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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-Q
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Quarterly Report Pursuant to Section 13 or 15(d)
Of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2004
Commission file number 0-15204
National Bankshares, Inc.
(Exact name of registrant as specified in its charter)
State or other jurisdiction of incorporation or organization - Virginia
Internal Revenue Service - Employer Identification No. 54-1375874
101 Hubbard Street, P.O. Box 90002, Blacksburg, VA 24062-9002
(540) 951-6300
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such requirements
for the past 90 days.
Yes _X_ No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b - 2 of the Exchange Act)
Yes _X_ No ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at August 9, 2004
- ----------------------------- -----------------------------
Common Stock, $2.50 Par Value 3,521,502
(This report contains 34 pages)
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2 NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-Q
Index
Part I Financial Information Page
- ----------------------------
Item 1 Financial Statements
Consolidated Balance Sheets, June 30, 2004 (Unaudited)
and December 31, 2003..............................................3
Consolidated Statements of Income for the Three Months
Ended June 30, 2004 and 2003 (Unaudited)..........................5
Consolidated Statements of Income for the Six Months Ended
June 30, 2004 and 2003 (Unaudited)................................7
Consolidated Statements of Changes in
Stockholders' Equity, Six Months Ended
June 30, 2004 and 2003 (Unaudited)..................................9
Consolidated Statements of Cash Flows,
Six Months Ended June 30, 2004 and 2003 (Unaudited)...............10
Notes to Consolidated Financial Statements.........................12
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations.....................17
Item 3 Quantitative and Qualitative Disclosures about
Market Risk........................................................8
Item 4 Controls and Procedures.............................................8
Part II Other Information
- -------------------------
Item 1 Legal Proceedings.................................................28
Item 2 Changes in Securities and Use of Proceeds and Issuer
Purchases of Equity Securities...................................28
Item 3 Defaults Upon Senior Securities...................................28
Item 4 Submission of Matters to a Vote of
Security Holders..................................................29
Item 5 Other Information..................................................30
Item 6 Exhibits and Reports on Form 8-K...................................30
Signatures.................................................................30
Index of Exhibits..........................................................30
2
Part I
Financial Information
Item 1. Financial Statements
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, 2004 and December 31, 2003
(Unaudited)
June 30, December 31,
($ In thousands, except share and per share data) 2004 2003
================ =================
Assets:
Cash and due from banks $16,973 $11,733
Federal Funds sold 4,765 ---
Interest-bearing deposits 9,720 36,220
Securities available for sale 147,592 129,300
Securities held to maturity (fair value
$111,155 in 2004 and $105,026 in 2003) 110,422 100,854
Mortgage loans held for sale 298 714
Loans:
Real estate construction loans 21,836 28,055
Real estate mortgage loans 126,581 87,899
Commercial and industrial loans 229,891 208,997
Loans to individuals 87,268 82,742
---------------- -----------------
Total loans 465,576 407,693
Less unearned income and deferred fees (837) (896)
---------------- -----------------
Loans, net of unearned income
and deferred fees 464,739 406,797
Less allowance for loan losses (5,886) (5,369)
---------------- -----------------
Loans, net 458,853 401,428
---------------- -----------------
Bank premises and equipment, net 11,682 10,094
Accrued interest receivable 5,087 4,610
Other real estate owned, net 1,489 1,663
Intangible assets and goodwill, net 17,759 9,958
Other assets 3,789 1,986
---------------- -----------------
Total assets $788,429 $708,560
================ =================
Liabilities and Stockholders' Equity:
- -------------------------------------
Noninterest-bearing demand deposits $94,036 $83,671
Interest-bearing demand deposits 205,168 172,370
Savings deposits 64,209 53,084
Time deposits 340,914 316,253
---------------- -----------------
Total deposits 704,327 625,378
---------------- -----------------
Other borrowed funds 374 135
Accrued interest payable 484 489
Other liabilities 1,814 1,917
---------------- -----------------
Total liabilities 706,999 627,919
---------------- -----------------
3
Stockholders' Equity Preferred stock of no
par value.
Authorized 5,000,000 shares; none
issued and outstanding --- ---
Common stock of $2.50 par value.
Authorized 10,000,000 shares; issued and
outstanding 3,521,502 shares in 2004 and
3,515,377 in 2003 8,804 8,788
Retained earnings 73,850 70,063
Accumulated other comprehensive income
(loss), net (1,224) 1,790
---------------- -----------------
Total stockholders' equity 81,430 80,641
---------------- -----------------
Total liabilities and
stockholders' equity $788,429 $708,560
================ =================
See accompanying notes to the consolidated financial statements.
4
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended June 30, 2004 and 2003
(Unaudited)
June 30, June 30,
($ In thousands, except share and per share data) 2004 2003
================================================= ================== =================
Interest income
===============
Interest and fees on loans $7,086 $7,617
Interest on interest-bearing deposits 50 73
Interest on federal funds sold 1 7
Interest on securities - taxable 1,549 1,356
Interest on securities - nontaxable 1,331 1,343
------------------ -----------------
Total interest income 10,017 10,396
------------------ -----------------
Interest expense
================
Interest on time deposits $100,000 or more 765 782
Interest on other deposits 1,893 2,474
Interest on borrowed funds 1 ---
------------------ -----------------
Total interest expense 2,659 3,256
------------------ -----------------
Net interest income 7,358 7,140
Provision for loan losses 304 402
------------------ -----------------
Net interest income after
provision for loan losses 7,054 6,738
------------------ -----------------
Noninterest income
==================
Service charges on deposit accounts 735 647
Other service charges and fees 58 66
Credit card fees 496 448
Trust income 322 245
Other income 77 93
Realized securities gains (losses), net (7) 5
------------------ -----------------
Total noninterest income 1,681 1,504
------------------ -----------------
Noninterest expense
===================
Salaries and employee benefits 2,574 2,360
Occupancy and furniture and fixtures 426 398
Data processing and ATM 285 289
Credit card processing 388 338
Intangibles amortization 228 239
Net costs of other real estate owned 53 13
Other operating expenses 961 932
------------------ -----------------
Total noninterest expense 4,915 4,569
------------------ -----------------
Income before income tax expense 3,820 3,673
Income tax expense 884 872
------------------ -----------------
Net income $2,936 $2,801
================== =================
5
Net income per share - basic $0.84 $0.80
================== =================
- diluted 0.83 0.79
================== =================
Weighted average number of common
shares outstanding - basic 3,518,882 3,512,514
================== =================
- diluted 3,535,274 3,532,960
================== =================
Dividends declared per share $0.63 $0.54
================== =================
See accompanying notes to consolidated financial statements.
6
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Six Months Ended June 30, 2004 and 2003
(Unaudited)
June 30, June 30,
($ In thousands, except share and per share data) 2004 2003
================================================= ================== =================
Interest income
- ---------------
Interest and fees on loans $14,031 $15,271
Interest on interest-bearing deposits 114 137
Interest on federal funds sold 1 11
Interest on securities - taxable 2,994 2,800
Interest on securities - nontaxable 2,674 2,653
------------------ -----------------
Total interest income 19,814 20,872
------------------ -----------------
Interest expense
================
Interest on time deposits $100,000 or more 1,458 1,615
Interest on other deposits 3,799 5,118
Interest on borrowed funds 1 1
------------------ -----------------
Total interest expense 5,258 6,734
------------------ -----------------
Net interest income 14,556 14,138
Provision for loan losses 592 842
------------------ -----------------
Net interest income after
provision for loan losses 13,964 13,296
------------------ -----------------
Noninterest income
==================
Service charges on deposit accounts 1,410 1,173
Other service charges and fees 130 141
Credit card fees 882 794
Trust income 831 504
Other income 180 265
Realized securities (losses), net (13) (4)
------------------ -----------------
Total noninterest income 3,420 2,873
------------------ -----------------
Noninterest expense
===================
Salaries and employee benefits 5,092 4,765
Occupancy and furniture and fixtures 864 832
Data processing and ATM 564 541
Credit card processing 702 625
Intangibles amortization 466 477
Net costs of other real estate owned 112 19
Other operating expenses 1,935 1,877
------------------ -----------------
Total noninterest expense 9,735 9,136
------------------ -----------------
Income before income tax expense 7,649 7,033
Income tax expense 1,753 1,600
------------------ -----------------
Net income $5,896 $5,433
================== =================
7
Net income per share - basic $1.68 $1.55
================== =================
- diluted 1.67 1.54
================== =================
Weighted average number of common
shares outstanding - basic 3,517,130 3,511,949
================== =================
- diluted 3,538,929 3,530,416
================== =================
Dividends declared per share $0.63 $0.54
================== =================
See accompanying notes to consolidated financial statements.
8
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Six Months Ended June 30, 2004 and 2003
(Unaudited)
Accumulated
Other
($ In thousands, except per Common Retained Comprehensive Comprehensive
share data) Stock Earnings Income Income Total
============ ============== ================ ================ ===========
Balances, December 31, 2002 $8,778 $62,525 $1,798 --- $73,101
Net income --- 5,433 --- 5,433 5,433
Dividend ($0.54 per share) --- (1,897) --- --- (1,897)
Exercise of stock options 4 25 --- --- 29
Other comprehensive income, net of tax:
Unrealized losses
(gains)on securities
available for sale, net
of income tax $970 --- --- --- 1,802 ---
Reclass adjustment net
of tax $1 --- --- --- 3 ---
------------ -------------- ---------------- ---------------- -----------
Other comprehensive income --- --- 1,805 1,805 1,805
------------ -------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- 7,238 ---
============ ============== ================ ================ ===========
Balances, June 30, 2003 $8,782 $66,086 $3,603 $--- $78,471
============ ============== ================ ================ ===========
Balances, December 31, 2003 $8,788 $70,063 $1,790 $--- $80,641
Net income --- 5,896 --- 5,896 5,896
Dividends ($0.63 per share) --- (2,216) --- --- (2,216)
Exercise of stock options 16 107 --- --- 123
Other comprehensive income,
net of tax
Unrealized losses on
securities available for
sale, net of income tax
$1,623 --- --- --- (3,022)
Reclass adjustment net of
income tax $5 --- --- --- 8 ---
------------ -------------- ---------------- ---------------- -----------
Other comprehensive income --- --- (3,014) (3,014) (3,014)
------------ -------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- $2,882 ---
============ ============== ================ ================ ===========
Balances, June 30,2004 $8,804 $73,850 $(1,224) $--- $81,430
============ ============== ================ ================ ===========
See accompanying notes to consolidated financial statements.
9
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2004 and 2003
(Unaudited)
June 30, June 30,
($In thousands) 2004 2003
================== =================
Cash flows from operating activities
- -------------------------------------
Net income $5,896 $5,433
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 592 842
Depreciation of bank premises and equipment 464 442
Amortization of intangibles 466 477
Amortization of premiums and accretion of
discount, net 68 377
Losses on sales of bank premises and equipment --- 40
Losses on sales and calls of securities
available for sale, net 26 6
(Gains) on calls of securities held to maturity (19) (2)
Losses and writedowns on other real estate owned 95 9
(Increase) decrease in:
Mortgage loans held for sale 416 661
Accrued interest receivable (477) (770)
Other assets 3,443 347
Increase (decrease) in:
Accrued interest payable (5) (126)
Other liabilities (103) (1,117)
------------------ -----------------
Net cash provided by operating
activities 10,862 6,619
------------------ -----------------
Cash flows from investing activities
- -------------------------------------
Net (increase) in federal funds sold (4,765) (1,718)
Net decrease in interest-bearing
deposits 26,500 1,036
Proceeds from calls, principal payments, sales and
maturities of securities available for sale 15,792 12,284
Proceeds from calls, principal payments and maturities
of securities held to maturity 4,252 8,222
Purchases of securities available for sale (28,718) (16,127)
Purchases of securities held to maturity (13,841) (13,251)
Purchases of loan participations (376) (1,975)
Collections of loan participations 168 215
Net (increase) in loans to customers (17,813) (7,789)
Acquisition of CNB 12,819
Proceeds from disposal of other real estate owned 347 67
Recoveries on loans charged off 107 161
Purchase of bank premises and equipment (2,056) (894)
Proceeds from disposal of bank premises and equipment 4 400
------------------ -----------------
Net cash (used in) investing
activities (33,218) (19,369)
------------------ -----------------
10
Cash flows from financing activities
- -------------------------------------
Net increase (decrease) in other deposits $14,049 $(2,173)
Net increase (decrease) in time deposits (15,048) 19,749
Net increase(decrease)in other borrowed funds 239 (227)
Stock options exercised 123 29
Cash dividends (2,216) (1,897)
------------------ -----------------
Net cash provided by financing activities 17,116 15,481
------------------ -----------------
Net increase in cash and due from banks 5,240 2,731
Cash and due from banks at beginning of period 11,733 12,316
------------------ -----------------
Cash and due from banks at end of period $16,973 $15,047
================== =================
Supplemental disclosure of cash flow information
- -------------------------------------------------
Cash paid for interest $5,263 $6,860
================== =================
Cash paid for income taxes $1,575 $1,603
================== =================
Loans charged to the allowance for loan losses $680 $602
================== =================
Loans transferred to other real estate owned $268 $282
================== =================
Unrealized gains (losses)on securities available for sale $(4,632) $2,776
================== =================
Transactions related to the acquisition of CNB
- -----------------------------------------------
Increase in assets and liabilities:
Investments $10,052 $ ---
Loans 40,371 ---
Deposits 59,979 ---
See accompanying notes to consolidated financial statements.
11
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2004
(Unaudited)
Note (1)
The consolidated financial statements of National Bankshares, Inc.
(Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg
(NBB), Bank of Tazewell County (BTC) and National Bankshares Financial Services,
Inc. (NBFS), (the Company), conform to accounting principles generally accepted
in the United States of America and to general practices within the banking
industry. The accompanying interim period consolidated financial statements are
unaudited; however, in the opinion of management, all adjustments consisting of
normal recurring adjustments which are necessary for a fair presentation of the
consolidated financial statements have been included. The results of operations
for the six months ended June 30, 2004 are not necessarily indicative of results
of operations for the full year or any other interim period. The interim period
consolidated financial statements and financial information included herein
should be read in conjunction with the notes to consolidated financial
statements included in the Company's 2003 Form 10-K.
Note (2) Stock-Based Compensation
At June 30, 2004, the Company had a stock-based employee compensation
plan, which is described more fully in the Company's Form 10-K dated December
31, 2003. The Company accounts for this plan under the recognition and
measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under the plan had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation.
Six months ended June 30, Three months ended June 30,
-------------- ------------ -------------- ------------
($ In thousands, except per share data) 2004 2003 2004 2003
- ---------------------------------------------------- -------------- ------------ -------------- ------------
Net income, as reported $5,896 $5,433 $2,936 $2,801
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards (51) (20) (26) (13)
-------------- ------------ -------------- ------------
Pro forma net income $5,845 $5,413 $2,910 $2,788
- ---------------------------------------------------- -------------- ------------ -------------- ------------
Earnings per share:
Basic-as reported $1.68 $1.55 $0.84 $0.80
- ---------------------------------------------------- -------------- ------------ -------------- ------------
Basic-pro forma $1.66 $1.54 $0.83 $0.79
- ---------------------------------------------------- -------------- ------------ -------------- ------------
Diluted-as reported $1.67 $1.54 $0.83 $0.79
- ---------------------------------------------------- -------------- ------------ -------------- ------------
Diluted-pro forma $1.65 $1.53 $0.82 $0.79
- ---------------------------------------------------- -------------- ------------ -------------- ------------
Stock options for 6,125 shares of NBI common stock were exercised in the
second quarter of 2004. There were no stock options granted or forfeited during
the period. For teh quarterended June 30, 2004, 16,500 options were excluded
from the calculation of diluted earnings per share as the effect would have been
anti-dilutive.
12
Note (3) Acquisitions
On December 24, 2003, the Company's BTC subsidiary entered into an
agreement to acquire the loans and assume the deposit liabilities of the
Richlands, Virginia branch office of FNB Southeast of Reidsville, North Carolina
(FNB). BTC received approval for this transaction from its primary regulator,
the Federal Reserve Bank on February 18, 2004. The transaction, which does not
include the purchase of fixed assets, was closed in the second quarter of 2004.
The purchase and assumption added approximately $7.2 million in loans and
approximately $15.0 million in deposits. The Company has determined that the
transaction does not constitute the acquisition of a business, and therefore
will be accounted for under the provisions of SFAS No. 147, Acquisitions of
Certain Financial Institutions.
The Company's NBB subsidiary entered into an agreement with The South
Financial Group of Greenville, South Carolina on February 2, 2004. The contract
provided that NBB would purchase substantially all of the assets and assume all
of the liabilities of The South Financial Group's wholly-owned subsidiary,
Community National Bank located in Pulaski, Virginia (CNB). This transaction
closed in June of 2004 at a purchase price of $12,850. It added approximately
$60 million in deposits and approximately $69 million in total assets. Any
goodwill and intangible assets arising from the transaction will be accounted
for under the provisions of SFAS No. 142 Goodwill and other Intangible Assets.
As of June 30,2004, it is estimated that the transaction will result in the
addition of approximately $6.7 in goodwill and $0.8 million in core deposit
intangible.
The results of operations are included in the financial statements from
the date of acquisition.
Note (4) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended
June 30, December 31,
2004 2003 2003
============== ============== =================
($In thousands, except for % data)
Balance at beginning of period $5,369 $5,092 $5,092
Provision for loan losses 592 842 1,691
Loans charged off (680) (602) (1,660)
Acquisition of CNB assets 498 --- ---
Recoveries 107 161 246
Balance at the end of period $5,886 $5,493 $5,369
============== ============== =================
Ratio of allowance for loan losses to the end
of period loans net of unearned income and
deferred fees 1.27% 1.31% 1.32%
============== ============== =================
Ratio of net charge-offs to
average loans, net of unearned income and
deferred fees(1) .28% .22% .34%
============== ============== =================
Ratio of allowance for loan losses to
nonperforming loans(2) 1,070.18% 5,182.08% 1,516.67%
============== ============== =================
(1) Net charge-offs are on an annualized basis.
(2) The Company defines nonperforming loans as total nonaccrual and
restructured loans. Loans 90 days past due and still accruing are
excluded.
13
June 30, December 31,
2004 2003 2003
============= ============ ================
($In thousands, except % data)
Nonperforming Assets
Nonaccrual loans $550 $106 $354
Restructured loans --- --- ---
------------- ------------ ----------------
Total nonperforming loans 550 106 354
Foreclosed property 1,489 743 1,663
------------- ------------ ----------------
Total nonperforming assets $2,039 $849 $2,017
============= ============ ================
Ratio of nonperforming assets to loans, net of
unearned income and deferred fees, plus other real
estate owned .44% .21% .49%
============= ============ ================
June 30, December 31,
2004 2003 2003
============= ============ ===============
Accruing Loans Past Due 90 Days or More
Past due 90 days or more and
still accruing $1,053 $1,088 $931
============= ============ ===============
Ratio of loans past due 90 days or
more and still accruing to loans, net
of unearned income and deferred fees .23% .26% .23%
============= ============ ===============
Impaired Loans:
Total impaired loans $540 $276 $871
============= ============ ===============
Impaired loans with a
valuation allowance $530 --- $506
Valuation allowance (242) --- (135)
------------- ------------ ---------------
Impaired loans net of allowance $288 --- $371
============= ============ ===============
Impaired loans with no
valuation allowance $10 $276 $365
============= ============ ===============
Average recorded investment
in impaired loans $725 $172 $353
============= ============ ===============
Income recognized on impaired
loans $--- $8 $66
============= ============ ===============
Amount of income recognized
on a cash basis $--- --- ---
============= ============ ===============
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 at June
30, 2004 were $10. Interest recognized on these loans was $1.
14
Note (5) Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for the sale by major security type as of
June 30, 2004 are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
U.S. Treasury $4,043 $49 $163 $3,929
U.S. Government agencies and
corporations 9,848 --- 41 9,807
State and political
subdivisions 79,189 1,092 1,483 78,798
Mortgage-backed
securities 17,330 234 78 17,486
Corporate debt
securities 34,910 324 1,407 33,827
Federal Reserve Bank stock-
restricted 209 --- --- 209
Federal Home Loan
Bank stock-restricted 1,552 --- --- 1,552
Other securities 1,841 143 --- 1,984
----------------- ----------------- ----------------- ------------------
Total securities
available for sale $148,922 $1,842 $3,172 $147,592
================= ================= ================= ==================
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of June
30, 2004 are as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
U.S. Government agencies and
corporations $15,974 $65 $521 $15,518
State and political
subdivisions 56,562 911 477 56,996
Mortgage-backed
securities 3,971 123 10 4,084
Corporate securities 33,915 1,263 621 34,557
----------------- ----------------- ----------------- ------------------
Total securities
held to maturity $110,422 $2,362 $1,629 $111,155
================= ================= ================= ==================
15
Note (6) Defined Benefit Plan
Components of Net Periodic Benefit Cost
Six months ended June 30
($ in Thousands)
Pension Benefits
2004 2003
---------- ---------
Service cost $ 248 $ 214
Interest cost 268 250
Expected return on plan assets (250) (210)
Amortization of prior service cost 4 4
Recognized net actuarial loss 60 56
Amortization of transition cost (6) (6)
---------- ----------
Net periodic benefit cost $ 324 $ 308
========== ==========
Employer Contributions
Bankshares previously disclosed in its financial statements for the year
ended December 31, 2003, an estimated minimum contribution of $623 to its
pension plan in 2004. That estimate has since been revised and Bankshares now
expects to contribute $522 to the pension plan for 2004. As of June 30, 2004,
the company has made contributions totaling $223. Bankshares anticipates making
all required contributions prior to the end of 2004.
National Bankshares, Inc. and Subsidiaries
(In thousands, except per share data)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The purpose of this discussion is to provide information about the
financial condition and results of operations of National Bankshares, Inc. and
its wholly owned subsidiaries (the Company), which are not otherwise apparent
from the consolidated financial statements and other information included in
this report. Reference should be made to the financial statements and other
information included in this report as well as the 2003 Annual Report on Form
10-K for an understanding of the following discussion and analysis.
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. The Company's actual results could
differ materially from those set forth in the forward-looking statements.
Critical Accounting Policies
General
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States (GAAP). The
financial information contained within our statements is, to a significant
extent, financial information that is based on measures of the financial effects
of transactions and events that have already occurred. A variety of factors
could affect the ultimate value that is obtained when earning income,
recognizing an expense, recovering an asset or relieving a liability. We use
historical loss factors as one factor in determining the inherent loss that may
be present in our loan portfolio. Actual losses could differ significantly from
the historical factors that we use. In addition, GAAP itself may change from one
previously acceptable method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change.
16
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that
losses be accrued when they are probable of occurring and estimable and (ii)
SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that
losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
Our allowance for loan losses has three basic components: the formula
allowance, the specific allowance and the unallocated allowance. Each of these
components is determined based upon estimates that can and do change when actual
events occur. The formula allowance uses a historical loss view as an indicator
of future losses and, as a result, could differ from the loss incurred in the
future. However, since this history is updated with the most recent loss
information, the errors that might otherwise occur are mitigated. The specific
allowance uses various techniques to arrive at an estimate of loss. Historical
loss information, expected cash flows and fair market value of collateral are
used to estimate these losses. The use of these values is inherently subjective
and our actual losses could be greater or less than the estimates. The
unallocated allowance captures losses that are attributable to various economic
events, industry or geographic sectors, whose impact on the portfolio have
occurred but have yet to be recognized in either the formula or specific
allowance.
Core deposit intangibles
Effective January 1, 2002, the Corporation adopted Financial Accounting
Standards Board Statement No. 142, Goodwill and Other Intangible Assets.
Accordingly, goodwill is no longer subject to amortization over its estimated
useful life, but is subject to at least an annual assessment for impairment by
applying a fair value based test. Additionally, Statement 142 requires that
acquired intangible assets (such as core deposit intangibles) be separately
recognized if the benefit of the asset can be sold, transferred, licensed,
rented, or exchanged and amortized over its estimated useful life. Branch
acquisition transactions were outside the scope of the Statement and therefore
any intangible asset arising from such transactions remained subject to
amortization over their estimated useful life.
In October 2002, the Financial Accounting Standards Board issued
Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement
amends previous interpretive guidance on the application of the purchase method
of accounting to acquisitions of financial institutions, and requires the
application of Statement No. 141, Business Combinations, and Statement No. 142
to branch acquisitions if such transactions meet the definition of a business
combination. The provisions of the Statement do not apply to transactions
between two or more mutual enterprises. In addition, the Statement amends
Statement No. 144, Accounting for the Impairment of Long-Lived Assets, to
include in its scope core deposit intangibles of financial institutions.
Accordingly, such intangibles are subject to a recoverability test based on
undiscounted cash flows and to the impairment recognition and measurement
provisions required for other long-lived assets held and used.
An outside evaluation of the intangible assets associated with the CNB
acquisition is presently being conducted. Exact allocations are not available at
this time. Based on available information, management believes that the amount
disclosed above as core deposit intangible could be increased or decreased by as
much as 25%.
Overview
National Bankshares, Inc. (NBI) is a financial holding company located in
Southwest Virginia. It conducts operations primarily through two full-service
banking affiliates, the National Bank of Blacksburg and Bank of Tazewell County.
It also has one nonbanking affiliate, National Bankshares Financial Services,
Inc., which offers investment and insurance products. Net income derived from
17
the nonbanking affiliate is not significant at this time or for the foreseeable
future. Management characterizes NBI as a "community bank" operation.
Performance Summary
The following table shows NBI's key performance ratios for the six months
ended June 30, 2004 and December 31, 2003 and 2002:
June 30, 2004 December 31, 2003 December 31, 2002
- ------------------------------------------------- -------------------- -------------------- ----------------------
Return on average assets 1.65% 1.64% 1.53%
- ------------------------------------------------- -------------------- -------------------- ----------------------
Return on average equity 14.27% 14.77% 14.33%
- ------------------------------------------------- -------------------- -------------------- ----------------------
Net interest margin (1) 4.70% 4.82% 4.74%
- ------------------------------------------------- -------------------- -------------------- ----------------------
Noninterest margin (2) 1.76% 1.81% 1.84%
- ------------------------------------------------- -------------------- -------------------- ----------------------
Basic net earnings per share $1.68 $3.26 $2.85
- ------------------------------------------------- -------------------- -------------------- ----------------------
Fully diluted net earnings per share $1.67 $3.24 $2.85
- ------------------------------------------------- -------------------- -------------------- ----------------------
(1) Net Interest Margin - Year-to-date tax-equivalent net interest income
divided by year-to-date average earning assets.
(2) Noninterest Margin - Noninterest income (including securities gains and
losses) less noninterest expense (excluding the provision for bad debts
and income taxes) divided by average year-to-date assets.
Earnings for the period ending June 30,2004 were $5,896 up $463 from the
same period in 2003.
As illustrated in the above table, the return on average assets continues
to improve.
The return on average equity has declined in part because of an increase in
capital due to earnings. Since the Company pays semi-annual dividends, capital
builds in the first and third quarters, which reduces the return on average
equity. In the second and fourth quarters the payout of capital for dividends
has a positive effect. Unrealized gains and losses on securities available for
sale, which can fluctuate by a substantial amount, can also affect the return
on average equity.
The interest margin and noninterest margin have remained relatively stable.
Basic earnings per share were $1.68 for the period ending June 30, 2004 and
$1.55 for the period ending June 30, 2003.
Overall profitability indicators remain stable or improving. Management
believes that the current trend will continue in the short term, providing that
interest rates remain stable. Rising interest rates may have an adverse affect
on profitability in the short to intermediate term especially if such rate
increases move to substantially higher levels in a short period of time. Based
on current information, rate increases are not expected to rise sharply. (See
the discussion on "Net Interest Income" for more information.)
Growth
The following table shows NBI's key growth indicators:
June 30, 2004 December 31, 2003 December 31, 2002
- ----------------------- ---------------------- --------------------- ----------------------
Securities $258,014 $230,154 $219,294
- ----------------------- ---------------------- --------------------- ----------------------
Loans, net 458,853 401,428 404,247
- ----------------------- ---------------------- --------------------- ----------------------
Deposits 704,327 625,378 608,271
- ----------------------- ---------------------- --------------------- ----------------------
Total assets 788,429 708,560 684,935
- ----------------------- ---------------------- --------------------- ----------------------
Bank-owned securities have increased by $27,860 in the first half of 2004.
Approximately $10.1 million was due to the purchase of substantially all of the
assets of the Community National Bank, Pulaski, VA (CNB) in the latter part of
the second quarter.
Loans net of unearned income increased by $57,942 in the first half of
2004. Loans assumed in the CNB transaction totaled approximately $40.4 million
and $7.2 in the purchase and assumption of certain assets and liabilities of the
Richlands, Virginia office of FNB Southeast (FNB). (See the discussion on "Net
Interest Income" for more details.)
Deposits increased in the first half of 2004 by $78,949. Deposits acquired
in the CNB transaction were approximately $60 million and $15 million in the FNB
branch purchase.
18
Total assets increased $79,869 in the first half of 2004 mostly due to the
CNB and FNB transactions.
Asset Quality
Key asset quality indicators are shown below:
June 30, 2004 December 31,2003 December 31, 2002
- --------------------------------------------- ------------------- ------------------- -------------------
Nonperforming loans $ 550 $ 354 $ 288
- --------------------------------------------- ------------------- ------------------- -------------------
Loans past due over 90 days 1,053 931 977
- --------------------------------------------- ------------------- ------------------- -------------------
Other real estate owned 1,489 1,663 537
- --------------------------------------------- ------------------- ------------------- -------------------
Allowance for loan losses to loans 1.27% 1.32% 1.24%
- --------------------------------------------- ------------------- ------------------- -------------------
Net charge-off ratio .28% .34% .35%
- --------------------------------------------- ------------------- ------------------- -------------------
Asset quality generally remains good, however there has been an
increased level of foreclosed properties, as shown in the above table.
Management has recognized the problem and has undertaken efforts to work with
delinquent borrowers. When these efforts are unsuccessful, management is moving
quickly to liquidate loan collateral and to institute legal collection
activities.
To date the net charge-off ratio has remained stable. Loans past due
ninety days or more were $1,053 at June 30, 2004, slightly higher than the $931
at December 2003 and the $977 at December 31, 2002.
Net Interest Income
Net interest income for the period ended June 30, 2004 was $14,556, an
increase of $418 or 2.96%. The net interest margin was 4.70% for the period
ended June 30,2004 and 4.81% for the period ended June 30, 2003.
During the past two years the Company has benefited from a relatively
long period of low interest rates, which has no recent precedent. The trend
continued into the first half of 2004. In June of 2004 the Federal Reserve Board
raised the federal funds rates 25 basis points, signaling the start of a higher
interest rate environment. Many forecasters agree that interest rates will trend
upward in small increments over the next several quarters. However, the impact
of world events, such as but not limited to, oil prices, problems in the Middle
East and terrorist related activities, could negatively impact the national
economy and alter plans for future interest rate increases. If such events were
to occur the Company, together with the entire banking industry, could be
affected to some extent.
The general impact of a rising interest rate scenario on the Company's
balance sheet follows.
Federal Funds Sold and Interest-bearing Deposits - These are overnight
funds used primarily for liquidity purposes. They mature daily and, accordingly,
interest rates change daily, which is advantageous in a period of rising
interest rates. However these funds yield low interest, making other investments
more attractive from an earnings standpoint.
Securities Available for Sale - This category provides a higher level of
earnings than overnight funds and can under certain circumstances be a source of
liquidity and also demonstrate the ability to re-price. While these securities
technically can be sold to provide liquidity and for interest rate sensitivity
purposes, temporary declines in fair market value due to rising interest rates
may make it unprofitable to sell the securities. In addition, embedded call
features may not be activated during periods of high rates, leaving the Company
with a "hold" or "sell" decision. See page 26 of the Company's 2003 Form 10-K
for re-pricing data.
Securities Held to Maturity - This category due to its nature is not
necessarily structured to be a source of liquidity or to moderate interest rate
sensitivity. These securities must be held to maturity except under extenuating
19
circumstances. In a rising rate environment, the difference in the amount of
interest-income earned and cost to fund the securities decreases. In other
words, net interest income from these investments declines. Embedded call
features may not be activated during periods of high rates. See the Company's
2003 Form 10-K for re-pricing data.
Mortgage loans held for sale - This category is primarily driven by
volume. In periods of low interest rates, mortgage refinancing activity and home
sales tend to accelerate and generate higher revenue levels than are experienced
in times of high interest rates. In the last two years, re-financing activity
has been significant. Recently, however, despite the continuing low rate
environment, activity has declined. This may signal the end to what many have
characterized as a refinancing boom.
Loans - While the low rate environment of the recent past is more
conducive to loan production than periods of extremely high interest rates,
interest rates that are unusually low are a sign of a weak or a recovering
economy. Ideal volumes may in fact be achieved in a more robust economy in which
more moderate rate levels exist. If the economy continues to recover as
forecast, higher loan volumes would have a positive impact on net interest
income.
Of particular concern is the area of loans to individuals, which has
been in a downward trend for several quarters, with the only growth coming from
loans purchased in purchase and assumption transactions. Management believes the
decline is due to several reasons.
o General economic conditions and the lack of employment in portions of
the Company's market area.
o A decline in consumer requests for new car financing because of special
incentives offered by automobile companies.
o Consumers' use of credit cards and home equity lines with higher credit
limits.
o Consumers taking advantage of low mortgage rates to refinance home mortgages
to obtain funds that might otherwise have been borrowed through a consumer
loan.
A reversal of this trend may occur to some extent as economic conditions
change and higher interest rates make mortgage refinancing less appealing.
However, management believes that the automotive related financing offers and
competition from the credit card sector will remain. Since loans to individuals
are generally higher yielding, this trend will not have a favorable effect on
net interest income.
Interest Expense
During periods of rising interest rates interest-bearing demand
deposits, and to a lesser degree savings deposits, migrate to higher rate,
longer-term time deposits. Generally, as rates climb, more migration occurs.
Given their re-pricing characteristics, interest-bearing demand deposits readily
respond to any interest rate movement. In other words, increases or decreases in
interest expense can occur quite quickly.
With a definite bias towards higher interest rates in the future, it is
expected that the net interest margin will decline, at least temporarily, in
response to rising interest rates. As previously stated, the ultimate impact of
rising interest rates is dependent upon the number of rate increases, the amount
of such and the level to which they ultimately rise is a matter of uncertainty.
Provision and Allowance for Loan Losses
The provision for loan losses for the period ended June 30, 2004 was
$592 a decrease of $250 from June 30, 2003.
Nonperforming assets at June 30, 2004 were $2,039 and $2,017 at December
31, 2003. Of the nonperforming assets outstanding at June 30, 2004, $550 were
nonaccrual loans and $1,489 foreclosed properties.
20
Efforts specifically designed to focus on and work intensively with
delinquent borrowers have been undertaken. When these efforts have been
unsuccessful, other more stringent legal collection measures and foreclosures
have been initiated.
Depending on the type of property and/or the circumstances surrounding a
particular credit, the time to deal with each situation may vary widely. Hence,
management cannot predict with any degree of certainty at what point in the
future problems associated with these credits will be resolved. Based on current
information, management believes that the volume of problem credits are at or
near their peak.
Loans ninety days past due and still accruing were $1,053 at June 30,
2004 and $931 at December 31, 2003.
The ratio of the allowance for loan losses to loans net of unearned
income and deferred fees was 1.27% at June 30, 2004, which compares to 1.32% at
December 31, 2003.
The annualized ratio of net charge-off to loans net of unearned income
was .28% at June 30, 2004 and .34% at December 31, 2003.
Noninterest Income
June 30, 2004 June 30, 2003 June 30, 2002
- ----------------------------------- ----------------------- ------------------------ ---------------------------
Service charges on deposits $1,410 $1,173 $1,104
- ----------------------------------- ----------------------- ------------------------ ---------------------------
Other service charges and fees 130 141 134
- ----------------------------------- ----------------------- ------------------------ ---------------------------
Credit card fees 882 794 683
- ----------------------------------- ----------------------- ------------------------ ---------------------------
Trust fees 831 504 480
- ----------------------------------- ----------------------- ------------------------ ---------------------------
Other income 180 265 349
- ----------------------------------- ----------------------- ------------------------ ---------------------------
Realized securities gains/losses (13) (4) 165
- ----------------------------------- ----------------------- ------------------------ ---------------------------
Noninterest income is comprised of several categories. Following is a
description of each, as well as the factors that influence each.
Service charges on deposit accounts consist of a variety of charges
imposed on demand deposits, interest-bearing deposits and savings deposit
accounts. These include, but are not limited to, the following:
o Demand deposit monthly activity fees
o Service charges for checks for which there are non-sufficient funds or
overdraft charges
o ATM transaction fees
The principal factors affecting current or future income are:
o Internally generated growth
o Acquisitions of other banks/branches or de novo branches
o Adjustments to service charge structures
In 2003, the Company made certain changes to its service charge
structure. These changes were not in effect in the first quarter of 2003. The
remainder of the increase was due to volume, combined with routine charge-offs.
Revenues are expected to continue to grow if for no other reason than the two
acquisitions. (See the comments under "Acquisitions.")
Other service charges and fees consist of several categories. The
primary categories are listed below.
o Fees for the issuance of official checks
o Safe deposit box rent
o Income from the sale of customer checks
o Income from the sale of credit life and accident and health insurance
Levels of income derived from these categories vary. Fees for the issuance of
official checks and customer check sales tend to grow as the existing franchise
grows and as new offices are added. Fee schedules, while subject to change,
generally do not alone yield a significant or discernable increase in income
21
when they change. The most significant growth in safe deposit box rent also
comes with an expansion of offices. Safe deposit box fee schedules, which are
already at competitive levels, are occasionally adjusted. Income derived from
the sale of credit life insurance and accident and health insurance varies with
loan volumes.
Credit card fees consist of three types of revenues as follows.
o Credit card transaction fees
o Debit card transaction fees
o Merchant fees
In all three cases volume is critical to growth in income. For debit and credit
cards the number of accounts, whether obtained from internal growth or by
acquisition, is the key factor. Merchant fees also depend on the number of
merchants in the Company's program, as well as the type of business and the
level of transaction discounts associated with them.
Trust income is somewhat dependent upon market conditions and the number
of estate accounts being handled at any given point in time. Financial market
conditions, which affect the value of trust assets managed, can vary, leading
to fluctuations in the related income. Over the past few years and into 2004,
the financial markets have experienced a significant degree of volatility.
Of the $327 increase, approximately $205 was attributable to income from
the settlement of estates. Improvement in market conditions accounts for the
majority of the remaining increase.
The other income category is used for types of income that cannot be
classified with other forms of noninterest income. The category includes such
things as:
o Net gains on the sale of fixed assets
o Rent on foreclosed property
o Income from cash value life insurance
o Other infrequent or minor forms of income
o Revenue from investment and insurance sales
Given the nature of the items included in this category, it is difficult to
determine trends or patterns. Items warranting discussion are usually
non-recurring in nature.
Other income for the first half of 2004 was down $85 when compared to
the first half of 2003. Two items unique to 2003 accounted for a large part of
the decrease. The first was a $40 rebate received by an affiliate bank from a
vendor. The second was a dividend paid to the Company's financial services
affiliate.
Net realized losses on securities at June 30, 2004 were a nominal $(13).
Noninterest Expense
June 30, 2004 June 30, 2003 June 30, 2002
- ----------------------------- --------------------------- -------------------------- ---------------------------
Salaries and employee $5,092 $4,765 $4,443
benefits
- ----------------------------- --------------------------- -------------------------- ---------------------------
Occupancy and furniture and 864 832 824
fixtures
- ----------------------------- --------------------------- -------------------------- ---------------------------
Data processing and ATM 564 541 586
- ----------------------------- --------------------------- -------------------------- ---------------------------
Credit card processing 702 625 484
- ----------------------------- --------------------------- -------------------------- ---------------------------
Intangibles and goodwill 466 477 478
amortization
- ----------------------------- --------------------------- -------------------------- ---------------------------
Net costs of other real 112 19 123
estate owned
- ----------------------------- --------------------------- -------------------------- ---------------------------
Other operating expenses 1,935 1,877 1,799
- ----------------------------- --------------------------- -------------------------- ---------------------------
Noninterest expense includes several categories. Following is a brief
description of the factors that affect each.
22
In addition to employee salaries, the salaries and benefits expense
category includes the costs of employment taxes and employee fringe benefits.
Certain of these are:
o Health insurance
o Employee life insurance
o Dental insurance
o Executive compensation plans (1)
o Pension plans (1)
o Employee stock option plan (1)
o Employer FICA
o Unemployment taxes
(1) See the 2003 Form 10-K and the Proxy Statement for the 2004 Annual
Stockholders meeting for further information.
For the first half of 2004, salary and benefits expense was up $327.
Routine salary increases and health insurance cost increases contributed to the
increase.
Of more significance are the recent purchase and assumption
transactions. While the FNB branch acquisition added no employees to the
payroll, the CNB purchase and assumption initially added twenty-one employees.
Because the Company's NBB subsidiary is operating the former CNB office as a
branch office, many former CNB employees were retained in their previous
positions. Some former CNB employees hold jobs that are performed elsewhere at
NBB. It is the Company's plan to place these employees in various areas of NBB
as vacancies arise in the normal course of business. While this strategy may
incur some increased cost in the short term, it will ultimately allow the
Company to add to its already experienced staff and preserve valuable community
relations.
Occupancy costs include such items as depreciation expense, maintenance
of the properties, repairs and real estate taxes.
This category is most affected by new property acquisitions resulting
from mergers, branch purchases or construction of new branch facilities.
Conversely, expense can be lowered by branch office consolidations or closures,
which though infrequent, have occurred. On occasion repairs and other expense
items can rise to significant levels, though not frequently. This category
increased a $32 when the first six months of 2004 and 2003 are compared.
The CNB purchase and assumption transaction did not add significantly to this
category because it was completed very near quarter-end.
The Company maintains its own data processing facility and has ATM's at
twenty-two subsidiary bank offices and other locations. Costs to operate these
are reflected in this category and include depreciation, maintenance,
communication lines and certain supplies.
Data processing costs were up $23 when the first halves of 2004 and 2003
are compared. While these cost increases are nominal, larger increases are
expected because of the completion of the two previously mentioned purchase and
assumption transactions. The first purchase and assumption transaction is quite
small and is not expected to greatly impact data processing and ATM expense. The
second acquisition involved the assets and liabilities of an existing bank,
including assumption of its existing data processing contract, which will remain
in force until mid 2005. While the contract terminates in mid 2005, no
substantial decreases in processing costs are expected. The Company also added
three ATM's at its bank affiliates during the second quarter.
Credit card processing includes costs associated with the processing of
credit cards, debit cards and merchant transactions. These expenses are related
to credit card income previously discussed in the "Noninterest Income" section,
and the comments in that section are applicable.
Intangibles expense is increased in 2004 due to the purchase and
assumption transactions that have been mentioned previously.
23
At June 30, 2004 the net cost of other real estate owned was $112. Given
the number and value of the OREO properties, more losses are possible. Expense
has risen steadily for the past three years. The June 30, 2004 costs are not
necessarily indicative of the full year for 2004. Other real estate owned at
June 30, 2004 was $1,489, which compares to $1,663 at December 31, 2003 and $537
at December 31, 2002. Given the number of foreclosures, it is likely that higher
costs will continue for 2004, possibly into 2005.
Other operating expenses include all other forms of expense not
classified elsewhere in the Company's statement of income. Included in this
category are such items as stationery and supplies, franchise taxes,
contributions, telephone, postage and other operating costs.
Many of the expenses included in this category are relatively stable or
increase with inflation moderately from year-to-year. However, there are some
items included in the category, such as other losses and charge-offs and
repossession expense, which can vary from time to time. While many of the items
in this category have identifiable trends, others may have frequent nonrecurring
items or items that occur at no particular frequency.
Overall cost for this category increased 3.10%, when the periods ending
June 30, 2004 and June 30, 2003 are compared.
Income Taxes
In 2003 the Company moved from the 34% tax rate to 35%. In addition to
the actual taxes paid, this change affected other areas including the book tax
provision, deferred taxes and tax equivalency calculations.
Balance Sheet
Year-to-date daily averages for the major balance sheet categories are
as follows:
Assets June 30, 2004 December 31, 2003
- ------------------------------------- ------------------- --------------------
Federal funds sold $ 207 $ 1,320
Interest-bearing deposits 23,600 21,958
Securities available for sale 138,839 125,042
Securities held to maturity 106,050 103,962
Mortgage loans held for sale 480 1,159
Real estate construction loans 22,340 29,575
Real estate mortgage loans 95,250 84,363
Commercial and industrial loans 215,284 207,855
Loans to individuals 83,085 90,365
Total Assets $ 719,195 $ 697,012
Liabilities and stockholders equity
- -------------------------------------
Noninterest-bearing demand deposits $86,779 $79,760
Interest-bearing demand deposits 174,550 167,428
Savings deposits 53,995 51,646
Time deposits 317,925 317,989
Other borrowings 226 194
Shareholders' equity $83,085 $77,486
Securities available for sale increased by $18,292 from December 31,
2003, while securities held to maturity increased by $9,568.
As shown in the statement of cash flow, of that increase $10,052 was
attributable to the CNB transaction. During the first half of 2004, $281 in
securities held to maturity were sold. This represents the sale of one issue and
was prompted by credit quality concerns.
24
The mix of loan categories at June 30, 2004 and December 31, 2003 is
shown in the following table.
June 30, 2004 December 31, 2003
- ------------------------------ --------------------- -----------------------
Construction loans (1) $21,836 $28,055
- ------------------------------ --------------------- -----------------------
Real estate loans 126,581 87,899
- ------------------------------ --------------------- -----------------------
Commercial and industrial loans 229,891 208,997
- ------------------------------ --------------------- -----------------------
Loans to individuals 87,268 82,742
- ------------------------------ --------------------- -----------------------
(1) All categories shown reflect gross loans at period-end.
The volume of mortgage loans held for sale is directly related to
interest rate levels. Activity generally peaks during periods of low interest
rates, declining as interest rates rise. Period-end balances are not indicative
of volume, as loans are constantly being originated and sold. The balance shown
at period-end reflects only loans held by NBB for which there are purchase
commitments from investors, but which have not yet been funded. At June 30, 2004
there were approximately $1,357 million in commitments to extend mortgage loans
outstanding.
Construction loans were $21,836 at June 30, 2004 and $28,055 at December
31, 2003, a decrease of $6,219. This category tends to fluctuate because of
demand and with the seasons. Demand may vary because of economic conditions.
Completion of construction projects generally occurs within one year, at which
time permanent financing through one of the Company's banking affiliates or
another lender is obtained. Loans for which the Company retains permanent
financing move into the commercial and industrial loan or mortgage loan
categories.
Real estate loans at June 30, 2004 were $126,581, which represents an
increase of $38,682 from December 31, 2003. Loans in this category are for
one-to-four family housing and are loans the banking affiliates elected to
retain rather than sell on the secondary market. Of that increase, approximately
$27.9 million were acquired from CNB and $2.6 million acquired from FNB,
Commercial and industrial loans were $229,891 at June 30, 2004, which
represents an increase of $20,894 from December 31, 2003. Included in this
category are loans for working capital, equipment, commercial real estate and
other loans for legitimate business needs. The CNB transaction accounted for
approximately $6.7 million of this growth and the FNB acquisition $2.4 million.
See Footnote 15 of the Company's 2003 Form 10-K for information related to
"Concentrations of Credit". Historically, growth in this category has been
satisfactory, and based on present knowledge, no adverse trends are anticipated.
Loans to individuals increased by $4,526 when June 30, 2004 is compared
to December 31, 2003. Growth attributable to the CNB transaction was
approximately $5.3 million and $2.2 million from FNB. This category has
experienced a downward trend. Growth observed in this area is the result of
acquisitions. See the comments under the caption "Net Interest Income" in this
report.
At June 30, 2004 total deposits were $704,327 compared to $625,378 at
December 31, 2004. Of the $78,949 increase, approximately $60 million came from
CNB and $15 million from FNB.
Liquidity and Capital Resources
Net cash provided by operating activities was $10,862 for the period
ended June 30, 2004, which compares to $6,619 for the same period the previous
year. Included in this segment of the cash flow statement is a change in other
assets of $7,619.
Net cash used in investing activities was $33,218 provided for the
period ended June 30, 2004, and $19,369 used for the period ended June 30, 2003.
Net cash used in financing activities was $76,265 for the period ending
June 30, 2004. The substantial changes in cash used in investing activities and
cash provided by financing activities are due to the CNB and FNB transactions.
Included in the supplemental cash flow data is interest paid on
deposits, which declined substantially when the periods June 30, 2004 and June
25
30, 2003 are compared. The decrease is due to a decline in interest expense due
to the lower interest rate environment.
The Company has other available sources of liquidity. They include lines
of credit with a correspondent bank, advances from the Federal Home Loan Bank,
and Federal Reserve Bank discount window borrowings.
Management is unaware of any commitment that would have a material and
adverse effect on liquidity at June 30, 2004.
Total shareholders' equity grew by $789 from December 31, 2003 to June
30, 2004. Earnings net of the change in unrealized gains and losses for
securities available for sale and dividends paid accounted for most of the
increase. Stock options exercised provided $123. The Tier I and Tier II
risk-based capital ratios at June 30, 2004 were 11.62% and 12.69%, respectively.
Derivatives
The Company is not a party to derivative financial instruments with
off-balance sheet risks such as futures, forwards, swaps and options. The
Company is a party to financial instruments with off-balance sheet risks such as
commitments to extend credit, standby letters of credit, and recourse
obligations in the normal course of business to meet the financing needs of its
customers. Management does not plan any future involvement in high- risk
derivative products. The Company has investments in collateralized mortgage
obligations, structured notes and other similar instruments that are included in
securities available for sale and securities held to maturity. The fair value of
these investments at June 30, 2004 was approximately $2,877. Amortized cost for
these securities was approximately $2,743.
Management Discussion and Analysis of the Financial Condition and results of
operations for the three months ended June 30,2004.
Performance Summary
The following table shows NBI's performance ratios for the three months ended
June 30,2004 and June 30,2003
June 30,2004 June 30,2003
- ------------------------------------------- ----------------- ----------------
Return on Average Assets 1.62% 1.60%
- ------------------------------------------- ----------------- ----------------
Return on Average Equity 14.23% 14.57%
- ------------------------------------------- ----------------- ----------------
Net Interest Margin 4.70% 4.72%
- ------------------------------------------- ----------------- ----------------
Basic Net Earnings per Share $0.84 $0.80
- ------------------------------------------- ----------------- ----------------
Fully diluted Net Earnings per Share $0.83 $0.79
- ------------------------------------------- ----------------- ----------------
As can be seen by the above data, these key indicators have been relatively
stable. The return on equity has declined slightly. Earnings per share data
reflects the continued growth in net income.
Following is a comparison of quarter-to-date daily averages for related
categories.
June 30,2004 June 30,2003
- ------------------- ---------------- -----------------
Securities $249,375 $228,010
- ------------------- ---------------- -----------------
Loans, net 421,679 407,415
- ------------------- ---------------- -----------------
Deposits 642,838 620,838
- ------------------- ---------------- -----------------
Total Assets 728,378 700,575
- ------------------- ---------------- -----------------
As can be seen by the above data, the Company has experienced solid growth when
the two quarters are compared. Much of the growth experienced was due to the
acquisition of the FNB branch loans and deposits by the company's BTC affiliate
that was completed in April of 2004. The CNB transaction occurred very late in
26
the second quarter, and it therfore had a much lesser effect on the quarterly
averages. The quarterly average for the upcoming third quarter will more
accurately reflect the impact of that transaction.
Net Income
Net income for the second quarter of 2004 was $2,936 compared to $2,801
for the same period in 2003. This result is a $0.04 increase in Basic Earnings
per Share.
While the FNB transaction had a small unquantifiable effect upon net
income in the second quarter of 2004, the CNB transaction, completed late in the
quarter, had virtually no effect.
Net Interest Income
Net interest income rose by $218 when the second quarter of 2004 and
2003 are compared. Overall interest income declined by $379, while deposit
expenses decreased by $597. The ongoing effect of the low interest rate
environment is apparent. (Previous comments in the discussion of year-to-date
"Net Interest Income" section apply.)
Provision for Loan Losses
The provision for loan losses was down $98 when the two periods are
compared.
Noninterest Income
Overall noninterest income increased by $177 or 11.77%. Areas
experiencing the greatest changes are as follows:
o Service charges on deposits, increased $88
o Credit Care Processing, increased $48
o Trust Income, increased $77
General comments made in the year-to-date discussion apply. There were
no material non-routine items in the second quarter of 2004.
Noninterest Expense
Overall non-interest expense grew by $346 when June 30, 2004 and
June 30, 2003 are compared. Three areas with the greatest increases follow:
o Salaries and employee benefits, increased $214
o Credit Card processing, increased $ 50
o OREO expense, increased $ 40
General comments made pertaining to salaries and employee benefits made
in the year-to-date discussion apply here. In addition, the CNB purchase and
assumption transaction affected this catergory.
Nearly all of CNB's employees were hired by the Company's NBB affiliate.
This resulted in approximately $35 in additional salaries and employee benefits
expense in the second quarter of 2004.
General comments related to credit card processing in the year-to-date
discussion apply. There were no material reportable non-routine transactions.
OREO expense is up. See the year-to-date discussion for additional
comments.
27
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company considers interest rate risk to be a significant market risk
and has systems in place to measure the exposure of net interest income to
adverse movement in interest rates. Interest rate shock analyses provide
management with an indication of potential economic loss due to future rate
changes. There have not been any changes, which would significantly alter the
results disclosed as of December 31, 2003.
(See the comments and other data under "Interest Rate Sensitivity.")
Item 4. Controls and Procedures
Under the supervision and with the participation of management,
including our principal executive officer and principal financial officer, we
have evaluated the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this report.
Based on that evaluation, our principal executive officer and principal
financial officer have concluded that these controls and procedures are
effective. There were no significant changes in our internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation.
Disclosure controls and procedures are our controls and procedures that
are designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate, to allow timely decisions regarding
required disclosure.
Part II
Other Information
Item 1 Legal Proceedings
None for the six months ended une 30, 2004.
Item 2 Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
On May 12, 2004 the Company's Board of Directors approved a
common stock repurchase plan (the Plan). Under the terms of the
Plan, management isauthorized to purchase in the open market
through a stockbroker at such time or times as management deems
to be advantageous to the Company and its stockholders the
number of shares deemed appropriate, with a total value not to
exceed $1 million. The Plan extends to May 31, 2005. No shares
of common stock were repurchased in the quarter ended June 30,
2004.
Item 3 Defaults upon Senior Securities
None for the six months ended June 30, 2004.
Item 4. Submission of Matters to a Vote of Security Holders
Three Class 2 Directors of the Company were elected by a
vote of the security holders for a term of three years
each.
(a) This matter was submitted to a vote at the Company's
Annual Meeting of Stockholders held on April 13, 2004.
28
(b) The name of each director elected at the meeting
follows:
Jack M. Lewis
James G. Rakes
Jeffrey R. Stewart
The name of each director whose term of office continued
after the meeting is listed:
L. Allen Bowman James A. Deskins, Sr. Paul A. Duncan
Mary G. Miller William T. Peery James M. Shuler
(c) The number of votes cast for or against each nominee
is provided below. There were no abstaining votes and no
broker non-votes.
Election of Directors
------------------------- ---------------------- ---------------------
Director Votes For Votes Against
------------------------- ---------------------- ---------------------
Jack M. Lewis 2,833,951 6,604
------------------------- ---------------------- ---------------------
James G. Rakes 2,833,718 6,837
------------------------- ---------------------- ---------------------
Jeffrey R. Stewart 2,825,115 15,440
------------------------- ---------------------- ---------------------
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
Form 8-K dated April 14, 2004 - Press release announcing
earnings for the first quarter of 2004, incorporated herein
by reference.
Form 8-K dated May 13, 2004 - Press release announcing that
the Board of Directors of National Bankshares, Inc. had
authorized the repurchase of up to $1 million of the
Company's common stock until May 31, 2005, incorporated
herein by reference.
Form 8-K dated June 28, 2004 - Press release announcing the
June 25, 2004 completion by the Company's NBB subsidiary of
the purchase of substantially all of the assets and the
assumption of all of the liabilities of Community National
Bank of Pulaski, Virginia, incorporated herein by
reference.
29
Signatures
National Bankshares, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
DATE: August 9, 2004 NATIONAL BANKSHARES, INC.
/s/ JAMES G. RAKES
----------------------
James G. Rakes
Chief Executive Officer
/s/ J. ROBERT BUCHANAN
-----------------------
J. Robert Buchanan
Chief Financial Officer
(1) Index of Exhibits
Page No. in
Exhibit No. Description Sequential System
- ----------- ----------- -----------------
3(i) Articles of Incorporation, as amended, of National (incorporated herein by
Bankshares, Inc. reference to Exhibit 3(a)
of the Annual Report on
Form 10-K for fiscal year
ended December 31, 1993)
3(i) Articles of Amendment to Articles of Incorporation (incorporated herein by
of National Bankshares, Inc., dated reference to exhibit 3(i)
April 8, 2003. of The Annual Report on
Form 10-K for the fiscal
year ended December 31, 2003)
4(i) Specimen copy of certificate for National (incorporated herein by
Bankshares, Inc. common stock, $2.50 par value reference to Exhibit 4(a)
of the Annual Report on
Form 10-K for fiscal year
ended December 31, 1993)
4(i) Article Fourth of the Articles of Incorporation (incorporated herein by
of National Bankshares, Inc. included in reference to Exhibit 4(b)
Exhibit No. 3(a)) of the Annual Report on
Form 10-K for fiscal year
ended December 31, 1993)
10(ii)(B) Computer software license agreement dated (incorporated herein by
June 18, 1990, by and between Information reference to Exhibit 10(e)
Technology, Inc. and The National Bank of of the Annual Report on Form
Blacksburg 10-K for fiscal year ended
December 31, 1992)
*10(iii)(A) National Bankshares, Inc. 1999 Stock Option (incorporated herein by
Plan reference to Exhibit 4.3 of
the Form S-8, filed as
Registration No. 333-79979
with the Commission on June 4,
1999)
*10(iii)(A) Employment Agreement dated January 2002 between (incorporated herein by
National Bankshares, Inc. and James G. Rakes reference to Exhibit 10(iii)(A)
of Form 10-Q for the period
ended June 30, 2002)
30
*10(iii)(A) Employment Lease Agreement dated August 14, 2002, (incorporated herein by
between National Bankshares, Inc. and reference to Exhibit 10(iii)(A)
The National Bank of Blacksburg of form 10-Q for the period
ended September 30, 2002)
*10(iii)(A) Change in Control Agreement dated January 5, (incorporated herein by
2003, between National Bankshares, Inc. and reference to Exhibit 10 iii(A)
Marilyn B. Buhyoff of Form 10-K for the period
ended December 31, 2002)
*10(iii)(A) Change in Control Agreement dated January 8, (incorporated herein by
2003, between National Bankshares, Inc. and reference to Exhibit 10 iii(A)
F. Brad Denardo of Form 10-K for the period
ended December 31, 2002)
*10(iii)(A) Change in Control Agreement dated June 1, (incorporated herein by
1998, between Bank of Tazewell County and reference to Exhibit 10 iii(A)
Cameron L. Forester of Form 10-K for the period
ended December 31, 2002)
31(i) Section 302 Certification of Chief Page 32
Executive Officer
31(ii) Section 302 Certification of Chief Page 32
Financial Officer
32(i) 18 U.S.C. Section 1350 Certification of Chief Page 34
Executive Officer
32(ii) 18 U.S.C. Section 1350 Certification of Chief Page 34
Financial Officer
* Indicates a management contract or compensatory plan required to be filed
herein.
31