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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly Period Ended September 30, 2002

Commission File Number 0-14773

NATIONAL BANCSHARES CORPORATION

Registrant’s telephone number: (330) 682-1010

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 filing requirements for the past 90 days.

Yes   X  . No        .

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of November 1, 2002:

Common Stock, Without Par Value: 2,230,981 Shares Outstanding

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National Bancshares Corporation

Index

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NATIONAL BANCSHARES CORPORATION

See notes to consolidated financial statements

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NATIONAL BANCSHARES CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME (Unaudited)

See notes to consolidated financial statements

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NATIONAL BANCSHARES CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See notes to consolidated financial statements.

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National Bancshares Corporation

Note 1. Basis of Presentation

     The accompanying consolidated financial statements include the accounts of National Bancshares Corporation (the “Company”) and its wholly owned subsidiary, First National Bank, Orrville, Ohio (the “Bank”). All significant intercompany transactions and balances have been eliminated. The consolidated balance sheet as of September 30, 2002, the consolidated statements of income and comprehensive income for the three and nine month periods ended September 30, 2002 and 2001, and the consolidated statements of cash flows for the nine month periods ended September 30, 2002 and 2001 have been prepared by the Company without audit. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

     The consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q, but do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These statements should be read in conjunction with the consolidated financial statements and footnotes in the Company’s annual report on Form 10-K for the year ended December 31, 2001. Operating results for the nine months ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.

     To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, fair values of financial instruments and fair values of certain securities are particularly subject to change.

     The Company provides a broad range of financial services to individuals and companies in northern Ohio. While the Company’s chief decision makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Accordingly, all the Company’s banking operations are considered by management to be aggregated in one reportable operating segment.

     In January 2001, the Company adopted a new accounting standard, Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS No. 137 and 138. As a result, the Company transferred securities with an amortized cost of approximately $30.5 million and a fair value of approximately $30.7 million from the held to maturity to the available for sale category to allow hedging of those securities in the future if deemed beneficial. The transfer had a positive impact on the company’s other comprehensive income and shareholders’ equity, net of taxes, of approximately $134,000.

     In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, “Business Combinations”. SFAS No. 141 requires all business combinations within its scope to be accounted for using the purchase method, rather than the pooling-of-interests method. The provisions of this Statement apply to all business combinations initiated after June 30, 2001. The Company followed the provisions of this pronouncement in its acquisition discussed below.

     Also in June 2001, the FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets”, which addresses the accounting for such assets arising from prior and future business combinations. Upon the adoption of this Statement, goodwill arising from business combinations is no longer amortized, but rather is assessed regularly for impairment, with any such impairment recognized as a reduction to earnings in the period identified. Other identified intangible assets, such as core deposit intangible assets, continue to be amortized over their estimated useful lives. The Company adopted this Statement on January 1, 2002. The Company’s intangible assets relating to branch purchases are continuing to be amortized as before.

     A new accounting standard, SFAS No. 143, dealing with asset retirement obligations will apply for 2003. The Company has not yet determined whether this standard will have a material affect on its financial position or results of operations.

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     Effective January 1, 2002, the Company adopted a new standard, SFAS No. 144, issued by the FASB on impairment and disposal of long-lived assets. The effect of this on the financial position and results of operations of the Company is not expected to be material.

     The FASB recently issued SFAS No. 145 and 146. SFAS No. 145 covers debt extinguishments and leases, and made some minor technical corrections. Gains and losses on extinguishments of debt, always treated as an extraordinary item under a previous standard, will now no longer be considered extraordinary, except under very limited conditions. If a capital lease is modified to an operating, than it will now be treated as a sale-leaseback instead of a new lease. SFAS No. 146 covers accounting for costs associated with exit or disposal activities, such as lease termination costs or employee severance costs. The Statement replaces EITF 94-3, and is to be applied prospectively to exit or disposal activities initiated after December 31, 2002. It requires these costs to be recognized when they are incurred rather than at the date of commitment to an exit or disposal plan. Management does not expect the adoption of these statements to be material.

     In October 2002, the FASB issued SFAS No. 147, “Acquisitions of Certain Financial Institutions,” which amends and reconsiders certain provisions of SFAS No. 72. This statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution. The statement provides that unidentified intangible assets associated with branch acquisitions, considered a business combination under the provisions of SFAS No. 141, “Business Combinations,” should be reclassified as goodwill and accounted for under the provisions of SFAS No. 142. The Company adopted this Statement on October 1, 2002. The effect of this Statement on the financial position and results of operations of the Company is not expected to be material.

Note 2. Acquisition

     On October 2, 2001, the Company entered into an Agreement and Plan of Merger to acquire Peoples Financial Corporation, located in Massillon, Ohio. Peoples Federal Savings and Loan Association, the wholly-owned subsidiary of Peoples Financial Corporation (Peoples Financial), was merged into First National Bank, Orrville, the wholly-owned subsidiary of the Company. Under the terms of the agreement, the Company paid $12.25 in cash for each of the 1,234,085 outstanding shares of Peoples Financial. The aggregate transaction value was $15.1 million. The merger was consummated on April 3, 2002 and was accounted for as a purchase. As such, Peoples Financial Corporation’s results of operations from the effective date of the acquisition are included in the Company’s 2002 financial statements. The merger provides the Company with an opportunity to expand into an adjacent and attractive market area.

     The following table summarizes the estimated fair values of the assets acquired and liabilities assumed. At April 3, 2002

($000s)

     The core deposit intangibles have a weighted average useful life of 10 years and the amortization is not tax deductible. The goodwill of $5,474,000 represents the acquisition cost in excess of book value of $5,832,000, less adjustment to reflect fair values of $674,000, plus merger related expenses of $316,000. Management is reviewing the possibility of allocating other identified intangible assets.

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     Below is a listing of the purchase accounting adjustments, which are included in the above fair values, including their estimated lives and amortization methods. These adjustments increased (decreased) the reported book values of the assets and liabilities acquired.

($000s)

     The following summarized unaudited pro forma financial information for the periods ended September 30, 2002 and 2001 assume the Peoples Financial Corporation acquisition occurred as of January 1, 2001. The September 30, 2002 financial information includes approximately $900 thousand in merger related expenses incurred by Peoples Financial Corporation.

Note 3. Federal Home Loan Bank Advances

Advances from the Federal Home Bank (FHLB) were as follows:
In thousands

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     FORWARD-LOOKING INFORMATION

     The Company cautions that any forward-looking statements contained in this report, in a report incorporated by reference to this report or made by management of the Company, involve risk and uncertainties, and are subject to change based on various important factors. When used herein, the terms “anticipates,” “plans,” “expects,” “believes,” and similar expressions as they relate to the Company or its management are intended to identify such forward looking statements. Actual results could differ materially from those expressed or implied. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations, and rapidly changing technology affecting financial services. Additionally, the Company claims no notification responsibilities should their opinions change from those expressed herein.

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     FINANCIAL CONDITION

     Balance Sheets

     Total assets increased $94.0 million or 47.5% from 12/31/01 principally due to the acquisition of Peoples Financial Corporation. Federal funds sold increased $5.8 million or 173.1% due mainly to the growth in deposits and other borrowings. Total securities declined $2.2 million or 3.6% from 12/31/01 to support loan demand. Net loans increased $78.2 million or 66.9% mainly due to the acquisition noted above. Commercial loans increased $11.5 million or 22.7% and real estate mortgages increased $67.7 million or 112.5%, while installment loans decreased $0.4 million or 5.6%. Goodwill increased $5.5 million and other assets (which includes core deposit intangible of $1.0 million) increased $1.0 million mainly due to the acquisition.

     The carrying amounts and estimated fair values of securities are summarized as follows:

The activity in the allowance for loan losses for the first nine months of 2002 and 2001 was as follows:

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     The allowance for loan losses is a valuation allowance for probable credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. The allowance is maintained at a level that is considered adequate to absorb all estimated losses. Management estimates the allowance balance required using the following methodology. All problem, past due and non-performing loans are closely monitored and analyzed by management on a regular basis. Management assigns a classification rating to these loans based on information about specific borrower situations and estimated collateral values. Management determines the loss that exists on each significant problem, past due and non-performing loan. Other past due loans that are not analyzed individually are pooled and evaluated by loan type. The probable loss that exists on past due loans is estimated using past loan loss experience. All other loans are pooled by loan type and evaluated based upon past loan loss experience. National and local economic conditions and other factors are also considered in determining an adequate level for the allowance for loan losses. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Management reviews the allowance for loan losses on a regular basis to determine the adequacy of the reserve.

     During 2002, management allocated additional funds to the loan loss specific reserves due mainly to one large impaired commercial loan. The impaired commercial loan has an outstanding balance of approximately $1.6 million. Based upon an analysis of the present value of future payments on the loan and the estimated market value of collateral, net of liens and other costs, management determined that approximately $1.1 million in specific reserves was required on this loan. On December 31, 2001 this loan had a specific reserve of $750 thousand. The estimated reserve amount on this loan may increase or decrease based upon future events. Management has established a workout payment plan with this customer. The customer is performing as agreed and the loan is not past due. The provision of $140 thousand for the nine months ended 9/30/02 is primarily due to the impaired commercial loan discussed above. This compares to a $40 thousand provision for the same period in 2001. The increased allocation discussed above for 2002 was offset by a decrease in other specific reserves.

     The allowance for loan losses to total loans outstanding was .85% for September 30, 2002 compared to 1.12% for December 31, 2001. The ratio was impacted by the acquisition of Peoples Financial Corporation. Their loan portfolio consisted mainly of one-to-four family real estate mortgage loans, which carry substantially less risk than other types of loans. On an annualized basis, net charge-offs to total average loans were .02% for the first nine months of 2002 and .07% for the first nine months of 2001. The ratio of non-performing loans to total loans was .16% ($310,138) for September 30, 2002 compared to .22% ($258,778) for December 31, 2001. Non-performing loans consist of loans that have been placed on nonaccrual status.

Impaired loans at September 30, 2002 and December 31, 2001 were as follows:

     A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

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     Total deposits increased $73.6 million or approximately 46.2% from 12/31/01, mainly due to the acquisition of Peoples Financial Corporation. Non-interest bearing demand accounts increased 15.0%, savings and N.O.W. accounts increased 37.2% and time deposits increased 76.4%. Time deposit balances are affected by the interest rates offered by competitors in our market area. Securities sold under repurchase agreements increased $0.2 million from 12/31/01. The Federal Reserve note account increased $0.9 million and Federal Home Loan Bank advances increased $15.3 million due to the acquisition. Other liabilities increased $1.5 million or 130.2% mainly due to an increase in deferred taxes related to unrealized gains on available for sale securities. Total shareholders’ equity increased $2.5 million or 8.0% from 12/31/01.

     Statements of Cash Flows

     Net cash from operating activities for the first nine months of 2002 was $1.5 million compared to $3.4 million for the first nine months of 2001. The decrease was due primarily to proceeds from the sale of loans in 2001 and related changes in other assets and other liabilities. Net cash from investing activities for the first nine months of 2002 was $11.2 million, compared to ($1.6) million for the first nine months of 2001. The increase was due primarily to a decrease in securities purchases and the net change in loans to customers. Net cash from financing activities was ($4.1) million for the first nine months of 2002 compared to ($3.6) million for the first nine months of 2001. The change was primarily due to the net change in demand and savings accounts, offset by declines in time deposits and repayments on Federal Home Loan Bank advances. Total cash and cash equivalents increased $8.6 million during the first nine months of 2002. With total cash and cash equivalents of $18.9 million as of 9/30/02, the Company’s liquidity ratios continue to remain favorable.

     Analysis of Equity

     The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. The following is a summary of the actual and required regulatory capital amounts and ratios.

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