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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 September 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 November 12, 2002
- ----------------------------- --------------------------------
Common Stock, $2.50 Par Value 3,511,377
(This report contains 33 pages)
19 NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-Q
Index
Part I Financial Information Page
Item 1 - Financial Statements
Consolidated Balance Sheets, September 30, 2002 3-4
and December 31, 2001
Consolidated Statements of Income for the 5-6
Three Months Ended
September 30, 2002 and 2001
Consolidated Statements of Income for the 7-8
Nine Months Ended
September 30, 2002 and 2001
Consolidated Statements of Changes in 9
Stockholders' Equity, Nine Months Ended
September 30, 2002 and 2001
Consolidated Statements of Cash Flows, 10-11
Nine Months Ended September 30, 2002 and 2001
Notes to Consolidated Financial 12-17
Statements
Item 2 - Management's Discussion and Analysis of 17-24
Financial Condition and Results of Operations
Item 3 - Quantitative and Qualitative Disclosures about 25
Market Risk
Item 4 - Controls and Procedures 25
Part II Other Information
Items 1 - 3 - Legal Proceedings; Changes in 26
Securities and Use of Proceeds;
Defaults Upon Senior Securities
Item 4 - Submission of Matters to a Vote of 26
Security Holders
Item 5 - Other Information 26
Item 6 - Exhibits and Reports on Form 8-K 26
Signatures 27
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2
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 2002 and December 31, 2001
(Unaudited) (Audited)
September 30, December 31,
($000's except share and per share data) 2002 2001
============ =============
Assets
Cash and due from banks $15,267 12,293
Interest-bearing deposits 16,844 15,510
Federal funds sold 644 1,080
Securities available for sale 109,072 88,667
Securities held to maturity (fair value
$91,116 in 2002 and $103,234 in 2001) 87,067 102,809
Mortgage loans held for sale 640 1,145
Loans:
Real estate construction loans 21,877 19,573
Real estate mortgage loans 80,772 77,339
Commercial and industrial loans 212,033 189,764
Loans to individuals 102,090 113,413
------------ -------------
Total loans 416,772 400,089
Less unearned income and deferred fees (1,375) (1,775)
------------ -------------
Loans, net of unearned income
and deferred fees 415,397 398,314
Less: allowance for loan losses (5,009) (4,272)
------------ -------------
Loans, net 410,388 394,042
------------ -------------
Bank premises and equipment, net 9,783 10,132
Accrued interest receivable 5,003 4,917
Other real estate owned, net 269 211
Intangible assets 11,150 11,866
Other assets 1,519 1,951
------------ -------------
Total assets $ 667,646 644,623
============ =============
Liabilities and stockholders' equity
Noninterest-bearing demand deposits $78,171 71,751
Interest-bearing demand deposits 154,400 134,230
Savings deposits 48,628 48,827
Time deposits 310,379 321,810
------------ -------------
Total deposits 591,578 576,618
------------ -------------
Other borrowed funds 587 203
Accrued interest payable 706 1,101
Other liabilities 1,763 1,440
------------ -------------
Total liabilities 594,634 579,362
------------ --------------
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 61,666 55,917
Accumulated other comprehensive income 2,568 566
------------ ---------------
Total stockholders' equity 73,012 65,261
Commitments and contingent liabilities
------------ --------------
Total liabilities and
Stockholders' equity $ 667,646 644,623
============ ==============
See accompanying notes to the consolidated financial statements
4
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended September 30, 2002 and 2001
(Unaudited)
September 30, September 30,
($000's except share and per share data) 2002 2001
================= ==============
Interest income
Interest and fees on loans $ 8,196 8,507
Interest on interest-bearing deposits 82 66
Interest on federal funds sold 14 100
Interest on securities - taxable 1,338 1,888
Interest on securities - nontaxable 1,130 885
----------------- ----------------
Total interest income 10,760 11,446
----------------- ----------------
Interest expense
Interest on time deposits $100,000 or more 818 1,139
Interest on other deposits 2,964 4,553
Interest on borrowed funds 1 3
----------------- ----------------
Total interest expense 3,783 5,695
----------------- ----------------
Net interest income 6,977 5,751
Provision for loan losses 519 377
----------------- ----------------
Net interest income after
provision for loan losses 6,458 5,374
----------------- ----------------
Noninterest income
Service charges on deposit accounts 574 554
Other service charges and fees 68 69
Credit card fees 357 321
Trust income 238 284
Other income 67 84
Realized securities gains, net 178 ---
----------------- ----------------
Total noninterest income 1,482 1,312
----------------- ----------------
Noninterest expense
Salaries and employee benefits 2,237 2,040
Occupancy and furniture and fixtures 436 437
Data processing and ATM 263 305
Credit card processing 280 255
Intangibles and goodwill amortization 238 239
Net costs of other real estate owned 16 32
Other operating expenses 910 868
----------------- ----------------
Total noninterest expense 4,380 4,176
----------------- ----------------
Income before income tax expense 3,560 2,510
Income tax expense 848 600
----------------- ----------------
Net income $ 2,712 1,910
================== ================
Net income per share, basic and diluted $ 0.78 0.54
================== ================
5
Weighted average number of common
shares outstanding 3,511,377 3,511,377
Dividends declared per share $ --- ---
================== ================
See accompanying notes to consolidated financial statements.
6
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Nine Months Ended September 30, 2002 and 2001
(Unaudited)
September 30, September 30,
($000's except share and per share data) 2002 2001
================== ================
Interest income
Interest and fees on loans $24,362 25,110
Interest on interest-bearing deposits 180 475
Interest on federal funds sold 33 606
Interest on securities - taxable 4,110 5,955
Interest on securities - nontaxable 3,314 2,363
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Total interest income 31,999 34,509
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Interest expense
Interest on time deposits $100,000 or more 2,605 3,562
Interest on other deposits 9,400 14,309
Interest on borrowed funds 4 7
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Total interest expense 12,009 17,878
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Net interest income 19,990 16,631
Provision for loan losses 1,711 1,041
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Net interest income after
provision for loan losses 18,279 15,590
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Noninterest income
Service charges on deposit accounts 1,678 1,639
Other service charges and fees 202 214
Credit card fees 1,040 917
Trust income 718 849
Other income 416 210
Realized securities gains (losses), net 343 (26)
------------------ ----------------
Total noninterest income 4,397 3,803
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Noninterest expense
Salaries and employee benefits 6,680 6,006
Occupancy and furniture and fixtures 1,260 1,280
Data processing and ATM 849 1,014
Credit card processing 764 757
Intangibles and goodwill amortization 716 674
Net costs of other real estate owned 139 52
Other operating expenses 2,709 2,739
------------------ ----------------
Total noninterest expense 13,117 12,522
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Income before income tax expense 9,559 6,871
Income tax expense 2,196 1,664
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Net income $ 7,363 5,207
================== ================
Net income per share, basic and diluted $ 2.10 1.48
================== ================
7
Weighted average number of common
shares outstanding 3,511,377 3,511,381
Dividends declared per share $ 0.46 0.43
=================== ================
See accompanying notes to consolidated financial statements.
8
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Nine Months Ended September 30, 2002 and 2001
(Unaudited)
Accumulated
Other
($000's, except for per Common Retained Comprehensivee Comprehensive
share data) Stock Earnings Income (Loss) Income (Loss) Total
========== ============= ================= ================= ===========
Balances, December 31, 2000 $ 8,780 51,629 (575) --- 59,834
Net income --- 5,207 --- 5,207 5,207
Dividend ($0.43 per share) --- (1,511) --- --- (1,511)
Other comprehensive income, net of tax:
Unrealized gains
on securities
available for sale, net
of income tax expense $1,087 --- --- --- 2,111 ---
Reclass adjustment net
of tax $9 --- --- --- 17 ---
----------------
Other comprehensive income --- --- 2,128 2,128 2,128
---------- ------------- ----------------- ----------------- -----------
Comprehensive income --- --- --- 7,335 ---
---------- ------------- ----------------- ----------------- -----------
Stock repurchase (1) (2) (6) --- --- (8)
---------- ------------- ----------------- ----------------- -----------
Balances, September 30, 2001 $ 8,778 55,319 1,553 --- 65,650
========== ============= ================= ================= ===========
Balances, December 31, 2001 $ 8,778 55,917 566 65,261
Net income --- 7,363 --- 7,363 7,363
Dividend ($0.46 per share) --- (1,614) --- --- (1,614)
Other comprehensive income, net of tax
Unrealized gains on
securities available for
sale, net of income tax
expense $1,144 --- --- --- 2,220 ---
Reclass adjustment net of
income tax expense $113 --- --- --- (218) ---
-----------------
Other comprehensive income --- --- 2,002 2,002 2,002
---------- ------------- ----------------- ----------------- -----------
Comprehensive income --- --- --- 9,365 ---
---------- ------------- ----------------- ----------------- -----------
Balances, September 30, 2002 $ 8,778 61,666 2,568 --- 73,012
========== ============= ================= ================= ===========
(1) Represents the repurchase of 500 shares at $16.25 per share.
See accompanying notes to consolidated financial statements.
9
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2002 and 2001
(Unaudited)
September 30, September 30,
($000's) 2002 2001
================= ==================
Cash flows from operating activities
Net income $ 7,363 5,207
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 1,711 1,041
Depreciation of bank premises and equipment 751 841
Amortization of intangibles 716 674
Amortization of premiums and accretion of
discount, net 282 265
Gains on sales of bank premises and equipment --- (1)
(Gains)losses on sales and calls of securities
available for sale, net (331) 26
Gains on calls of securities held to (12) ---
maturity
Losses and write-downs on other real estate owned 58 4
(Increase) decrease in:
Mortgage loans held for sale 505 (613)
Accrued interest receivable (86) (330)
Other assets (599) (194)
Increase (decrease) in:
Accrued interest payable (395) (208)
Other liabilities 323 69
----------------- -----------------
Net cash provided by operating
activities 10,286 6,781
----------------- -----------------
Cash flows from investing activities
Net decrease in federal funds sold 436 20,321
Net (increase) decrease in interest-bearing
deposits (1,334) 1,062
Proceeds from calls, maturities and principal payments of
securities available for sale 12,258 39,244
Proceeds from sales of securities available for
sale 828 ---
Proceeds from calls, maturities and principal payments of securities
held to maturity 15,846 12,736
Purchases of securities available for sale (30,252) (14,609)
Purchases of securities held to maturity (249) (66,521)
Purchases of loan participations (2,676) (3,401)
Collections of loan participations 3,527 3,099
Purchase of loans from acquisition --- (9,255)
Net increase in loans to customers (19,220) (27,044)
Proceeds from disposal of other real estate owned 103 273
Recoveries on loans charged off 93 89
Purchase of bank premises and equipment (413) (804)
Proceeds from disposal of bank premises and equipment 11 15
----------------- ------------------
Net cash used in investing
activities (21,042) (44,795)
----------------- ------------------
10
Cash flows from financing activities
Deposits purchased net of premium paid --- 29,885
Net (decrease) in time deposits (11,431) (10,593)
Net increase in other deposits 26,391 21,796
Net increase in other borrowed funds 384 200
Dividends paid on common stock (1,614) (1,511)
Repurchase of common stock --- (8)
----------------- ------------------
Net cash provided by financing
activities 13,730 39,769
----------------- ------------------
Net increase in cash and due from banks 2,974 1,755
Cash and due from banks at beginning of period 12,293 11,130
----------------- ------------------
Cash and due from banks at end of period $15,267 12,885
================= ==================
Supplemental disclosure of cash flow information
Cash paid for interest $ 12,404 18,086
================= ==================
Cash paid for income taxes $ 2,464 1,713
================= ==================
Loans charged to the allowance for loan losses $ 1,067 892
================= ==================
Loans transferred to other real estate owned $ 219 780
================= ==================
Unrealized gains on securities available for sale $ 3,033 3,224
================= ==================
See accompanying notes to consolidated financial statements.
11
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 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 three and nine months ended September 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.
Note (2) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended
September 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 1,711 1,041 1,408
Loans charged off (1,067) (892) (1,128)
Recoveries 93 89 106
-------------- -------------- ----------------
Balance at the end of period $ 5,009 4,124 4,272
============== ============== ================
Ratio of allowance for loan losses to the end
of period loans net of unearned income and
deferred fees 1.21% 1.05% 1.07%
=============== ============== ================
Ratio of net charge-offs (recoveries) to
average loans, net of unearned income and
deferred fees(1) .32% .29% .27%
=============== ============== ================
Ratio of allowance for loan losses to
nonperforming loans(2) 1,361.14% 930.93% 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.
12
September 30, December 31,
2002 2001 2001
============= ============ ================
($000's, except for % data)
Nonperforming Assets
Nonaccrual loans $368 443 354
Restructured loans --- --- ---
------------- ------------ ----------------
Total nonperforming loans 368 443 354
Foreclosed property 269 1,043 211
------------- ------------ ----------------
Total nonperforming assets $637 1,486 565
============= ============ ================
Ratio of nonperforming assets to loans, net of
unearned income and deferred fees, plus other real
estate owned .15% .38% .14%
============= ============ ================
13
September 30, December 31,
2002 2001 2001
============= ============ ================
Accruing Loans Past Due 90 Days or More
Past due 90 days or more and
still accruing $895 620 980
============= ============ ================
Ratio of loans past due 90 days or
more to loans, net of unearned
income and deferred fees .22% .16% .25%
============= ============ ================
Impaired Loans
Total impaired loans $387 811 340
============= ============ ================
Impaired loans with a
valuation allowance $43 191 65
Valuation allowance (26) (114) (39)
------------- ------------- ----------------
Impaired loans net of allowance $17 77 26
============= ============ ================
Impaired loans with no
valuation allowance $344 620 275
============= ============ ================
Average recorded investment
in impaired loans $462 646 671
============= ============ ================
Income recognized on impaired
loans $ 11 31 57
============= ============ ================
Amount of income recognized
on a cash basis --- --- ---
============= ============ ================
14
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
September 30, 2002 are as follows:
September 30, 2002
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Available for sale:
U.S. Treasury $ 3,747 233 --- 3,980
U.S. Government
agencies and
corporations 5,317 50 1 5,366
State and political
subdivisions 61,983 2,556 12 64,527
Mortgage-backed
securities 13,110 487 1 13,596
Corporate debt
securities 17,497 459 70 17,886
Federal Reserve Bank stock 208 --- --- 208
Federal Home Loan
Bank stock 1,656 --- --- 1,656
Other securities 1,663 190 --- 1,853
----------------- ----------------- ----------------- ------------------
Total securities
available for sale $105,181 3,975 84 109,072
================= ================= ================= ==================
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of
September 30, 2002 are as follows:
September 30, 2002
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Held to Maturity:
U.S. Government
agencies and
corporations $8,021 189 --- 8,210
State and political
subdivisions 46,012 2,171 21 48,162
Mortgage-backed
securities 10,219 388 --- 10,607
Corporate securities 22,814 1,413 90 24,137
----------------- ----------------- ----------------- ------------------
Total securities
held to maturity $87,066 4,161 111 91,116
================= ================= ================= ==================
15
Note (4) Recent Accounting Prouncements
Recent Accounting Pronouncements
In April 2002, the Financial Accounting Standards Board issued Statement
145, Rescission of FASB No. 4, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections. This Statement rescinds FASB Statement No. 4, Reporting
Gains and Losses from Extinguishment of Debt, and an amendment of that
Statement, FASB Statement No. 64, Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements. This Statement also rescinds FASB Statement No. 44,
Accounting for Intangible Assets of Motor Carriers. This Statement amends FASB
Statement No. 13, Accounting for Leases, to eliminate an inconsistency between
the required accounting for sale-leaseback transactions and the required
accounting for certain lease modifications that have economic effects that are
similar to sale-leaseback transactions. This Statement also amends other
existing authoritative pronouncements to make various technical corrections,
clarify meanings, or describe their applicability under changed conditions. The
provisions of this Statement related to the rescission of Statement 4 shall be
applied in fiscal years beginning after May 15, 2002. The provisions of this
Statement related to Statement 13 are effective for transactions occurring after
May 15, 2002, with early application encouraged.
In June 2002, the Financial Accounting Standards Board issued Statement
146, Accounting for Costs Associated with Exit or Disposal Activities. This
Statement addresses financial accounting and reporting for costs associated with
exit or disposal activities and nullifies Emerging Issues Task Force (EITF)
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." The standard requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. The provisions of this Statement
are effective for exit or disposal activities that are initiated after December
31, 2002, with early application encouraged.
The Financial Accounting Standards Board issued Statement No. 147,
Acquisitions of Certain Financial Institutions, an Amendment of FASB Statements
No. 72 and 144 and FASB Interpretation No. 9 in October 2002. FASB Statement No.
72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, and
FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17 When a Savings
and Loan Association or a Similar Institution Is Acquired in a Business
Combination Accounted for by the Purchase Method, provided interpretive guidance
on the application of the purchase method to acquisitions of financial
institutions Except for transactions between two or more mutual enterprises,
this Statement removes acquisitions of financial institutions from the scope of
both Statement 72 and Interpretation 9 and requires that those transactions be
accounted for in accordance with FASB Statements no. 141, Business Combinations,
and No. 142, Goodwill and Other Intangible Assets. Thus, the requirement in
paragraph 5 of Statement 72 to recognize (and subsequently amortize) any excess
of the fair value of liabilities assumed over the fair value of tangible and
identifiable intangible assets acquired as an unidentifiable intangible asset no
longer applies to acquisitions with the scope of this Statement . In addition,
this Statement amends FASB Statement No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor and borrower-relationship assets and credit cardholder intangible
assets. Consequently, those intangible assets are subject to the same
undiscounted cash flow recoverability test and impairment loss recognition and
measurement provisions that Statement 144 requires for other long-lived assets
that are held and used.
Paragraph 5 of this Statement, which relates to the application of the
purchase method of accounting, is effective for acquisitions for which the date
of acquisition is one or after October 1, 2002. The provisions in paragraph 6
16
related to accounting for the impairment or disposal of certain long-term
customer-relationship intangible assets are effective on October 1, 2002.
Transition provisions for previously recognized unidentifiable intangible assets
in paragraphs 8-14 are effective on October 1, 2002, with earlier application
permitted.
This Statement clarifies that a branch acquisition that meets the
definition of a business should be accounted for as a business combination,
otherwise the transaction should be accounted for as an acquisition of net
assets that does not result in the recognition of goodwill.
The transition provisions state that if the transaction that gave rise
to the unidentifiable intangible asset was a business combination, the carrying
amount of that asset shall be reclassified to goodwill as of the later of the
date of acquisition or the date Statement 142 was first applied (fiscal years
beginning after December 15, 2001). Any previously issued interim statements
that reflect amortization of the unidentifiable intangible asset subsequent to
the Statement 142 application date shall be restated to remove that amortization
expense They carrying amounts of any recognized intangible assets that meet the
recognition criteria of Statement 141 that have been included in the amount
reported as an unidentifiable intangible asset and for which separate accounting
records have been maintained shall be reclassified and accounted for as assets
apart from the unidentifiable intangible asset and shall not be reclassified to
goodwill.
The Company is currently in the process of evaluating the impact, if
any, arising from the adoption of Statement 147.
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
17
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.
Forward Looking Statements
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 in the first half of 2003.
While the Company's yield on earning assets would improve in a higher rate
scenario, 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. Additional uncontrollable
events that may affect 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 scenarios or rate environments,
it cannot predict the ultimate outcome.
In the meantime, while interest rates remain at low levels, it is
expected that the Company's yield on earning assets will gradually decline as
older higher rate loans and investments mature. A corresponding or proportionate
decline in the cost to fund earning assets is not anticipated as many of the
higher rate time deposit instruments have already matured. The ultimate effect
on the net interest margin is not known as the outcome is dependent upon the
timing of any future interest rate increases and other factors previously
mentioned related to the general economy and world events.
18
Analysis of Financial Condition and Results of Operations for the Nine Months
Ended September 30,2002
- --------------------------------------------------------------------------------
Net income for the nine months ended September 30, 2002 was $7,363,
which represents an increase of $2,156 or 41.4% when compared to the same period
in 2001. The annualized return on average assets for the nine months ended
September 30 2002 was 1.52% and 1.10% for the period ended September 30, 2001.
The annualized return on average equity was 14.31% for the period ended
September 30, 2002 and 11.13% for September 30, 2001.
Earnings per share for the period ended September 30, 2002 was $2.10 and
$1.48 in 2001 for the same period.
Net Interest Income
Net interest income at the end of the third quarter of 2002 was $19,990,
an increase of $3,359 or 20.2%. Interest income decreased $2,510 or 7.3%, when
the periods ending September 30, 2002 and 2001 are compared. Interest expense
decreased $5,869, or 32.8%, when the two periods are compared. The yield on
earning assets was 7.37%, decreasing 65 basis points from September 30, 2001.
The cost to fund earning assets for the period ending September 30, 2002 was
2.62% or a 138 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.
Following is a table showing the year-to-date average balances for
interest-earning assets, interest-bearing liabilities and the related yield and
cost.
Average Yield
Balance Interest Cost
Loans, net 410,020 24,467 7.98%
Taxable securities 88,912 4,110 6.18%
Nontaxable securities 97,834 5,049 6.90%
Federal funds sold 2,653 33 1.66%
Interest-bearing deposits 14,328 180 1.68%
---------------------------------------
Total interest-earning assets 613,747 33,839 7.37%
=======================================
Interest-bearing demand deposits 143,263 1,631 1.52%
Savings deposits 49,126 382 1.04%
Time deposits 310,026 9,992 4.31%
Short-term borrowings 297 4 1.80%
---------------------------------------
Total interest-bearing liabilities 502,712 12,009 3.19%
=======================================
-----------------------------
Net interest income/interest spread 21,830 4.18%
=============================
=============
Net yield on earning assets 4.76%
=============
19
Provision and Allowance for Loan Losses
The ratio of the allowance for loan losses to loans net of unearned
income was 1.21% at September 30 2002. This compares to 1.05% at September 30,
2001. The provision for the first nine months of 2002 was $1,711, up $670 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 increasing losses in the consumer loan portfolio. With most
of the growth occurring in commercial loans the Company's exposure to losses
resulting from defaults in a small number of large credits has also increased.
The ratio of the allowance for loan losses to loans at December 31, 2001 was
1.07%.
Noninterest Income
Noninterest income 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 September 30, 2002 was $4,397, an increase of $594
or 15.6%.
Credit card fees increased $123 or 13.4%. This increase was primarily
due to volume.
Trust income decreased by 15.4% when compared to the first nine 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 $343 for the period ended
September 30, 2002. In 2002 the Company sold two thirds of its investment in a
local bank holding company, which produced a gain of approximately $334. 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.
Other income contained some nonrecurring or infrequent items as well as
two new forms of revenues, which accounted for a portion of the $206 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 of approximately $48. Other income includes commissions from the sale of
securities and insurance products in the amount of $195 compared to $51 at
September 30, 2001.
Noninterest Expense
Noninterest expense for the period ended September 30 2002 was $13,117
an increase of $595 or 4.8%.
Salaries and employee benefits increased by $674 or 11.2% when the
periods ended September 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
20
benefits associated with the Company's financial services affiliate. Routine
merit salary and promotional salary increases further contributed to the
increase in this category.
Data processing costs decreased $165 or 16.3%. 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 increased $7 or 0.9%. 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. The decrease caused by these
items in part,offsets the increases in expenses related to volume.
Intangibles expense for the third quarter of 2002 was $716 compared to
$674 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 September 30, 2002 were $667,646, an increase of $23,023
or 3.6% from period end assets at December 31, 2001.
Securities
Securities available for sale increased by 23.0%, while securities held
to maturity decreased 15.3%. (Refer to the table previously presented for
portfolio composition.)
Loans
Loans net of unearned income grew by $17,083 or 4.3% from December 31,
2001. Since December 31, 2001, construction loans increased by $2,304 or 11.8%,
with real estate mortgage loans increasing $3,433 or 4.4%. The largest increase,
however, was in the commercial loan category which grew by $22,269 or 11.7%. The
only category to show a decrease was loans to individuals, which declined by
$11,323 or 10.0%. 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 decline of these loans could have a
measurable impact on the Company's net interest margin.
Deposits
Total deposits increased $14,960 or 2.6% when September 30, 2002 and
December 31, 2001 are compared.
Noninterest-bearing demand deposits increased $6,420 or 8.9%, when
September 30, 2002 and December 31, 2001 are compared. During the same period
interest-bearing demand deposits increased by 15.0%, while savings deposits
declined 0.4%. Management believes that the increase in interest-bearing demand
deposits is in part due to the customers' expectations of higher interest rates
in the near to intermediate term. Hence, the Company's customers are not
21
committing their funds to longer-term time deposits. Thus the largest decrease
in deposits took place in time deposits category, which declined by $11,431 or
3.6%.
Daily Averages
Daily averages for the major categories are as follows:
(000's) September 30,2002 December 31,2001
--------------------- ---------------------
Loans, net $409,342 380,970
Securities available for sale 90,972 109,682
Securities held to maturity 95,774 79,127
Total assets 647,301 635,692
Total deposits 575,880 569,139
Stockholders' equity 68,817 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 $10,286. The primary sources are net
income and net sales of real estate loans held for sale.
Cash used in investing activities was $21,042. As can be seen from the
cash flow statement the principal use of cash was for lending activities and the
purchase of securities available for sale.
Financing activities during the period provided $13,730 mainly in the
other deposit category.
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 office will be
located in the downtown area and is expected to be opened in the second quarter
of 2003.
In a move to control costs and to enhance customer service, the
Company's BTC affiliate plans to consolidate its two Bluefield, Virginia offices
into the newly renovated office at Virginia Avenue.
22
Analysis of the Financial Condition and Results of Operations for the
Three Months Ending September 30, 2002
- --------------------------------------------------------------------------------
Net income for the three months ended September 30, 2001 was $2,712, an
increase of $802 or 42.0% over the same period in 2001. The annualized return on
average assets for the third quarter of 2002 was 1.65% and 1.18% for the third
quarter of 2001. The annualized return on average equity for the third quarter
of 2002 was 15.30%. This compares to 11.84% for the same period in 2000.
Basic earnings per share for the three months ended September 30,2002
was $0.78, an increase of $0.24 from the third quarter of 2001.
Net interest income
Net interest income for the quarter ended September 30, 2002 was $6,977
or a 21.3% 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 third quarter of 2002 was $519.
This compares to $377 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 contributes to the need for an increased provision.
Noninterest income
Noninterest income for the third quarter of 2002 was $1,482, an increase
of $170 over the period ending September 30, 2001. Previously mentioned
securities gains accounted for the majority of this increase.
Service charges on deposits remained relativity unchanged increasing $20
or 3.6% when the quarter-ended September 30, 2002 is compared to the same period
in 2001.
Trust income decreased by 16.2% 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
recently have been generally lower.
Noninterest expense
Noninterest expense for the quarter ended September 30, 2002 was $4,380.
This represents an increase of $204 or 4.9% when compared to the quarter ended
September 30, 2001. This quarterly increase is consistent with the year-to-date
overall increase of 4.8% experienced so far this year.
23
Balance Sheet
Total average assets for the quarter ended September 30, 2002 were
$657,504, which represents an increase of $13,447 or 2.1% over total assets at
September 30, 2001. A comparison of selected quarterly averages follows.
($000) September 30, 2002 September 30, 2001
------------------ ------------------
Securities available for sale $ 96,937 109,332
Securities held to maturity 89,474 88,583
Loans net of unearned income and fees 414,319 387,997
Noninterest-bearing deposits 75,223 69,489
Interest-bearing deposits 508,714 507,744
Stockholder's equity 71,104 63,995
24
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.
Item 4. Controls and Procedures
Under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, we
have evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within 90 days of the filing of this quarterly report.
Based on that evaluation, our principal executive officer and principal
financial officer have concluded that these controls and procedures are
effective. There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Disclosure controls and procedures are our controls and procedures that
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate, to allow timely decisions regarding
required disclosure.
25
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 September 30, 2002.
Item 4. Submission of Matters to a Vote of Security Holders
None
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
September 2002. See the index to exhibits for items incorporated
by reference to this filing.
26
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: 11/13/02 /s/ James G. Rakes
------------ -------------------------------------------
James G. Rakes, Chairman,
President and Chief Executive Officer
Date: 11/13/02 /s/ J. Robert Buchanan
------------ -------------------------------------------
J. Robert Buchanan, Treasurer
(principal financial officer)
27
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, 1992, (incorporated
by and between National Bankshares, Inc. and herein by
James G. Rakes reference to
Exhibit
10(a) of
the Annual
Report on
Form 10K
for fiscal
year ended
December
31, 1992)
*10(iii)(A) Capital Accumulation Plan (included in (incorporated
Exhibit No. 10(a)) herein by
reference to
Exhibit 10(b) of
the Annual Report on
Form 10K for
fiscal year ended
December 31, 1992)
28
*10(iii)(A) Employee Lease Agreement dated May 7, 1992, (incorporated
by and between National Bankshares, Inc. and herein by
The National Bank of Blacksburg reference to
Exhibit 10(c) of
the Annual Report on
Form 10K for
fiscal year ended
December 31, 1992)
*10(iii)(A) National Bankshares, Inc. 1999 Stock Option (incorporated
Plan herein by reference
to Exhibit 4.3 of
the Form S-8, filed
as Registration No.
333-79979 with the
Commission on June
4, 1999)
*10(iii)(A) Employment Agreement dated January 2002
between National Bankshares, Inc. and (incorporated herein
James G. Rakes by reference to
Exhibit 10(iii) (A)
Form 10Q for the
period ended June
30, 2002.)
10(iii)(A) Employee Lease agreement dated August
14, 2002, by and between National Bankshares
and The National Bank of Blacksburg
99(a) Certification of Chief Executive Officer
Pursuant to 18 U.S.C. Section 350
99(b) Certification of Chief Financial Officer
Pursuant to 18 U.S.C. Section 350
29