Cardinal Bankshares (CDBK) 10-Q 2010 Q3 Quarterly report

U. S. SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

Commission File No. 0-28780

CARDINAL BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

Virginia	54-1804471
(State of Incorporation)	(I.R.S. Employer Identification No.)

101 Jacksonville Circle, P. O. Box 215, Floyd, Virginia 24091

(Address of principal executive offices)

(540) 745-4191

(Registrant’s telephone number)

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 by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨.    No  ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. (Check one):

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨.    No  x.

The number of shares outstanding of the issuer’s Common Stock, $9 par value as of November 10, 2010 was 1,535,733.

CARDINAL BANKSHARES CORPORATION

FORM 10-Q

September 30, 2010

INDEX

		Page
Part I.	Financial Information
Item 1.	Consolidated Balance Sheets as of September 30, 2010 (Unaudited) and December 31, 2009 (Audited)		3
	Consolidated Statements of Income for the three months and nine months ended September 30, 2010 and 2009 (Unaudited)		4
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009 (Unaudited)		5
	Notes to Consolidated Statements (Unaudited)		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		14
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		18
Item 4T.	Controls and Procedures		18
Part II.	Other Information
Item 1.	Legal Proceedings		19
Item 1A.	Risk Factors		19
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		19
Item 3.	Defaults Upon Senior Securities		19
Item 4.	Removed and Reserved		19
Item 5.	Other Information		19
Item 6.	Exhibits		19
SIGNATURES			20
CERTIFICATIONS			21

Cardinal Bankshares Corporation and Subsidiary

Consolidated Balance Sheets

	(UnAudited)			(Audited)
	September 30,			December 31,
(In thousands, except share data)	2010			2009
Assets
Cash and due from banks	$	3,582		$	3,498
Interest-bearing deposits		9,488			184
Federal funds sold		20,200			22,175
Investment securities available for sale, at fair value		39,706			36,684
Investment securities held to maturity (fair value September 30, 2010 $14,975 - December 31, 2009 $16,069)		14,408			15,864
Restricted equity securities		575			575
Total loans		151,017			150,081
Allowance for loan losses		(2,772	)		(2,670	)
Net loans		148,245			147,411
Bank premises and equipment, net		3,904			3,792
Accrued interest receivable		879			1,031
Foreclosed assets		509			261
Bank owned life insurance		5,238			5,115
Other assets		2,442			2,820
Total assets	$	249,176		$	239,410
Liabilities and Stockholders’ Equity
Noninterest-bearing deposits	$	28,791		$	27,294
Interest-bearing deposits		188,003			180,907
Total deposits		216,794			208,201
Accrued interest payable		151			143
Other liabilities		287			358
Total liabilities		217,232			208,702
Commitments and contingent liabilities		—			—
Stockholders’ Equity
Common stock, $10 par value, 5,000,000 shares authorized, 1,535,733 shares issued and outstanding		15,357			15,357
Additional paid-in capital		2,925			2,925
Retained earnings		13,422			12,716
Accumulated other comprehensive gain (loss), net		240			(290	)
Total stockholders’ equity		31,944			30,708
Total liabilities and stockholders’ equity	$	249,176		$	239,410

See Notes to Consolidated Financial Statements.

3

Cardinal Bankshares Corporation and Subsidiary

Consolidated Statements of Income (Unaudited)

	Three months ended September 30,					Nine months ended September 30,
(In thousands, except share data)	2010		2009			2010		2009
Interest income
Loans and fees on loans	$	2,217	$	2,306		$	6,611	$	6,644
Federal funds sold and securities purchased under agreements to resell		11		13			33		37
Investment securities:
Taxable		321		263			971		880
Exempt from federal income tax		177		187			550		579
Deposits with banks		2		—			3		2
Total interest income		2,728		2,769			8,168		8,142
Interest expense
Deposits		1,109		1,251			3,352		3,827
Total interest expense		1,109		1,251			3,352		3,827
Net interest income		1,619		1,518			4,816		4,315
Provision for loan losses		90		446			361		576
Net interest income after provision for loan losses		1,529		1,072			4,455		3,739
Noninterest income
Service charges on deposit accounts		48		48			145		134
Other service charges and fees		27		29			97		85
Net Realized gains on sales of securities		—		27			98		50
Other operating income		67		84			198		232
Total noninterest income		142		188			538		501
Noninterest expense
Salaries and employee benefits		836		892			2,378		2,602
Occupancy and equipment		186		171			517		495
Foreclosed Assets, Net		48		—			51		—
Other operating expense		361		323			1,182		1,139
Total noninterest expense		1,431		1,386			4,128		4,236
Income before income taxes		240		(126	)		865		4
Income tax expense (benefit)		2		(132	)		36		(276	)
Net Income	$	238	$	6		$	829	$	280
Basic earnings per share	$	0.16	$	—		$	0.54	$	0.18
Diluted earnings per share	$	0.16	$	—		$	0.54	$	0.18
Dividends declared per share	$	—	$	—		$	0.08	$	0.08
Weighted average basic shares outstanding		1,535,733		1,535,733			1,535,733		1,535,733
Weighted average diluted shares outstanding		1,535,733		1,535,733			1,535,733		1,535,733

See Notes to Consolidated Financial Statements.

4

Cardinal Bankshares Corporation and Subsidiary

Consolidated Statements of Cash Flows (Unaudited)

(In thousands) Nine Months Ended September 30,	2010			2009
Cash flows from operating activities
Net income	$	829		$	280
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		191			219
Accretion of discounts on securities, net of amortization of premiums		290			54
Provision for loan losses		361			576
Net realized (gains) losses on investment securities		(98	)		(50	)
Net realized (gains) losses on sale of foreclosed assets		69			(5	)
Deferred compensation and pension expense		—			—
Changes in operating assets and liabilities:
Accrued income		152			187
Other assets		(16	)		(417	)
Accrued interest payable		8			(37	)
Other liabilities		(71	)		(204	)
Net cash provided by operating activities		1,715			603
Cash flows from investing activities
Net decrease in interest-bearing deposits in banks		(9,304	)		(257	)
Net (increase) decrease in federal funds sold		1,975			(7,300	)
Purchases of available for sale securities		(15,683	)		(12,584	)
Sales of available for sale securities		983			1,988
Maturities, calls and paydowns of available for sale securities		12,293			11,698
Purchases of held to maturity securities		(1,306	)		(1,209	)
Maturities, calls and paydowns of held to maturity securities		2,756			2,411
Call (purchase) of restricted equity securities		—			(41	)
Proceeds from the sale of foreclosed properties		120			146
Net increase in loans		(1,632	)		(7,087	)
Net purchases of bank premises and equipment		(303	)		(66	)
Net cash used by investing activities		(10,101	)		(12,301	)
Cash flows from financing activities
Net increase (decrease) in noninterest-bearing deposits		1,497			(266	)
Net increase in interest-bearing deposits		7,096			12,294
Dividends Paid		(123	)		(123	)
Net cash provided by financing activities		8,470			11,905
Net increase (decrease) in cash and cash equivalents		84			207
Cash and cash equivalents, beginning		3,498			3,299
Cash and cash equivalents, ending	$	3,582		$	3,506
Supplemental disclosures of cash flow information
Interest paid	$	3,344		$	3,864
Income taxes paid	$	251		$	14
Supplemental disclosures of noncash activities
Other real estate acquired in settlement of loans	$	437		$	123

See Notes to Consolidated Financial Statements.

5

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all of the disclosures and notes required by generally accepted accounting principles. In the opinion of management, all material adjustments (which are of a normal recurring nature) considered necessary for a fair presentation have been made. The results for the interim period are not necessarily indicative of the results to be expected for the entire year or any other interim period. The information reported herein should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. Certain previously reported amounts have been reclassified to conform to current presentations.

Principles of Consolidation

The consolidated financial statements of the Company include the accounts of the Company, the Bank and FBC, Inc. All material intercompany transactions and balances have been eliminated.

Cash and Cash Equivalents

For purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption “cash and due from banks”.

Subsequent Events

In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure through the date the financial statements were issued.

Note 2. Allowance for Loan Losses

Changes in the allowance for loan losses are as follows:

Nine months ended September 30, (In thousands)	2010			2009
Balance, at January 1	$	2,670		$	1,659
Provision charged to expense		361			576
Recoveries of amounts previously charged off		8			10
Loans charged off		(267	)		(85	)
Balance, at September 30,	$	2,772		$	2,160

Note 3. Commitments and Contingencies

The Company’s exposure to credit loss in the event of nonperformance by the other party for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as for on-balance sheet instruments. A summary of the Company’s commitments at September 30 for the years indicated follows:

(In thousands)	2010		2009
Commitments to extend credit	$	9,875	$	22,783
Standby letters of credit		629		924
Total	$	10,504	$	23,707

6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 4. Employee Benefit Plan

The Bank has a qualified noncontributory, defined benefit pension plan, which covers substantially all of its employees. Effective October 1, 2009 the Bank terminated its single employer plan with the Virginia Bankers Association (VBA). In conjunction with this transaction, the Bank adopted the Pentegra Defined Benefit Plan for Financial Institutions (Pentegra), a multiemployer plan. All plan assets and liabilities were transferred from the VBA plan to the Pentegra Plan. GAAP states the determining factor for recording pension expense or a liability for employers participating in a multiemployer plan is the amount of the contribution required for the period. The benefits are primarily based on years of service and earnings. The following is a summary of the components of the net periodic benefit cost.

Three months ended September 30, (In thousands)	2009
Service cost	$	45,145
Interest cost		52,772
Expected return on plan assets		(37,197	)
Amortization of net obligation at transition		(757	)
Amortization of prior service cost		1,495
Recognized net actuarial loss		11,250
Net periodic benefit cost	$	72,708
Nine months ended September 30, (In thousands)	2009
Service cost	$	135,435
Interest cost		158,316
Expected return on plan assets		(111,591	)
Amortization of net obligation at transition		(2,271	)
Amortization of prior service cost		4,485
Recognized net actuarial loss		33,750
Net periodic benefit cost	$	218,124

As of September 30, 2010, the required employer contribution for the year of $127,452 has been made.

Note 5. Fair Value

The estimated fair values of the Company’s financial instruments are as follows:

(In thousands)	September 30, 2010				December 31, 2009
	Carrying		Fair		Carrying		Fair
	Amount		Value		Amount		Value
Financial assets
Cash and due from banks	$	3,582	$	3,582	$	3,498	$	3,498
Interest-bearing deposits with banks		9,488		9,488		184		184
Federal funds sold		20,200		20,200		22,175		22,175
Securities, available for sale		39,706		39,706		36,684		36,684
Securities, held to maturity		14,408		14,975		15,864		16,069
Restricted equity securities		575		575		575		575
Total loans		151,017		154,207		150,081		150,647
Accrued interest receivable		879		879		1,031		1,031
Financial liabilities
Deposits		216,794		218,286		208,201		210,364
Accrued interest payable		151		151		143		143
Off-balance sheet assets (liabilities)
Commitments to extend credit and standby letter of credit		—		—		—		—

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 5. Fair Value (continued)

Generally accepted accounting principles (“GAAP”) provides a framework for measuring and disclosing fair value of assets and liabilities recognized in the balance sheet, whether the measurements are made on a recurring basis (for example, available for sale investment securities) or on a nonrecurring basis (for example, impaired loans).

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.

Fair Value Hierarchy

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine the fair value. These levels are:

Level 1	-	Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2	-	Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3	-	Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques.

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value:

Investment Securities Available for Sale

Investment securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage backed securities issued by government sponsored entities, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 5. Fair Value (continued)

Loans

The Company does not record loans at fair value on a recurring basis, however, from time to time, a loan is considered impaired and an allowance for loan loss is established. Loans for which it is probable that payment of interest and principle will not be made in accordance with the contractual terms of the loan are considered impaired. Once a loan is identified as individually impaired, management measures impairment. The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represents loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observerable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3.

Foreclosed Assets

Foreclosed assets are adjusted for fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised value of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset at nonrecurring Level 3.

Assets and Liabilities Recorded as Fair Value on a Recurring Basis

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.

(In Thousands)
September 30, 2010	Total		Level 1		Level 2		Level 3
Government sponsored enterprises	$	2,917	$	—	$	2,917	$	—
State and municipal securities		3,173		—		3,173		—
Mortgage-backed securities		29,772		—		29,772		—
Other securities		3,844		—		3,844		—
Investment securities available for sale	$	39,706	$	—	$	39,706	$	—
Total assets at fair value	$	39,706	$	—	$	39,706	$	—
(In Thousands)
December 31, 2009	Total		Level 1		Level 2		Level 3
Government sponsored enterprises	$	4,875	$	2,993	$	1,882	$	—
State and municipal securities		2,697		—		2,697		—
Mortgage-backed securities		25,646		1,047		24,599		—
Other securities		3,466		—		3,466		—
Investment securities available for sale	$	36,684	$	4,040	$	32,644	$	—
Total assets at fair value	$	36,684	$	4,040	$	32,644	$	—

There were no liabilities measured at fair value on a recurring basis at September 30, 2010 and December 31, 2009.

9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Assets and Liabilities Recorded as Fair Value on a Nonrecurring Basis

The Company may be required from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with U. S generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included in the table below:

(In Thousands)
September 30, 2010	Total		Level 1		Level 2		Level 3
Commerical	$	140	$	—	$	140	$	—
Real Estate
Construction and land development		3,676		—		3,676		—
Residential, 1-4 families		129		—		129		—
Nonfarm, nonresidential		655		—		655		—
Impaired Loans	$	4,600		—	$	4,600	$	—
Foreclosed assets		509		—		509		—
Total assets at fair value	$	5,109	$	—	$	5,109	$	—
(In Thousands)
December 31, 2009	Total		Level 1		Level 2		Level 3
Commerical	$	96	$	—	$	96	$	—
Real Estate
Construction and land development		3,572		—		3,572		—
Residential, 1-4 families		213		—		213		—
Nonfarm, nonresidential		772		—		772		—
Impaired Loans	$	4,653		—	$	4,653	$	—
Foreclosed assets		261		—		261		—
Total assets at fair value	$	4,914	$	—	$	4,914	$	—

There were no liabilities measured at fair value on a nonrecurring basis at September 30, 2010 and December 31, 2009.

10

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 6. Securities

Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent. The carrying amount of securities and their approximate fair values follow:

September 30, 2010 (In thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Available for sale
Government sponsored enterprises	$	2,860	$	57	$	—		$	2,917
State and municipal securities		2,993		180		—			3,173
Mortgage-backed securities		29,427		471		(126	)		29,772
Other securities		4,062		10		(228	)		3,844
	$	39,342	$	718	$	(354	)	$	39,706
Held to maturity
State and municipal securities	$	14,381	$	580	$	(13	)	$	14,948
Mortgage-backed securities		27		—		—			27
	$	14,408	$	580	$	(13	)	$	14,975
December 31, 2009 (In thousands)
Available for sale
Government sponsored enterprises	$	4,908	$	2	$	(35	)	$	4,875
State and municipal securities		2,661		55		(19	)		2,697
Mortgage-backed securities		25,500		281		(135	)		25,646
Other securities		4,056		—		(590	)		3,466
	$	37,125	$	338	$	(779	)	$	36,684
Held to maturity
State and municipal securities	$	15,834	$	364	$	(159	)	$	16,039
Mortgage-backed securities		30		—		—			30
	$	15,864	$	364	$	(159	)	$	16,069

Restricted equity securities, carried at cost, consist of investments in stock of the Federal Home Loan Bank of Atlanta (“FHLB”) and The Federal Reserve Bank of Richmond (Federal Reserve), which are upstream correspondents of the Bank. The FHLB requires financial institutions to make equity investments in the FHLB in order to borrow from it. The Bank is required to hold that stock so long as it borrows from the FHLB. The Federal Reserve requires banks to purchase stock as a condition of membership in the Federal Reserve system.

Investment securities with amortized cost of approximately $7.1 million and $8.4 million at September 30, 2010 and December 31, 2009, respectively, were pledged as collateral on public deposits and for other purposes as required or permitted by law.

Gross realized gains and losses for the three and nine-month periods ended September 30, 2010 and 2009:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2010		2009		2010		2009
(In thousands)
Realized gains, available for sale securities	$	—	$	27	$	94	$	48
Realized gains, held to maturity securities		—		—		4		2
	$	94	$	27	$	98	$	50

11

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 6. Securities (continued)

The scheduled maturities of debt securities available for sale and held to maturity at September 30, 2010 were as follows:

	Available for Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
(In thousands)
Due in one year or less	$	302	$	307	$	625 $		633
Due after one year through five years		925		867		5,727		5,970
Due after five years through ten years		3,301		3,335		3,670		3,849
Due after ten years		34,814		35,197		4,386		4,523
	$	39,342	$	39,706	$	14,408	$	14,975

For mortgage-backed securities, the Company reports maturities based on anticipated lives. Actual results may differ due to interest rate fluctuations.

The following tables show the unrealized losses and related fair values in the Company’s held to maturity and available for sale investment securities portfolios. This information is aggregated by investment category and by the length of time that individual securities have been in a continuous unrealized loss position at September 30, 2010 and December 31, 2009 respectively.

	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
September 30, 2010 (In thousands)	Value		Losses			Value		Losses			Value		Losses
Government sponsored enterprises	$	—	$	—		$	—	$	—		$	—	$	—
State and municipal securities		—		—			425		(13	)		425		(13	)
Mortgage- backed securities		8,042		(124	)		715		(2	)		8,757		(126	)
Other Securities		512		(1	)		1,784		(227	)		2,296		(228	)
Total temporarily impaired securities	$	8,554	$	(125	)	$	2,924	$	(242	)	$	11,478	$	(367	)

	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
December 31, 2009 (In thousands)	Value		Losses			Value		Losses			Value		Losses
Government sponsored enterprises	$	4,232	$	(35	)	$	—	$	—		$	4,232	$	(35	)
State and municipal securities		3,291		(94	)		726		(84	)		4,017		(178	)
Mortgage- backed securities		5,544		(77	)		1,393		(58	)		6,937		(135	)
Other Securities		295		—			2,670		(590	)		2,965		(590	)
Total temporarily impaired securities	$	13,362	$	(206	)	$	4,789	$	(732	)	$	18,151	$	(938	)

Management considers the nature of the investment, the underlying causes of the decline in market or fair value, the severity and duration of the decline and other evidence, on a security-by-security basis, in determining if the decline in fair value is other than temporary.

At September 30, 2010 the Company had 1 state and municipal securities with an aggregate unrealized loss of approximately $13 thousand, 20 mortgaged-backed securities with an aggregate unrealized loss of approximately $126 thousand and 6 other securities with an aggregate unrealized loss of approximately $228 thousand. Management does not believe that gross unrealized losses, which totals 3.10% of the amortized costs of the related investment securities, represent an other-than-temporary impairment. The Company has both the ability and the intent to hold all of these securities for a period of time necessary to recover the amortized cost.

At December 31, 2009, the Company had 5 government-sponsored securities with an aggregate unrealized loss of approximately $35 thousand, 11 state and municipal securities with an aggregate unrealized loss of approximately $178 thousand, 12 mortgaged-backed securities with an aggregate unrealized loss of approximately $135 thousand and 8 other securities with an aggregate unrealized loss of approximately $590 thousand. Management does not believe that gross unrealized losses, which totals 4.91% of the amortized costs of the related investment securities, represent an other-than-temporary impairment.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 7. Recent Accounting Pronouncements

The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting and or disclosure of financial information by the Company.

In July 2010, the Financial Accounting Standards Board issued Accounting Standards Update 2010-20,Disclosures About the Credit Quality of Financing Receivables and the Allowance for Credit Loss. This Update is intended to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The amendments in this Update apply to all entities, both public and nonpublic. The amendments in this Update affect all entities with financing receivables, excluding short-term trade accounts receivable or receivables measured at fair value or lower of cost or fair value. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.

Reclassifications

Certain reclassifications have been made to the prior years’ financial statements to place them on a comparable basis with the current year. Net income and stockholders’ equity previously reported were not affected by these reclassifications.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cardinal Bankshares Corporation (the “Company” and “Cardinal Bankshares”), a Virginia corporation, is a bank holding company headquartered in Floyd, Virginia. The Company serves the marketplace primarily through its wholly owned banking subsidiary, Bank of Floyd (the “Bank”), a Virginia chartered, Federal Reserve member commercial bank. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) to the extent provided by law. Bank of Floyd is supervised and examined by the Federal Reserve and the Bureau of Financial Institutions of the State Corporation Commission of the Commonwealth of Virginia (the “SCC”). At September 30, 2010, the Bank operated seven branch facilities in the counties of Floyd, Montgomery, Roanoke, Pulaski and Carroll. The main office is in Floyd with a limited service office located in Willis. The Roanoke office is in the Cave Spring area of Roanoke County. The Salem office is located on West Main Street in Salem, Virginia. The Hillsville office is located in Carroll County. The Christiansburg office serves Montgomery County. The Bank’s Pulaski County office is located in the Fairlawn community.

Through Bank of Floyd’s network of banking facilities, Cardinal Bankshares provides a wide range of commercial banking services to individuals, small to medium-sized businesses, institutions and governments located in Virginia. The Company conducts substantially all of the business operations of a typical independent commercial bank, including the acceptance of checking and savings deposits, and the making of commercial, real estate, personal, home improvement, automobile and other installment loans. The Company also offers other related services, such as traveler’s checks, safe deposit boxes, depositor transfer, customer note payment, collection, notary public, escrow, drive-in and ATM facilities, and other customary banking services. Cardinal Bankshares does not offer trust services.

The following discussion provides information about the major components of the financial condition, results of operations, asset quality, liquidity, and capital resources of Cardinal Bankshares. The discussion and analysis should be read in conjunction with the Consolidated Financial Statements.

Critical Accounting Policy

Management believes the policy with respect to the methodology for the determination of the allowance for loan losses involve a high degree of complexity. Management must make difficult and subjective judgments, assumptions or estimates that could cause reported results to differ materially. This critical policy and its application are periodically reviewed with the Audit Committee and Board of Directors.

FINANCIAL CONDITION

Total assets as of September 30, 2010 were $249.2 million, an increase of 4.1% or $9.8 million from year-end 2009. Total loans increased .6% or $936 thousand during the first nine-months of this year to $151.0 million.

The investment securities portfolio reflected an increase of 3.0% or $1.6 million during the first nine months of the year. Federal funds sold decreased $2.0 million during the first nine months of the year. Interest-bearing deposits increased $9.3 million over year-end 2009 as a result of increased deposits.

As of September 30, 2010, total deposits were $216.8 million, up approximately 4.1% or $8.6 million compared to year-end 2009. Non-interest-bearing core deposits increased to $28.8 million as compared to $27.3 million at year-end 2009. Interest-bearing deposits increased 3.9% or $7.1 million to $188.0 million. Deposits greater than $100 thousand amounted to $65.8 million at September 30, 2010 as compared to $62.7 million at year-end 2009.

Stockholders’ equity was $31.9 million as of September 30, 2010 compared to $30.7 million as of December 31, 2009. Net income of $829 thousand for the period combined with an increase in accumulated other comprehensive gain of $530 thousand and dividends paid of $123 thousand accounted for the increase in stockholders’ equity.

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RESULTS OF OPERATIONS

Net income for the nine months ended September 30, 2010 was $829 thousand, an increase of 196.1% compared to $280 thousand for the nine months ended September 30, 2009. Net income for the three months ended September 30, 2010 was $238 thousand, and increase of 3,866.7% compared to $6 thousand for the three months ended September 30, 2009. Diluted earnings per share increased 300.0% to $.54 for the nine months ended September 30, 2010. Diluted earnings per share for the same period a year earlier was $.18. Diluted earnings per share increased $.16 for the three months ended September 30, 2010. Diluted earnings per share for the same period a year earlier was $.00. The provision for loan losses was increased $361 thousand during the nine months ended September 30, 2010, representing a decrease of $215 thousand over the same period for the previous year. The provision for loan losses was $90 thousand during the three months ended September 30, 2010, representing a decrease of $356 thousand over the same period for the previous year. In addition, for the nine months ended September 30, 2010, interest expense decreased $475 thousand, non-interest income increased $37 thousand and salaries and employee benefits decreased $224 thousand. During the three months ended September 30, 2010, interest expense decreased $142 thousand, non-interest income decreased $46 thousand and salaries and employee benefits decreased $56 thousand.

Total interest income for the nine months ended September 30, 2010 increased $26 thousand to $8.2 million, an increase of .3%. This resulted primarily from increased income on taxable investment securities. Total interest income for the three months ended September 30, 2010 decreased $41 thousand to $2.7 million, a decrease of 1.5% over the same prior year period. This resulted primarily from decreased income on loans and fees on loans. Noninterest income for the nine months period ended September 30, 2010, increased 7.4% to $538 thousand versus the same time period for the prior year. The increase was due primarily to gains realized on the sale of securities. Total interest expense for the nine months period ended September 30, 2010, decreased $475 thousand to $3.8 million continuing the decline of rates paid on interest-bearing deposits accounts even though total deposits increased. Total interest expense for the three months period ended September 30, 2010, decreased $142 thousand to $1.1 million. Noninterest expense decreased $108 thousand to $4.1 million for the nine months ended September 30, 2010 as compared to the same period in 2009. Reduced salaries and employee benefits accounted for the decrease in noninterest expense. Noninterest expense increased $45 thousand to $1.4 million for the three months ended September 30, 2010. Increased expense related to foreclosed assets accounted for the increase in noninterest expense. Due to increased earnings for the nine months period ended September 30, 2010, an income tax expense of $36 thousand was incurred versus an income tax benefit of $276 thousand for the same period in the previous year. During the three months period ended September 30, 2010, an income tax expense of $2 thousand was incurred versus an income tax benefit of $132 thousand for the same period in the previous year.

ASSET QUALITY

The allowance for loan losses represents management’s estimate of an amount adequate to absorb potential future losses inherent in the loan portfolio. In assessing the adequacy of the allowance, management relies predominately on its ongoing review of the lending process and the risk characteristics of the portfolio in the aggregate. Among other factors, management considers the Company’s loan loss experience, the amount of past-due loans, current and anticipated economic conditions, and the estimated current values of collateral securing loans in assessing the level of the allowance for loan losses. In the first nine months of 2010 the provision for loan losses was $361 thousand as compared to $576 thousand provision for the same period in 2009. The provision continued to increase due to $267 thousand in write-offs and continued economic uncertainty. Based upon management’s periodic reviews of the loan portfolio using the above-mentioned factors, the current year increase in the provision for loan losses was felt appropriate. Management believes the provision recorded in 2010 maintains the allowance at a level adequate to cover potential losses.

The allowance for loan losses totaled $2.8 million at September 30, 2010. The allowance for loan losses to period end loans was 1.84% at September 30, 2010 compared to 1.78% and 1.40% at December 31, 2009 and September 30, 2009, respectively. The Company recovered balances previously charged off on loans in the amount of $8 thousand during the first nine months of 2010. This compares with recoveries for the nine months ended September 30, 2009 of $10 thousand. The Company charged-off loans in the amount of $267 thousand during the first nine months of 2010 as compared to $85 thousand in charge-offs for the same nine months of 2009.

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The allowance for loan losses represents management’s estimate of an amount adequate to provide for potential losses inherent in the loan portfolio. The adequacy of the loan loss reserve and the related provision are based upon management’s evaluation of the risk characteristics of the loan portfolio under current economic conditions with consideration to such factors as financial condition of the borrowers, collateral values, growth and composition of the loan portfolio, the relationship of the allowance to outstanding loans and delinquency trends. In addition, management took into account not only the current state of the economy, but information from various sources, including government economic data, Federal Reserve economic reports, the local economy including local real estate activity and safety and soundness discussions with Primary Regulators, which not only expected the current economic downturn to persist, but also expected continued significant losses in commercial real estate. Geographic location was taken into account regarding the depth of economic decline, valuation for certain loans and corresponding collateral. Management also collected additional financial data from certain customers to ascertain current financial strength and cash flow Finally, management maintained the historical overall conservative approach of the Company in calculating additions to the allowance for loan losses. While management uses all available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

Nonperforming assets, which consist of nonaccrual loans, loans 90 days or more past due and other real estate owned, were $8.3 million as of September 30, 2010 compared to $5.9 million as of December 31, 2009. The increase in nonperforming assets occurred in the nonaccrual category as the current economic climate persists, creating cash flow issues for certain loan customers. Management is taking aggressive actions to mitigate any material losses related to nonperforming assets. As of September 30, 2010 the Company’s impaired loans with a valuation allowance amounted to $5.9 million, an increase of $300 thousand from December 31, 2009. The valuation allowance related to the impaired loans was $1.3 million at September 30, 2010 and $1.2 million at December 31, 2009.

During the third quarter, management identified two loans totaling $4.8 million that required classification as troubled debt restructures. One loan with a balance of $2.3 million is still performing, and the other loan in the amount of $2.5 million is recorded in non-accrual loans.

LIQUIDITY

In determining the Company’s liquidity requirements, both sides of the balance sheet are managed to ensure that adequate funding sources are available to support loan growth, deposit withdrawals or any unanticipated need for funds.

Securities available for sale that mature within one year, or securities that have a weighted average life of one year or less are sources of liquidity. Anticipated mortgage-backed securities pay downs and maturing loans also generate cashflows to meet liquidity requirements. Wholesale funding sources are also used to supply liquidity such as federal funds purchased and large denomination certificates of deposit. The Company considers its sources of liquidity to be adequate to meet its anticipated needs.

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CAPITAL RESOURCES

Cardinal Bankshares’ capital position provides the necessary assurance required to support anticipated asset growth and to absorb potential losses.

The Company’s Tier I capital position was $31.7 million at September 30, 2010, or 19.35% of risk-weighted assets. Total risk-based capital was $33.8 million or 20.61% of risk-weighted assets

Tier I capital consists primarily of common stockholders’ equity, while total risk-based capital includes the allowance for loan losses. Risk weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities. To be well capitalized under current risk-based capital standards, all banks are required to have Tier I capital of at least 4% and total capital of 8%. Based on these standards, Cardinal Bankshares is categorized as well capitalized at September 30, 2010.

In addition to the risk-based capital guidelines, banking regulatory agencies have adopted leverage capital ratio requirements. The leverage ratio – or core capital to assets ratio – works in tandem with the risk-capital guidelines. The minimum leverage ratios range from three to five percent. At September 30, 2010, the Company’s leverage capital ratio was 12.98%.

During the first nine months of 2010 Cardinal Bankshares has seen growth in deposits, a small increase in loans and an increase in the provision for loan losses, while maintaining its history of being well capitalized and maintaining strong liquidity far exceeding minimum standards and equal or greater than its peers.

A WARNING ABOUT FORWARD-LOOKING STATEMENTS

This Form 10-Q contains forward-looking statements. The Company may also make written forward-looking statements in periodic reports to the Securities and Exchange Commission, proxy statements, offering circulars and prospectuses, press releases and other written materials and oral statements made by Cardinal Bankshares’ officers, directors or employees to third parties. Statements that are not historical facts, including statements about the Company’s beliefs and expectations, are forward-looking statements. These statements are based on beliefs and assumptions of the Company’s management, and on information currently available to management. Forward-looking statements include statements preceded by, followed by or that include the words “believes,” “expects,” “estimates,” “anticipates,” “plans,” or similar expressions. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update publicly any of them in light of new information or future events.

Forward-looking statements involve inherent risks and uncertainties. Management cautions the readers that a number of important factors could cause actual results to differ materially from those contained in any forward-looking statement. Such factors include, but are not limited to, the following: competitive pressures among depository and other financial institutions may increase significantly; changes in the interest rate environment may reduce margins; general economic or business conditions may lead to a deterioration in credit quality or a reduced demand for credit; legislative or regulatory changes, including changes in accounting standards, may adversely affect the business in which Cardinal Bankshares is engaged; changes may occur in the securities markets; and competitors of the Company may have greater financial resources and develop products that enable such competitors to compete more successfully than Cardinal Bankshares.

Other factors that may cause actual results to differ from the forward-looking statements include the following: the timely development of competitive new products and services by the Company and the acceptance of such products and services by customers; changes in consumer spending and savings habits; the effects of competitors’ pricing policies; the Company’s success in managing the costs associated with the expansion of existing distribution channels and developing new ones, and in realizing increased revenues from such distribution channels, including cross-selling initiatives; and mergers and acquisitions and their integration into the Company and management’s ability to manage these other risks.

Management of Cardinal Bankshares believes these forward-looking statements are reasonable; however undue reliance should not be placed on such forward-looking statements, which are based on current expectations.

Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. The future results and stockholder values of Cardinal Bankshares may differ materially from those expressed in forward-looking statements contained in this report. Many of the factors that will determine these results and values are beyond the Company’s ability to control or predict.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Under the filer category of “smaller reporting company”, as defined in Rule 12b-2 of the Exchange Act, the Company is not required to provide information requested by Part I, Item 3 of its Form 10-Q.

Item 4T. CONTROLS AND PROCEDURES

As of the end of the period to which this report relates, the Company has carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures in accordance with Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange Act”).

The design of any system of controls is based in part upon certain assumptions about the likelihood of future events. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, there can be no assurance that any design will succeed in achieving its stated goal under every potential condition, regardless of how remote. While we have evaluated the operation of our disclosure controls and procedures and found them effective, there can be no assurance that they will succeed in every instance to achieve their objective.

Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in enabling us to record, process, summarize and report effectively and in a timely manner the information required to be disclosed in reports we file under the Exchange Act. There have not been any changes in our internal control over financial reporting that occurred during the last quarter that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.

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Part II. OTHER INFORMATION

Item:	1	Legal proceedings - None
	1A.	Risk factors
		Under the category of “smaller reporting company”, as defined in Rule 12b-2 of the Exchange Act, the Company is not required to provide information requested by Part II, Item 1A of its Form 10-Q.
	2	Unregistered sales of equity securities and use of proceeds - None
	3	Defaults upon senior securities - None
	4	Removed and Reserved
	5	Other information - None
	6	Exhibits

31.1	–	Certification of Chief Executive Officer Pursuant To Rule 13a-14(a)
31.2	–	Certification of Chief Financial Officer Pursuant To Rule 13a-14(a)
32.1	–	Certification of Chief Executive Officer and Chief Financial Officer Pursuant To 18 U.S.C. Section 1350

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized.

CARDINAL BANKSHARES CORPORATION

/s/ Ronald Leon Moore

Ronald Leon Moore

Chairman, President & Chief Executive Officer

/s/ J. Alan Dickerson

J. Alan Dickerson

Vice President & Chief Financial Officer

Date: November 10, 2010

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