================================================================================
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, 2003
Commission file number 0-15204
National Bankshares, Inc.
(Exact name of registrant as specified in its charter)
State or other jurisdiction of incorporation or organization - Virginia
Internal Revenue Service - Employer Identification No. 54-1375874
101 Hubbard Street, P.O. Box 90002, Blacksburg, VA 24062-9002
(540) 951-6300
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such requirements
for the past 90 days.
Yes _X_ No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b - 2 of the Exchange Act)
Yes _X_ No ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 4, 2003
- ------------------------------ -------------------------------
Common Stock, $2.50 Par Value 3,515,377
(This report contains 32 pages)
NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-Q
Index
Page
Part I Financial Information
- -----------------------------
Item 1 - Financial Statements
Consolidated Balance Sheets, September 30, 2003 (Unaudited)
and December 31, 2002 3-4
Consolidated Statements of Income for the
Three Months Ended September 30, 2003 and 2002 (Unaudited) 5-6
Consolidated Statements of Income for the Nine Months
Ended September 30, 2003 and 2002 (Unaudited) 7-8
Consolidated Statements of Changes in
Stockholders' Equity, Nine Months Ended
September 30, 2003 and 2002 (Unaudited) 9
Consolidated Statements of Cash Flows,
Nine Months Ended September 30, 2003 and 2002 (Unaudited) 10-11
Notes to Consolidated Financial Statements 12-16
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 17-23
Item 3 - Quantitative and Qualitative Disclosures about
Market Risk 24
Item 4 - Controls and Procedures 24
Part II Other Information
- -------------------------
Items 1 - 3 - Legal Proceedings; Changes in 25
Securities and Use of Proceeds;
Defaults Upon Senior Securities
Item 4 - Submission of Matters to a Vote of 25
Security Holders
Item 5 - Other Information 25
Item 6 - Exhibits and Reports on Form 8-K 25
Signatures 26
- ----------
Index to Exhibits 27-28
- -----------------
2
Part I
Financial Information
Item 1. Financial Statements
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002
(Unaudited) (Audited)
September 30, December 31,
($ In thousands except share and 2003 2002
per share data) ============ ==============
Assets:
- -------
Cash and due from banks $13,045 $12,316
Interest-bearing deposits 18,330 18,818
Federal funds sold 133 1,724
Securities available for sale 125,808 119,734
Securities held to maturity (fair value
$110,543 in 2003 and $103,187 in 2002) 106,719 99,560
Mortgage loans held for sale 90 846
Loans:
Real estate construction loans 31,007 22,294
Real estate mortgage loans 87,907 82,193
Commercial and industrial loans 207,996 209,368
Loans to individuals 86,600 96,762
------------ --------------
Total loans 413,510 410,617
Less unearned income and deferred fees (981) (1,278)
------------ --------------
Loans, net of unearned income
and deferred fees 412,529 409,339
Less: allowance for loan losses (5,502) (5,092)
------------ --------------
Loans, net 407,027 404,247
------------ --------------
Bank premises and equipment, net 10,133 9,938
Accrued interest receivable 5,049 4,290
Other real estate owned, net 940 537
Intangible assets and goodwill, net 10,197 10,912
Other assets 2,094 2,013
------------ --------------
Total assets $699,565 $684,935
============ ==============
Liabilities and Stockholders' Equity:
- -------------------------------------
Noninterest-bearing demand deposits $84,655 $74,032
Interest-bearing demand deposits 166,640 165,216
Savings deposits 53,897 48,956
Time deposits 312,578 320,067
------------ --------------
Total deposits 617,770 608,271
------------ --------------
Other borrowed funds 92 748
Accrued interest payable 516 700
Other liabilities 1,919 2,115
------------ --------------
Total liabilities 620,297 611,834
------------ --------------
3
Stockholders' Equity Preferred stock of
no par value.
Authorized 5,000,000 shares; none
issued and outstanding --- ---
Common stock of $2.50 par value.
Authorized 10,000,000 shares; issued and
outstanding 3,512,877 shares in 2003 and
3,511,377 in 2002 8,782 8,778
Retained earnings 68,997 62,525
Accumulated other comprehensive income 1,489 1,798
------------ --------------
Total stockholders' equity 79,268 73,101
------------ --------------
Total liabilities and
stockholders' equity $699,565 $684,935
============ ==============
See accompanying notes to the consolidated financial statements
4
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended September 30, 2003 and 2002
(Unaudited)
September 30, September 30,
($000's except share and per share data) 2003 2002
================= =================
Interest income:
================
Interest and fees on loans $7,495 $8,196
Interest on interest-bearing deposits 43 82
Interest on federal funds sold 5 14
Interest on securities - taxable 1,377 1,338
Interest on securities - nontaxable 1,342 1,130
----------------- -----------------
Total interest income 10,262 10,760
----------------- -----------------
Interest expense:
=================
Interest on time deposits $100,000 or more 710 818
Interest on other deposits 2,130 2,964
Interest on borrowed funds --- 1
----------------- -----------------
Total interest expense 2,840 3,783
----------------- -----------------
Net interest income 7,422 6,977
Provision for loan losses 435 519
----------------- -----------------
Net interest income after
provision for loan losses 6,987 6,458
----------------- -----------------
Noninterest income:
===================
Service charges on deposit accounts 704 574
Other service charges and fees 65 68
Credit card fees 416 357
Trust income 253 238
Other income 77 67
Realized securities gains, net 7 178
------------------ -----------------
Total noninterest income 1,522 1,482
------------------ -----------------
Noninterest expense:
====================
Salaries and employee benefits 2,396 2,237
Occupancy and furniture and fixtures 416 436
Data processing and ATM 310 263
Credit card processing 324 280
Intangibles and goodwill amortization 238 238
Net costs of other real estate owned 19 16
Other operating expenses 1,001 910
----------------- -----------------
Total noninterest expense 4,704 4,380
----------------- -----------------
Income before income tax expense 3,805 3,560
Income tax expense 894 848
----------------- -----------------
Net income $2,911 $2,712
================= =================
5
Net income per share - basic $0.83 $0.78
================= ===================
- diluted 0.82 0.78
================= ===================
Weighted average number of common
shares outstanding - basic 3,512,477 3,511,377
- diluted 3,534,615 3,518,691
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, 2003 and 2002
(Unaudited)
September 30, September 30,
($000's except share and per share data) 2003 2002
================= =================
Interest income:
================
Interest and fees on loans $22,766 $24,362
Interest on interest-bearing deposits 180 180
Interest on federal funds sold 16 33
Interest on securities - taxable 4,177 4,110
Interest on securities - nontaxable 3,995 3,314
----------------- -----------------
Total interest income 31,134 31,999
----------------- -----------------
Interest expense:
=================
Interest on time deposits $100,000 or more 2,325 2,605
Interest on other deposits 7,248 9,400
Interest on borrowed funds 1 4
----------------- -----------------
Total interest expense 9,574 12,009
----------------- -----------------
Net interest income 21,560 19,990
Provision for loan losses 1,277 1,711
----------------- -----------------
Net interest income after
provision for loan losses 20,283 18,279
----------------- -----------------
Noninterest income:
===================
Service charges on deposit accounts 1,877 1,678
Other service charges and fees 206 202
Credit card fees 1,210 1,040
Trust income 757 718
Other income 342 416
Realized securities gains, net 3 343
----------------- -----------------
Total noninterest income 4,395 4,397
----------------- -----------------
Noninterest expense:
====================
Salaries and employee benefits 7,161 6,680
Occupancy and furniture and fixtures 1,248 1,260
Data processing and ATM 851 849
Credit card processing 949 764
Intangibles and goodwill amortization 715 716
Net costs of other real estate owned 38 139
Other operating expenses 2,878 2,709
----------------- -----------------
Total noninterest expense 13,840 13,117
----------------- -----------------
Income before income tax expense 10,838 9,559
Income tax expense 2,494 2,196
----------------- -----------------
Net income $8,344 $7,363
================= =================
7
Net income per share - basic $2.38 $2.10
================= ==================
- diluted 2.36 2.10
================= ==================
Weighted average number of common
shares outstanding - basic 3,512,262 3,511,377
- diluted 3,531,819 3,515,902
Dividends declared per share $0.54 $0.46
================= ==================
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, 2003 and 2002
(Unaudited)
Accumulated
Other
($000's, except for per Common Retained Comprehensive Comprehensive
share data) Stock Earnings Income Income Total
============ ============== ================ ================ ===========
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 expense tax $1,144 --- --- --- 2,220 ---
Reclass adjustment net
of tax $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
============ ============== ================ ================ ===========
Balances, December 31, 2002 $8,778 62,525 1,798 --- $73,101
Net income --- 8,344 --- 8,344 8,344
Dividend ($0.54 per share) --- (1,897) --- --- (1,897)
Exercise of stock options 4 25 --- --- 29
Other comprehensive income,
net of tax
Unrealized losses on
securities available for
sale, net of income tax $166 --- --- --- (307) ---
Reclass adjustment net of
income tax $1 --- --- --- (2) ---
----
Other comprehensive income --- --- (309) (309) (309)
------------ -------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- 8,035 ---
============ ============== ================ ================ ===========
Balances, September 30,2003 $8,782 68,997 1,489 --- $79,268
============ ============== ================ ================ ===========
See accompanying notes to consolidated financial statements.
9
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2003 and 2002
(Unaudited)
September 30, September 30,
($000's) 2003 2002
=================== =================
Cash flows from operating activities:
- -------------------------------------
Net income $8,344 $7,363
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 1,277 1,711
Depreciation of bank premises and equipment 687 751
Amortization of intangibles 715 716
Amortization of premiums and accretion of
discount, net 383 282
(Gains) on sales and calls of securities
available for sale, net (1) (331)
(Gains) on calls of securities held to maturity (2) (12)
Losses and writedowns on other real estate owned 18 58
(Increase) decrease in:
Mortgage loans held for sale 756 505
Accrued interest receivable (759) (86)
Other assets 32 (599)
Increase (decrease) in:
Accrued interest payable (184) (395)
Other liabilities (196) 323
------------------- -----------------
Net cash provided by operating
activities $11,070 $10,286
------------------- -----------------
Cash flows from investing activities:
- -------------------------------------
Net decrease in federal funds sold $1,591 $436
Net (increase) decrease in interest-bearing
deposits 488 (1,334)
Proceeds from calls, principal payment, sales and maturities of
securities available for sale 19,825 13,086
Proceeds from calls principal payments and maturities of
securities held to maturity 14,493 15,846
Purchases of securities available for sale (26,514) (30,252)
Purchases of securities held to maturity (21,839) (249)
Purchases of loan participations (2,051) (2,676)
Collections of loan participations 1,292 3,527
Net (increase) in loans to customers (3,992) (19,220)
Proceeds from disposal of other real estate owned 81 103
Recoveries on loans charged off 192 93
Purchase of bank premises and equipment (1,331) (413)
Proceeds from disposal of bank premises and equipment 449 11
------------------- -----------------
Net cash (used in) investing
activities $(17,316) $(21,042)
10
Cash flows from financing activities:
- -------------------------------------
Net (decrease)in time deposits $ (7,489) $(11,431)
Net increase in other deposits 16,988 26,391
Net increase(decrease)in other borrowed funds (656) 384
Exercise of stock options 29 ---
Dividends paid on common stock (1,897) (1,614)
------------------- -----------------
Net cash provided by financing
activities 6,975 13,730
------------------- -----------------
Net increase in cash and due from banks 729 2,974
Cash and due from banks at beginning of period 12,316 12,293
------------------- -----------------
Cash and due from banks at end of period $13,045 $15,267
=================== =================
Supplemental disclosure of cash flow information:
- -------------------------------------------------
Cash paid for interest $9,758 $12,404
=================== =================
Cash paid for income taxes $2,509 $2,464
=================== =================
Loans charged to the allowance for loan losses $1,059 $1,067
=================== =================
Loans transferred to other real estate owned $502 $219
=================== =================
Unrealized gains (losses)on securities available for sale $(476) $3,033
=================== =================
See accompanying notes to consolidated financial statements.
11
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2003
(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, 2003 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 2002 Annual Report
to Stockholders and additional information supplied in the 2002 Form 10-K.
Note (2) Stock-Based Compensation
At September 30, 2003, the Company had a stock-based employee
compensation plan which is described more fully in the Company's Form 10-K dated
December 31, 2002. The Company accounts for this plan under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under the plan had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation.
Nine months ended Three months ended
September 30, September 30,
- ---------------------------------------------------- ------------------------------ ----------------------------
($ In thousands, except per share data) 2003 2002 2003 2002
Net income, as reported $8,344 $7,363 $2,911 $2,712
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards (30) (17) (10) (5)
-------------- --------------- -------------- -------------
Pro forma net income $8,314 $7,346 $2,901 $2,707
- ---------------------------------------------------- -------------- --------------- -------------- -------------
Earnings per share:
- -------------------
Basic-as reported $2.38 $2.10 $0.83 $0.78
- ---------------------------------------------------- -------------- --------------- -------------- -------------
Basic-pro forma $2.37 $2.09 $0.83 $0.77
- ---------------------------------------------------- -------------- --------------- -------------- -------------
Diluted-as reported $2.36 $2.10 $0.82 $0.78
- ---------------------------------------------------- -------------- --------------- -------------- -------------
Diluted-pro forma $2.35 $2.09 $0.82 $0.77
- ---------------------------------------------------- -------------- --------------- -------------- -------------
There were no stock options granted or forfeited in the first three
quarters of 2003. The only stock options exercised during that period were 1,500
options exercised during the second quarter, 500 at an original grant price of
$22.00 per share and 1,000 at $18.75 per share.
12
Note (3) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended
September 30, December 31,
2003 2002 2002
============== ============== =================
($000's, except for % data)
Balance at beginning of period $5,092 $4,272 $4,272
Provision for loan losses 1,277 1,711 2,251
Loans charged off (1,059) (1,067) (1,571)
Recoveries 92 93 140
-------------- -------------- -----------------
Balance at the end of period $5,502 $5,009 $5,092
============== ============== =================
Ratio of allowance for loan losses to the end
of period loans net of unearned income and
deferred fees 1.33% 1.21% 1.24%
============== ============== =================
Ratio of net charge-offs (recoveries) to
average loans, net of unearned income and
deferred fees(1) .28% .32% .35%
Ratio of allowance for loan losses to
nonperforming loans(2) 2,895.79% 1,361.14% 1,768.06%
============== ============== =================
(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.
September 30, December 31,
2003 2002 2002
============= ============ ================
($000's, except for % data)
Nonperforming Assets:
- ---------------------
Nonaccrual loans $190 $368 $288
Restructured loans --- --- ---
------------- ------------ ----------------
Total nonperforming loans 190 368 288
Foreclosed property 940 269 537
------------- ------------ ----------------
Total nonperforming assets $1,130 $637 $825
============= ============ ================
Ratio of nonperforming assets to loans, net of
unearned income and deferred fees, plus other real
estate owned .27% .15% .20%
============= ============ ================
13
September 30, December 31,
2003 2002 2002
============= ============ ===============
Accruing Loans Past Due 90 Days or More:
- ----------------------------------------
Past due 90 days or more and
still accruing $2,207 $895 $977
============= ============ ===============
Ratio of loans past due 90 days or
more and still accruing to loans, net of
unearned income and deferred fees .53% .22% .24%
============= ============ ===============
Impaired Loans:
- --------------
Total impaired loans $380 $387 $139
============= ============ ===============
Impaired loans with a
valuation allowance --- $43 $93
Valuation allowance --- (26) (33)
------------- ------------ ---------------
Impaired loans net of allowance --- $17 $60
============= ============ ===============
Impaired loans with no
valuation allowance $380 $344 $46
============= ============ ===============
Average recorded investment
in impaired loans $224 $462 $397
============= ============ ===============
Income recognized on impaired
loans $19 $11 $11
============= ============ ===============
Amount of income recognized
on a cash basis --- --- ---
============= ============ ===============
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 at
September 30, 2003 were $10.
14
Note (4) Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for the sale by major security type as of
September 30, 2003 are as follows:
September 30, 2003
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Available for sale:
U.S. Treasury $2,247 $117 --- $2,364
U.S. Government agencies and
corporations 5,639 31 5 5,665
State and political
subdivisions 79,318 2,144 356 81,106
Mortgage-backed
securities 10,032 355 --- 10,387
Corporate debt
securities 22,623 752 303 23,072
Federal Reserve Bank stock-
restricted 209 --- --- 209
Federal Home Loan
Bank stock-restricted 1,646 --- --- 1,646
Other securities 1,219 140 --- 1,359
----------------- ----------------- ----------------- ------------------
Total securities
available for sale $122,933 $3,539 $664 $125,808
================= ================= ================= ==================
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of
September 30, 2003 are as follows:
September 30, 2003
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Held to Maturity:
U.S. Government agencies and
corporations $10,996 $122 $70 $11,048
State and political
subdivisions 56,806 1,912 155 58,563
Mortgage-backed
securities 5,071 213 --- 5,284
Corporate securities 33,846 2,118 316 35,648
----------------- ----------------- ----------------- ------------------
Total securities
held to maturity $106,719 $4,365 $541 $110,543
================= ================= ================= ==================
15
Recent Accounting Announcements
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN 45"). The Interpretation
elaborates on the disclosures to be made by a guarantor in its financial
statements under certain guarantees that it has issued. It also clarifies that a
guarantor is required to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation undertaken in issuing the guarantee. The
Interpretation requires disclosure of the nature of the guarantee, the maximum
potential amount of future payments that the guarantor could be required to make
under the guarantee, and the current amount of the liability, if any, for the
guarantor's obligations under the guarantee. The recognition requirements of the
Interpretation were effective beginning January 1, 2003. Management does not
anticipate that the recognition requirements of this Interpretation will have a
material impact on the Corporation's consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"). This Interpretation
provides guidance with respect to the identification of variable interest
entities and when the assets, liabilities, noncontrolling interests, and results
of operations of a variable interest entity need to be included in a
corporation's consolidated financial statements. The Interpretation requires
consolidation by business enterprises of variable interest entities in cases
where the equity investment at risk is not sufficient to permit the entity to
finance its activities without additional subordinated financial support from
other parties, which is provided through other interests that will absorb some
or all of the expected losses of the entity, or in cases where the equity
investors lack one or more of the essential characteristics of a controlling
financial interest, which include the ability to make decisions about the
entity's activities through voting rights, the obligations to absorb the
expected losses of the entity if they occur, or the right to receive the
expected residual returns of the entity if they occur. The Interpretation
applies immediately to variable interest entities created after January 31,
2003, and applies to previously existing entities beginning in the fourth
quarter of 2003. Management is currently evaluating the applicability of FIN 46
but the adoption of this Interpretation is not expected to have a material
impact on the Corporation's consolidated financial statements.
In April 2003, the Financial Accounting Standards Board issued Statement
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This Statement is effective for contracts
entered into or modified after June 30, 2003 and is not expected to have an
impact on the Company's consolidated financial statements.
In May 2003, the Financial Accounting Standards Board issued Statement No.
150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. This Statement establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. It requires that an issuer classify a financial
instrument that is within its scope as a liability (or an asset in some
circumstances). Many of those instruments were previously classified as equity.
This Statement is effective for financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003, except for mandatory redeemable
financial instruments of nonpublic entities. Adoption of the Statement did not
result in an impact on the Company's consolidated financial statements.
16
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 2002 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 is inherently subjective
and our actual losses could be greater or less than the estimates. The
unallocated allowance captures losses that are attributable to various economic
17
events, industry or geographic sectors whose impact on the portfolio have
occurred but have yet to be recognized in either the formula or specific
allowance.
Core deposit intangibles
Effective January 1, 2002, the Corporation adopted Financial Accounting
Standards Board Statement No. 142, Goodwill and Other Intangible Assets.
Accordingly, goodwill is no longer subject to amortization over its estimated
useful life, but is subject to at least an annual assessment for impairment by
applying a fair value based test. Additionally, Statement 142 requires that
acquired intangible assets (such as core deposit intangibles) be separately
recognized if the benefit of the asset can be sold, transferred, licensed,
rented, or exchanged, and amortized over its estimated useful life. Branch
acquisition transactions were outside the scope of the Statement and therefore
any intangible asset arising from such transactions remained subject to
amortization over their estimated useful life.
In October 2002, the Financial Accounting Standards Board issued
Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement
amends previous interpretive guidance on the application of the purchase method
of accounting to acquisitions of financial institutions, and requires the
application of Statement No. 141, Business Combinations, and Statement No. 142
to branch acquisitions if such transactions meet the definition of a business
combination. The provisions of the Statement do not apply to transactions
between two or more mutual enterprises. In addition, the Statement amends
Statement No. 144, Accounting for the Impairment of Long-Lived Assets, to
include in its scope core deposit intangibles of financial institutions.
Accordingly, such intangibles are subject to a recoverability test based on
undiscounted cash flows, and to the impairment recognition and measurement
provisions required for other long-lived assets held and used. The Company has
determined that the acquisitions that generated the intangible assets and
goodwill on the consolidated balance sheets in the amount of $10,912 and $11,866
at December 31, 2002 and 2001, respectively, did not constitute the acquisition
of a business, and therefore will continue to be amortized.
Analysis of Financial Condition and Results of Operations for the Nine Months
Ended June 30, 2003
- --------------------------------------------------------------------------------
Net income for the nine months ended September 30, 2003 was $8,344,
which represents an increase of $981 or 13.32% when compared to the same period
in 2002. The annualized return on average assets for the nine months ended
September 30, 2003 was 1.60% and 1.52% for September 30, 2002. The annualized
return on average equity was 14.55% for the period ended September 30, 2003 and
14.31% for September 30, 2002.
Basic earnings per share for the period ended September 30, 2003 was
$2.38 and $2.10 in 2002 for the same period.
Net Interest Income
Net interest income at the end of the third quarter of 2003 was $21,560,
an increase of $1,570 or 7.85% over the same period in 2002. Interest income
decreased $865 or 2.70%, when the periods ending September 30, 2003 and 2002 are
compared. Interest expense decreased $2,435, or 20.28%, when the two periods are
compared. The yield on earning assets was 6.77%, decreasing 60 basis points from
September 30, 2002. The cost to fund earning assets for the period ending
September 30, 2003 was 1.94% or a 68 basis point decrease from the same period
in 2002. This resulted in an increase in the net interest margin of 8 basis
points. Substantially lower funding costs due to the low interest rate
environment accounted for most of the improvement in net interest income.
18
Following is a table showing the quarter-to-date average balances for
interest-earning assets, interest-bearing liabilities and the related yield and
cost.
Average
Balance Interest Yield Cost
----------------- ---------------- -------------
Loans, net (1) $416,382 $7,522 7.17%
Taxable securities 107,060 1,377 5.10%
Nontaxable securities (1) 125,166 2,034 6.45%
Federal funds sold 1,315 5 1.51%
Interest-bearing deposits 18,549 43 0.92%
----------------- ---------------- -------------
Total interest-earning assets $668,472 $10,981 6.52%
================= ================ =============
Interest-bearing demand deposits $168,281 $356 0.84%
Savings deposits 52,920 59 0.44%
Time deposits 314,098 2,425 3.06%
Short-term borrowings 181 --- ---
================= ================ =============
Total interest-bearing liabilities $535,480 $2,840 2.10%
================= ================ =============
Net interest income/interest spread $8,141 4.42%
================ =============
Net interest margin (2) 4.83%
================ =============
(1) Yield is on a tax equivalent basis.
(2) The net interest margin consists of annualized net interest
income on a fully tax equivalent basis divided by average
earnings assets.
Risk factors and forward looking statements apply as discussed in the
Company's 2002 Form 10-K in the Security, Liquidity, Interest Rate Sensitivity,
Securities and Net Interest Income sections.
Provision and Allowance for Loan Losses
The adequacy of the allowance for loan losses is based on management's
judgement and analysis of current and historical loss experience, risk
characteristics of the loan portfolio, concentrations of credit and asset
quality, as well as other internal and external factors such as general economic
conditions.
An internal credit review department performs pre-credit analyses of
large credits and also conducts periodic credit reviews. Changing trends in the
loan mix are also evaluated in determining the adequacy of the allowance for
loan losses.
The ratio of the allowance for loan losses to loans net of unearned
income was 1.33% at September 30, 2003. This compares to 1.21% at September 30,
2002. The provision for the first nine months of 2003 was $1,277, down $434 over
the same period the prior year.
While management continues to believe that overall credit quality
remains satisfactory, the level of exposure to loss has increased, particularly
in the loans to individuals category. In addition, much of the growth recently
experienced has been in the commercial loan category. While the number of
possible defaults would only constitute a small number of loans, the sizable
dollar amount of the individual credits tends to increase the possibility of
greater loss. Loans past due ninety days or more increased by $1,230 since
December 31, 2002.
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
19
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 ending September 30, 2003 and 2002 was $4,395 and $4,397,
respectively.
Service charges on deposit accounts increased by $199 or 11.86%, when
compared to the same period in 2002. A portion of this increase was due to
modifications in the terms of certain demand deposit products and the associated
service charges.
Other service charges and fees increased $4 when September 30, 2003 and
September 30, 2002 are compared.
Credit card fees increased $170, or 16.35%. This increase was primarily
the result of an increased volume of merchant and interchange fees.
Trust income increased by $39 in 2003, when compared to the first nine
months of 2002. 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.
Realized securities gains were $3 for the first nine months of 2003. The
net gains were primarily associated with the adjustment of the Company's
investment in certain limited liability companies offset by gains on called
securities. Previous year net gains were associated with the sale of equity
securities by Bankshares.
Noninterest Expense
Noninterest expense for the period ended September 30, 2003 was $13,840,
an increase of $723 or 5.51%.
Salaries and employee benefits increased by $481 or 7.20%, at September
30, 2003 as compared with the same period. Rising pension costs and normal
salary adjustments accounted for the majority of the increase.
Occupancy expenses decreased $12 or .95%, when the first nine months of
2003 and 2002 are compared.
Data processing costs increased $2 or .24%.
Credit card processing increased $185 or 24.21% due to volume. As
previously noted credit card income was also up for the year because of volume
in the merchant and debit card areas.
Intangibles expense for the first nine months of 2003 and 2002 was $715
and $716. There were no impairment write downs during the period.
Other operating costs increased by $169 or 6.24%, when the periods
September 30, 2003 and 2002 are compared. Included in this category are
franchise taxes, which increased by $71, and repossession expense, which
increased by $50.
Income Taxes
In the third quarter of 2003, the Company's level of profits resulted in
an increase from 34% to 35% in the federal income tax rate applicable to the
Company. In addition to the actual taxes paid to the government, this change
affects other areas, including the book tax provisions, deferred taxes, and tax
equivalency calculations.
20
Balance Sheet
Total assets at September 30, 2003 were $699,565, an increase of $14,630
or 2.14% from period end assets at December 31, 2002. This increase was
primarily due to deposit growth, which was $9,499 or 1.56%.
Securities
Securities available for sale increased by 5.07%, while securities held
to maturity increased 7.19%. (Refer to the table previously presented for
portfolio composition.) Funds for these increases came primarily from deposit
growth.
Loans
Loans net of unearned income grew by $3,190 or .78% from December 31,
2002. Since December 31, 2002, construction loans increased by $8,713 or 39.08%,
with real estate mortgage loans increasing $5,714 or 6.95%. The commercial loan
category decreased by $1,372 or .66% due to demand. Loans to individuals
declined by $10,162 or 10.50%. It is not known to what extent loans to
individuals will ultimately decline or when growth in this area will resume, the
general economic conditions. In addition, because of the many financing
alternatives available to customers, it is unknown whether percentage of loans
to individuals to total loans will return to previous levels.
Deposits
Total deposits at September 30, 2003 increased $9,499 or 1.56%, as
compared with total deposits at December 31, 2002 are compared.
Noninterest-bearing demand deposits increased $10,623 or 14.35% when
September 30, 2003 and December 31, 2002 are compared. During the same period,
interest-bearing demand deposits increased by .86%, while savings deposits were
up 10.09%. Time deposits declined by $7,489 or 2.34%. This data indicates that
depositors continue to gravitate toward liquid short-term deposit instruments.
This trend is expected to continue until rising rates make longer term time
deposits a more attractive investment.
Daily Averages
Daily averages for the major categories are as follows:
(000's) September 30, 2003 December 31,2002
-------------------------- ---------------------
Loans, net $405,903 $404,717
Securities available for sale 123,387 96,877
Securities held to maturity 103,305 94,616
Total assets 695,291 655,783
Total deposits 615,958 583,298
Stockholders' equity 76,648 69,895
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 $11,070. The primary sources were net
income and net sales of real estate loans held for sale.
Cash from investing activities was $(17,316). The cash flow statement
shows that the principal use of cash was for securities.
Financing activities during the period produced $6,975 in cash, mainly
due to an increase in deposits.
21
Management is not aware of any commitments that will result in, or are
likely to result in, a material and adverse impact on liquidity.
Capital Resources
Total stockholders' equity increased by $6,167 from December 31, 2002 to
September 30, 2003. Net income of $8,344 accounted for most of the increase,
offset by a dividend to shareholders in the amount of $1,897. The Company's risk
based capital ratios at September 30, 2003 are as follows.
Total capital 14.90%
Tier I 13.77%
Leverage ratio 9.84%
The Company's banking affiliates continue to meet the regulatory criteria
for well capitalized.
Analysis of Financial Condition and Results of Operations for the Three Months
Ended September 30, 2003
- --------------------------------------------------------------------------------
Net income for the third quarter of 2003 was $2,911 an increase of $199
or 7.34% over the same period in 2002. The return on average assets for the
three months ended September 30, 2003 was 1.66%, which compared to 1.65% for the
same quarter in 2002. The return on average equity for the third quarter of 2003
was 14.78%, a slight decrease from 2002, when the return or average equity was
15.30%, or an annualized basis.
Net Interest Income
Net interest income for the third quarter of 2003 was $7,422 an increase
of 6.38% over the same period in 2002. Because of the continuation of the low
interest rate environment, previously established trends persisted during the
third quarter. Higher rate earning assets continued to mature and/or reprice and
move into lower rate earning assets. At the same time, interest bearing
liabilities also continued to mature and/or reprice into liabilities with lower
rates. The net interest margin for the third quarter of 2003 was 4.83%, compared
to 4.87% for the same period in 2002.
Provision for Loan Losses
The provision for loan losses for the third quarter of 2003 was $435, a
decrease of $84 from the third quarter of 2002.
Management continues to expect net charge-off levels to be higher in
2003, particularly in the area of loans to individuals.
Noninterest Income
Service charges for the third quarter were up $130, when compared to the
third quarter of 2002. During the second quarter the Company made certain
modifications to its demand deposit products that have so far resulted in an
increase in service charge income. It is not known whether this level of income
will be sustainable, as the ongoing acceptance of product changes by the
Company's customer base is as yet uncertain.
22
Other Service Charges
This category shows a decline of $3 when compared to the same quarter in
2002. This category is comprised of various miscellaneous types of income which
vary from period to period.
Credit Card Income
Credit card income for the quarter ended September 30, 2003 was $416, an
increase of $59 or 16.53%. The majority of the increase was due to the volume of
business in merchant and debit cards.
Trust Income
Trust income increased by $15 or 6.30% when the third quarter of 2003
and 2002 are compared. Trust income varies due to the nature of the business.
Estate income, for example, is unpredictable. Market values of trust assets,
which can vary widely, also affect the level of income. Realized Gains or Losses
on Securities
Realized Gains or Losses on Securities
Net securities gains were $7 in the third quarter of 2003. In 2002 the
Company sold certain stock owned by Bankshares for a substantial gain, resulting
in $178 in net gains for that quarter.
Salaries and Wages
Salaries and wages are up $159 or 7.11% at September 30, 2003 when
compared with the same period last year. As previously mentioned, rising pension
costs and normal salary reviews accounted for most of the increase.
Other Expense
Other expenses, including occupancy, data processing, and other expense,
normally fluctuate to a degree. Credit card processing expenses were up $44 due
primarily to increase in volume related to merchant and debit cards.
Daily Averages
Following are quarterly averages for selected categories:
Major Categories September 30, 2003 September 30, 2002
- ---------------- ------------------ ------------------
Loan, net $409,307 $409,413
Securities available for sale 124,683 96,937
Securities held to maturity 104,111 89,474
Total assets 697,216 657,504
Total deposits 616,574 583,937
Stockholders equity 78,143 71,104
Loans and Deposits September 30,2003 September 30, 2002
- ------------------ ----------------- ------------------
Construction loans $31,754 $23,018
Real estate loans 84,776 80,060
Commercial loans 210,433 208,318
Loan to individuals 88,855 104,372
Noninterest bearing demand deposits 81,275 75,223
Interest bearing demand deposits 168,281 153,472
Saving deposits 52,920 48,495
Time deposits 314,098 306,747
23
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 investments in collateralized mortgage
obligations, structured notes and other similar instruments that are included in
securities available for sale and securities held to maturity. The fair value of
these investments at September 30, 2003 was approximately $2,208. Amortized cost
for these securities was approximately $2,289.
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, 2002.
Item 4. Controls and Procedures
Under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, we
have evaluated the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this report.
Based on that evaluation, our principal executive officer and principal
financial officer have concluded that these controls and procedures are
effective. There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Disclosure controls and procedures are our controls and procedures that
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate, to allow timely decisions regarding
required disclosure.
24
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, 2003.
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
Form 8K dated July 11, 2003 - Press release announcing
earnings for the second quarter of 2003, incorporated by
reference herein.
Form 8K dated July 21, 2003 - Press release announcing the
Company's inclusion in the Russell (R) 3000 Index,
incorporated by reference herein.
25
Signatures
National Bankshares, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
DATE: November 14, 2003 NATIONAL BANKSHARES, INC.
/s/ JAMES G. RAKES
-----------------------------
James G. Rakes
Chief Executive Officer
/s/ J. ROBERT BUCHANAN
-----------------------------
J. Robert Buchanan
Chief Financial Officer
26
Index to Exhibits
Page No. In
Exhibit No. Description Sequential System
- ----------- ----------- -----------------
3(i) Articles of Incorporation, as amended, (incorporated herein
of National Bankshares, Inc. 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 (incorporated herein by
National Bankshares, Inc. common stock, reference to Exhibit
$2.50 par value 4(a) of the Annual
Report on Form 10K for
fiscal year ended
December 31, 1993)
4(i) Article Four of the Articles of (incorporated herein by
Incorporation of National Bankshares, reference to Exhibit
Inc. 4(b) of the Annual
Report on Form 10K for
fiscal year ended
December 31, 1993)
10(ii)(B) Computer software license agreement (incorporated herein by
dated June 18, 1990, by and between reference to Exhibit
Information Technology, Inc. and The 10(e) of the Annual
National Bank of Blacksburg Report on Form 10K for
fiscal year ended
December 31, 1992)
*10(iii)(A) National Bankshares, Inc. 1999 (incorporated herein by
Stock Option Plan of the reference to Exhibit 4.3
Form S-8, filed as
Registration No.
333-79979 with the
Commission on June 4,
1999)
*10(iii)(A) Employment Agreement dated January (incorporated herein by
2002 between National Bankshares, Inc. reference to Exhibit
and James G. Rakes 10(iii)(A) of Form 10Q
for the period ended
June 30, 2002)
*10(iii)(A) Employee Lease agreement dated August (incorporated herein by
14, 2002, by and between National reference to Exhibit
Bankshares and The National Bank of 10(iii)(A) of Form 10Q
Blacksburg for the period ended
September 30, 2002)
*10(iii)(A) Change in Control Agreement dated (incorporated herein by
January 5, 2003, between National reference to Exhibit
Bankshares, Inc. and Marilyn B. 10(iii) on Form 10K for
Buhyoff. the Fiscal Year ended
December 31, 2002)
*10(iii)(A) Change in Control Agreement dated (incorporated herein by
January 8, 2003, between National reference to Exhibit
Bankshares, Inc. and F. Brad Denardo 10(iii) on Form 10K for
the Fiscal Year ended
December 31, 2002)
*10(iii)(A) Change in Control Agreement dated (incorporated herein by
June 1, 1998, between Bank of Tazewell reference to Exhibit
County and Cameron L. Forester 10(iii) on Form 10K for
the Fiscal Year ended
December 31, 2002)
27
31(a) Section 302 Certification of Chief
Executive Officer Page 30
31(b) Section 302 Certification of Chief
Financial Officer Page 31
32(a) Certification of Chief Executive
Officer Pursuant to 18 U.S.C.
Section 350 Page 32
32(b) Certification of Chief Financial
Officer Pursuant to 18 U.S.C.
Section 350 Page 33
28