this ratio.
Noninterest Income
Noninterest income is an important source of the Company's income. This
category is comprised of service charges on deposit accounts, other service
charges and fees, credit card fees, trust income and other income. Net
securities gains and losses are also included in this category. Noninterest
income for the period ended June 30, 2002 was $2,915, an increase of $424 or
17.0%.
Credit card fees increased $87 and 14.6%. This increase was primarily
due to volume.
Trust income decreased by 15.0% when compared to the first six months of
2001. Trust income is dependent on market conditions as well as the types of
accounts being handled at any given point in time. The level of estate business,
for example, cannot be predicted with any degree of precision. Market
conditions, which control values of assets managed and in turn trust fees, have
been less favorable. With the current market volatility, management believes
that market conditions, though unpredictable, will tend to have an adverse
affect on trust fees.
Realized securities gains/(losses) were $165 for the period ended June
30, 2002. In the second quarter of 2002 the Company sold one third of its
investment in a local bank holding company, which produced a gain of
approximately $157. Also included in realized net gains and losses are the
result of called securities and write-downs in investments in limited liability
companies (LLC). The LLC investments allow the company to derive income from
title insurance, life & casualty insurance and investment products. The
write-downs represent an adjustment of the Company's equity investment in these
companies.
Subsequent to June 30, 2002, an additional one third of its interest in
the previously mentioned local bank holding company was sold. A gain of
approximately $177 was realized and will be reflected in the Company's third
quarter operating results.
Other income contained some nonrecurring or infrequent items as well as
two new forms of revenues, which accounted for a portion of the $223 increase
over 2001. Contributing to this increase were nontaxable proceeds from a life
insurance policy, which was approximately $36 and a recovery of legal fees of
$14 incurred in a prior year. In addition, there was a nonrecurring adjustment
to fees for approximately $48. Other income also included commissions from the
sale of securities and insurance products in the amount of $135, which compares
to $4 at June 30, 2001.
16
Noninterest Expense
Noninterest expense for the period ended June 30 2002 was $8,737, an
increase of $391 or 4.7%.
Salaries and employee benefits increased by $477 or 12.0% when the
periods ended June 30, 2002 and 2001 are compared. This increase was due in part
to the acquisition of a branch in late March 2001. Due to the timing of the
purchase the full impact of the additional expense was not experienced in 2001.
Also, included in the 2002 expense is the full effect of salaries and employee
benefits associated with the Company's financial services affiliate. Routine
merit salary and promotional salary increases also contributed to the increase
in this category.
Data processing costs decreased $123 or 17.4%. This decline was
primarily due to a reduction achieved in maintenance costs and the absence of
conversion costs associated with the 2001 branch acquisition that has been
discussed.
Credit card processing decreased $18 or 3.6% due to volume. Included in
credit card expense for 2002 were two nonrecurring items. The first was a rebate
of processing charges of approximately $42. The second was a rebate for $10
received as a signing bonus for a new processor. These increases were offset in
part by higher expenses related to volume.
Intangibles expense for the second quarter of 2002 was $478 compared to
$436 during the same period last year. This increase was related to the branch
acquisition that occurred in the latter part of March 2001. Since the
transaction occurred late in the first quarter of 2001 intangibles expense was
prorated.
Balance Sheet
Total assets at June 30, 2002 were $649,823, an increase of $5,200 or
0.8% from period end assets at December 31, 2001.
Securities
Securities available for sale increased by 9.4%, while securities held
to maturity decreased 8.6%. (Refer to the table previously presented for
portfolio composition.)
Loans
Loans net of unearned income grew by $16,775 or 4.2% from December 31,
2001. Since December 31, 2001, construction loans increased by $3,312 or 16.9%
with real estate mortgage loans increasing $3,186 or 4.1%. The largest increase,
however was experienced in the commercial loan category which grew by $18,282 or
9.6% due to demand. The only category to show a decrease was loans to
individuals, which declined by $8,258 or 7.3%. Given the general economic
conditions, it is not known to what extent loans to individuals will ultimately
decline or when growth in this area will resume. Loans to individuals generally
produce higher yields than other loan categories. A prolonged and substantial
run-off of these loans could have a measurable impact on the Company's net
interest margin.
17
Deposits
Total deposits decreased $1,419 or 0.3% when June 30 2002 and December
31, 2001 are compared.
Noninterest-bearing demand deposits increased $4,877 or 6.8%, when June
30, 2002 and December 31, 2001 are compared. During the same period
interest-bearing demand deposits increased by 9.5%, while savings deposits were
up 0.3%. Management believes that the increase in interest-bearing demand
deposits is in part due to the customers' expectation of higher interest rates
in the near to intermediate term. Hence, the Company's customers are not
committing their funds for longer terms. The largest decrease in deposits took
place in time deposits, which declined by $16,414 or 5.1%, as management has
allowed higher cost time deposits to run-off.
Daily Averages
Daily averages for the major categories are as follows:
(000's) June 30,2002 December 31,2001
------------------- ---------------------
Loans, net $406,812 380,970
Securities available for sale 87,937 109,682
Securities held to maturity 98,876 79,127
Total assets 642,400 635,692
Total deposits 572,071 569,139
Stockholders' equity 67,651 63,460
Liquidity
Liquidity is the ability to provide sufficient cash levels to meet
financial commitments and to fund loan demand and deposit withdrawals.
Cash from operating activities was $6,661. The primary sources were net
income and net sales of real estate loans held for sale.
Cash used in investing activities was $7,243. As can be seen from the
cash flow statement the principal use of cash was for lending activities.
Financing activities during the period was a user of cash, mainly due to
a decline in in the area of time deposits previously noted.
Management is not aware of any commitments that will result in, or are
likely to result in, a material and adverse decline in liquidity.
Branching Activity
The Company's NBB affiliate announced in the second quarter its plans to
establish a new branch in Christiansburg, Virginia. The new branch will be
located in the downtown area and is expected to be opened in the first quarter
of 2003.
18
Analysis of the Financial Condition and Results of Operations for the
Three Months Ended June 30, 2002
- --------------------------------------------------------------------------------
Net income for the three months ended June 30, 2001 was $2,547, a
increase of $866 or 51.5% over the same period in 2001. The annualized return on
average assets for the second quarter of 2002 was 1.58% and 1.04% for the second
quarter of 2001. The annualized return on average equity for the second quarter
of 2002 was 14.93%. This compares to 10.83% for the same period in 2000.
Basic earnings per share for the three months ended June 30,2002 was
$0.72, an increase of $0.24 from the second quarter of 2001.
Net interest income
Net interest income for the quarter ended June 30, 2002 was $6,685 or a
21.6% increase from the same quarter in 2001. As previously discussed the
Company continues to benefit from the low interest rate environment.
Provision for loan losses
The provision for loan losses for the second quarter of 2002 was $546.
This compares to $332 for the same period the prior year. The increase in the
provision was necessitated in part by loan growth and a higher level of
charge-offs. As previously mentioned, an increasing concern for loss exposure,
in the consumer loan portfolio exists. The shift in the loan portfolio mix as
discussed previously also contributed to the need for an increased provision.
Noninterest income
Noninterest income for the second quarter of 2002 was $1,546, an
increase of $250 over the period ending June 30, 2001. Previously mentioned
securities gains accounted for the majority of this increase.
Service charges on deposits remained relativity unchanged decreasing $6 or
1.0% when the quarter-ended June 30, 2002 is compared to the same period in
2001.
Credit card income also showed slight improvement due to volume.
Trust income decreased by 16.0% when the two periods are compared. As
previously discussed various factors contribute to the level of trust income.
Market values of assets managed are dependent on market valuations, which as of
late have been generally down.
Noninterest expense
Noninterest expense for the quarter ended June 30, 2002 was $4,348. This
represents an increase of $63 or 1.5% when compared to the quarter ended June
30, 2001. This category contains two nonrecurring items related to credit card
expense. Please refer to the year-to- date discussion for details.
19
Balance Sheet
Total average assets for the quarter ended June 30, 2002 were $646,533,
which represents an increase of $358 or 0.1% over total assets at June 30, 2001.
A comparison of selected quarterly averages follows.
($000) June 30, 2002 June 30, 2001
------------- -------------
Federal funds sold $ 2,448 16,934
Federal Home Loan Bank deposits 12,397 16,476
Securities available for sale 89,285 115,613
Securities held to maturity 97,023 85,938
Loans net of unearned income and fees 406,119 371,907
Noninterest-bearing deposits 74,917 66,527
Interest-bearing deposits 500,833 515,149
Borrowed money 97 246
20
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Derivatives
The Company is not a party to derivative financial instruments with
off-balance sheet risks such as futures, forwards, swaps and options. The
Company is a party to financial instruments with off-balance sheet risks such as
commitments to extend credit, standby letters of credit, and recourse
obligations in the normal course of business to meet the financing needs of its
customers. Management does not plan any future involvement in high risk
derivative products. The Company has limited amounts of collateralized mortgage
obligations, structured notes and other similar instruments that are included in
securities available for sale and securities held to maturity.
Interest Rate Sensitivity
The Company considers interest rate risk to be a significant market risk
and has systems in place to measure the exposure of net interest income to
adverse movement in interest rates. Interest rate shock analyses provides
management with an indication of potential economic loss due to future rate
changes. There have not been any changes, which would significantly alter the
results disclosed as of December 31, 2001.
21
National Bankshares, Inc. and Subsidiaries
Part II
Other Information
Items 1-3. Legal Proceedings; Changes in Securities and Use of Proceeds;
Defaults upon Senior Securities
None for the three months ended June 30, 2002.
Item 4. Submission of Matters to a Vote of Security Holders
Three class 3 Directors of the Company were elected by a
vote of the security holders for a term of three years
each.
(a) This matter was submitted to a vote at the Company's
Annual Meeting of Stockholders held on April 9, 2002.
(b) The name of each director elected at the meeting follows:
James A. Deskins, Sr.
William T. Peery
James M. Shuler
The name of each director whose term of office continued after
the meeting is listed:
L. Allen Bowman
Alonso A. Crouse
Paul A. Duncan
Cameron L. Forrester
James G. Rakes
Jeffrey R. Stewart
(c) The number votes cast for or against each nominee is
provided below. There were no abstaining votes and
broker non-votes.
Election of directors
Director Votes For Votes Against
-------- --------- -------------
James A. Deskins, Sr. 2,657,077 15,480
William T. Peery 2,659,268 13,289
James M. Shuler 2,664,050 8,507
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
The Company had no filings on Form 8-K for the quarter ended June
2002. See the index to exhibits for items incorporated by reference
to this filing.
22
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
National Bankshares, Inc.
(Registrant)
Date: 08/14/2002 /s/ James G. Rakes
-------------- -------------------------------------
James G. Rakes, Chairman
President and Chief Executive Officer
Date: 08/14/2002 /s/ J. Robert Buchanan
------------ -------------------------------------
J. Robert Buchanan, Treasurer
(principal financial officer)
23
Index to Exhibits
Page No. in
Exhibit No. Description Sequential System
- ----------- ----------- -----------------
3(i) Articles of Incorporation, as amended, of (incorporated
National Bankshares, Inc. herein by
reference to
Exhibit 3(a) of
the Annual Report
on Form 10K for
fiscal year ended
December 31, 1993)
4(i) Specimen copy of certificate for National (incorporated
Bankshares, Inc. common stock, $2.50 par herein by
value reference to
Exhibit 4(a) of
the Annual Report
on Form 10K for
fiscal year ended
December 31, 1993)
4(i) Article Fourth of the Articles of (incorporated
Incorporation of National Bankshares, Inc. herein by
included in Exhibit No. 3(a)) reference to
Exhibit
4(b) of the
Annual
Report on
Form 10K
for fiscal
year ended
December
31, 1993)
10(ii)(B) Computer software license agreement dated (incorporated
June 18, 1990, by and between Information herein by
Technology, Inc. and The National Bank of reference to
Blacksburg Exhibit 10(e) of
the Annual Report
on Form 10K for
fiscal year ended
December 31, 1992)
*10(iii)(A) Employment Agreement dated January 1, 2002,
by and between National Bankshares, Inc. and
James G. Rakes
*10(iii)(A) Capital Accumulation Plan (included in
Exhibit No. 10(iii)(A)
24
*10(iii)(A) National Bankshares, Inc. 1999 Stock Option (incorporated
Plan herein by reference
to Exhibit 4.3 of
the Form S-8,
filed as
Registration No.
333-79979 with the
Commission on June
4, 1999)
99(a) Certification of Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350
99(b) Certification of Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350
25