Cardinal Bankshares (CDBK) 10-Q 2011 Q2 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 June 30, June 30, 2011 2011

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  x    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, $10 par value as of August 4, 2011 was 1,535,733.

CARDINAL BANKSHARES CORPORATION

FORM 10-Q

June 30, 2011

INDEX

		Page
Part I.	Financial Information
Item 1.	Consolidated Balance Sheets as of June 30, 2011 (Unaudited) and December 31, 2010 (Audited)		3
	Consolidated Statements of Income for the six months ended June 30, 2011 and 2010 (Unaudited)		4
	Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010 (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

Cardinal Bankshares Corporation and Subsidiary

Consolidated Balance Sheets

(In thousands, except share data)	(UnAudited) June  30, 2011			(Audited) December  31, 2010
Assets
Cash and due from banks	$	3,355		$	2,948
Interest-bearing deposits		271			7,792
Federal funds sold		28,975			21,550
Investment securities available for sale, at fair value		47,948			42,644
Investment securities held to maturity		14,022			14,698
(fair value June 30, 2011 $14,408 – December 31, 2010 $14,780)
Restricted equity securities		602			575
Total loans		141,864			148,916
Allowance for loan losses		(3,054	)		(3,073	)
Net loans		138,810			145,843
Bank premises and equipment, net		2,963			3,846
Accrued interest receivable		903			954
Foreclosed assets		279			509
Bank owned life insurance		5,359			5,279
Other assets		2,745			2,430
Total assets	$	246,232		$	249,068
Liabilities and Stockholders’ Equity
Noninterest-bearing deposits	$	28,360		$	28,264
Interest-bearing deposits		184,623			188,721
Total deposits		212,983			216,985
Accrued interest payable		87			111
Other liabilities		541			85
Total liabilities		213,611			217,181
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		13,960			13,439
Accumulated other comprehensive income, net		379			166
Total stockholders’ equity		32,621			31,887
Total liabilities and stockholders’ equity	$	246,232		$	249,068

See Notes to Consolidated Financial Statements.

3

Cardinal Bankshares Corporation and Subsidiary

Consolidated Statements of Income (Unaudited)

	Three months ended June 30,					Six months ended June 30,
(In thousands, except share data)	2011		2010			2011		2010
Interest income
Loans and fees on loans	$	2,005	$	2,226		$	4,156	$	4,394
Federal funds sold and securities purchased under agreements to resell		12		11			24		22
Investment securities:
Taxable		345		291			684		650
Exempt from federal income tax		168		188			341		372
Deposits with banks		—		1			1		1
Total interest income		2,530		2,717			5,206		5,439
Interest expense
Deposits		748		1,109			1,537		2,242
Total interest expense		748		1,109			1,537		2,242
Net interest income		1,782		1,608			3,669		3,197
Provision for loan losses		253		(109	)		439		271
Net interest income after provision for loan losses		1,529		1,717			3,230		2,926
Noninterest income
Service charges on deposit accounts		55		48			102		96
Other service charges and fees		31		31			57		70
Net realized gains on sales of securities		43		93			43		98
Other operating income		94		67			170		131
Total noninterest income		223		239			372		395
Noninterest expense
Salaries and employee benefits		823		812			1,615		1,542
Occupancy and equipment		135		161			312		330
Foreclosed assets, Net		27		1			34		3
Loss on sale of fixed assets		12		—			82		—
Other operating expense		419		405			826		821
Total noninterest expense		1,416		1,379			2,869		2,696
Income before income taxes		336		577			733		625
Income tax expense (benefit)		15		106			89		34
Net Income	$	321	$	471		$	644	$	591
Basic earnings per share	$	0.21	$	0.31		$	0.42	$	0.39
Diluted earnings per share	$	0.21	$	0.31		$	0.42	$	0.39
Dividends declared per share	$	0.08	$	0.08		$	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) Six Months Ended June 30,	2011			2010
Cash flows from operating activities
Net income	$	644		$	591
Adjustments to reconcile net income to net cash provided by operations:
Depreciation and amortization		120			120
Accretion of discounts on securities, net of amortization of premiums		185			195
Provision for loan losses		439			271
Net realized (gains) losses on securities		(43	)		(98	)
Net realized (gains) losses on sale of foreclosed assets		20			21
Deferred compensation and pension expense (benefit)		—			—
Changes in operating assets and liabilities:
Accrued income		51			(102	)
Other Assets		(444	)		(39	)
Accrued interest payable		(24	)		7
Other liabilities		456			(175	)
Net cash provided by operating activities		1,404			791
Cash flows from investing activities
Net increase (decrease) in interest-bearing deposits in banks		7,521			(4,876	)
Net (increase) decrease in federal funds sold		(7,425	)		2,425
Purchases of available for sale securities		(13,063	)		(13,558	)
Sales of available for sale securities		2,849			983
Maturities, calls and paydowns of available for sale securities		5,101			8,937
Purchases of held to maturity securities		—			(1,306	)
Maturities, calls and paydowns of held to maturity securities		605			2,308
Call (purchase) of restricted equity securities		(27	)		—
Proceeds from sale of foreclosed assets		210			10
Net decrease in loans		6,594			839
Net (purchases) dispositions of bank premises and equipment		763			(287	)
Net cash provided (used) by investing activities		3,128			(4,525	)
Cash flows from financing activities
Net increase in noninterest-bearing deposits		96			1,188
Net increase (decrease) in interest-bearing deposits		(4,098	)		2,007
Dividends Paid		(123	)		(123	)
Net cash (used in) provided by financing activities		(4,125	)		3,072
Net increase (decrease) in cash and cash equivalents		407			(662	)
Cash and cash equivalents, beginning		2,948			3,498
Cash and cash equivalents, ending	$	3,355		$	2,836
Supplemental disclosures of cash flow information
Interest paid	$	1,561		$	2,235
Income taxes paid	$	296		$	213
Supplemental disclosures of noncash activities
Other real estate acquired in settlement of loans	$	—		$	230

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, 2010. 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. Loans and Allowance for Loan Losses

The major components of loans in the Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010 are summarized below:

	2011			2010
Commercial	$	6,573		$	7,230
Real estate
Construction and land development		11,310			13,110
Residential, 1-4 families		27,834			29,961
Residential, 5 or more families		4,048			4,277
Farmland		1,295			1,274
Nonfarm, nonresidential		83,098			85,049
Agricultural		52			72
Consumer		2,839			2,923
Other		5,162			5,388
Gross loans		142,211			149,284
Unearned discount and net deferred loan fees and costs		(347	)		(368	)
Total loans	$	141,864		$	148,916

Changes in the allowance for loan losses are as follows:

Three months ended June 30, (In thousands)	2011			2010
Balance, at January 1	$	3,073		$	2,670
Provision charged to expense		439			271
Recoveries of amounts previously charged off		10			5
Loans charged off		(468	)		(24	)
Balance, at June 30	$	3,054		$	2,922

6

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

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 June 30 for the years indicated follows:

(In thousands)	2011		2010
Commitments to extend credit	$	10,559	$	15,208
Standby letters of credit		500		629
Total	$	11,059	$	15,837

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.

As of June 30, 2011, the required employer contribution of $253 thousand for the plan year ending June 30, 2011, has been made. The Company expects contributions for the 2011-2012 plan year to be approximately $244 thousand.

Note 5. Fair Value

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

	June 30, 2011				December 31, 2010
(In thousands)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and due from banks	$	3,355	$	3,355	$	2,948	$	2,948
Interest-bearing deposits with banks		271		271		7,792		7,792
Federal funds sold		28,975		28,975		21,550		21,550
Securities, available for sale		47,948		47,948		42,644		42,644
Securities, held to maturity		14,022		14,408		14,698		14,780
Restricted equity securities		602		602		575		575
Total loans		141,864		143,709		148,916		151,187
Accrued interest receivable		903		903		954		954
Financial liabilities
Deposits		212,983		214,086		216,985		218,256
Accrued interest payable		87		87		111		111
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)
June 30, 2010	Total		Level 1		Level 2		Level 3
Government sponsored enterprises	$	3,943	$	—	$	3,943	$	—
State and municipal securities		3,127		—		3,127		—
Mortgage-backed securities		38,624		—		38,624		—
Other securities		2,254		—		2,254		—
Investment securities available for sale	$	47,948	$	—	$	47,948	$	—
Total assets at fair value	$	47,948	$	—	$	47,948	$	—
(In Thousands)
December 31, 2010	Total		Level 1		Level 2		Level 3
Government sponsored enterprises	$	3,724	$	—	$	3,724	$	—
State and municipal securities		3,049		—		3,049		—
Mortgage-backed securities		32,823		1,040		31,783		—
Other securities		3,048		—		3,048		—
Investment securities available for sale	$	42,644	$	1,040	$	41,604	$	—
Total assets at fair value	$	42,644	$	1,040	$	41,604	$	—

There were no liabilities measured at fair value on a recurring basis at June 30, 2011 and December 31, 2010.

9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 5. Fair Value (continued)

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)
June 30, 2011	Total		Level 1		Level 2		Level 3
Commercial	$	103	$	—	$	103	$	—
Real Estate
Construction and land development		4,604		—		4,604		—
Residential, 1-4 families		12		—		12		—
Nonfarm, nonresidential		234		—		234		—
Impaired Loans		4,953		—		4,953		—
Foreclosed assets		279		—		279		—
Total assets at fair value	$	5,232	$	—	$	5,232	$	—
(In Thousands)
December 31, 2010	Total		Level 1		Level 2		Level 3
Commercial	$	134	$	—	$	134	$	—
Real Estate
Construction and land development		3,567		—		3,567		—
Residential, 1-4 families		115		—		115		—
Nonfarm, nonresidential		511		—		511		—
Impaired Loans		4,317		—		4,317		—
Foreclosed assets		509		—		509		—
Total assets at fair value	$	4,826	$	—	$	4,826	$	—

There were no liabilities measured at fair value on a nonrecurring basis at June 30, 2011 and December 31, 2010.

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:

June 30, 2011 (In thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses		Fair Value
Available for sale
Government sponsored enterprises	$	3,980	$	9	$	46	$	3,943
State and municipal securities		2,994		133		—		3,127
Mortgage-backed securities		38,146		592		114		38,624
Other securities		2,254		15		15		2,254
	$	47,374	$	749	$	175	$	47,948
Held to maturity
State and municipal securities	$	13,997	$	422	$	37	$	14,382
Mortgage-backed securities		25		1		—		26
	$	14,022	$	423	$	37	$	14,408
December 31, 2010 (In thousands)
Available for sale
Government sponsored enterprises	$	2,853	$	30	$	17	$	2,866
State and municipal securities		2,994		66		11		3,049
Mortgage-backed securities		32,483		454		104		32,833
Other securities		4,063		15		182		3,896
	$	42,393	$	565	$	314	$	42,644
Held to maturity
State and municipal securities	$	14,672	$	279	$	198	$	14,753
Mortgage-backed securities		26		1		—		27
	$	14,698	$	280	$	198	$	14,780

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 $6.6 million and $7.1 million at June 30, 2011 and December 31, 2010, 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-month period ended June 30, 2011 and 2010:

	Three Months Ended June 30,				Six Months Ended June 30,
	2011		2010		2011		2010
(In thousands)
Realized gains, available for sale securities	$	43	$	93	$	43	$	94
Realized gains, held to maturity securities		—		—		—		4
	$	43	$	93	$	43	$	98

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 June 30, 2011 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	$	—	$	—	$	1,012	$	1,021
Due after one year through five years		1,416		1,383		4,813		4,993
Due after five years through ten years		2,994		3,110		3,592		3,727
Due after ten years		42,964		43,455		4,605		4,667
	$	47,374	$	47,948	$	14,022	$	14,408

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 June 30, 2011 and December 31, 2010 respectively.

	Less Than 12 Months				12 Months or More				Total
June 30, 2011 (In thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Government sponsored enterprises	$	—	$	—	$	954	$	46	$	954	$	46
State and municipal securities		267		10		411		27		678		37
Mortgage- backed securities		10,393		77		1,843		37		12,236		114
Other Securities		1,000		15		—		—		1,000		15
Total temporarily impaired securities	$	11,660	$	102	$	3,208	$	110	$	14,868	$	212
	Less Than 12 Months				12 Months or More				Total
December 31, 2010 (In thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Government sponsored enterprises	$	982	$	17	$	—	$	—	$	982	$	17
State and municipal securities		5,559		158		387		51		5,946		209
Mortgage- backed securities		12,054		100		668		4		12,722		104
Other Securities		1,016		8		1,327		174		2,343		182
Total temporarily impaired securities	$	19,611	$	283	$	2,382	$	229	$	21,993	$	512

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 June 30, 2011 the Company had 2 government-sponsored securities with an aggregate unrealized loss of approximately $46 thousand, 2 state and municipal securities with an aggregate unrealized loss of approximately $37 thousand, 30 mortgaged-backed securities with an aggregate unrealized loss of approximately $114 thousand and other securities with an aggregate unrealized loss of approximately $15 thousand. Management does not believe that gross unrealized losses, which totals 1.4% 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, 2010, the Company had one government-sponsored securities with an aggregate unrealized loss of approximately $17 thousand, 21 state and municipal securities with an aggregate unrealized loss of approximately $209 thousand, 24 mortgaged-backed securities with an aggregate unrealized loss of approximately $104 thousand and six other securities with an aggregate unrealized loss of approximately $182 thousand. Management does not believe that gross unrealized losses, which totals 2.3% 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

In May 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-04,Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S GAAP and IFRSs. The amendments in this update explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. The amendments apply to all reporting entities that are required or permitted to measure or disclose the fair value of an asset, a liability, or an instrument classified in a reporting entity’s shareholders’ equity in the financial statements. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The amendments are not expected to have a significant impact on the Company.

In June 2011, the Financial Accounting Standards Board issued Accounting Standards Update 2011-05,Presentation of Comprehensive Income. This update seeks to improve comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. generally accepted accounting principles (GAAP) and International Reporting Standards (IFRS), the FASB decided to eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity, among other amendments in this update. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. The amendments are not expected to have a significant impact on the Company.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

Note 8. 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 June 30, 2011, 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 June 30, 2011 were $246.2 million, a decrease of 1.1% or $2.8 million from year-end 2010. Total loans decreased 4.8% or $7.1 million during the first six months of this year to $141.9 million.

The investment securities portfolio reflected an increase of 8.0% or $4.7 million during the first six months of the year. Federal funds sold increased 34.5% or $7.4 million during the first six months of the year to $29.0 million. Interest-bearing deposits decreased 96.5% or $7.5 million to $271 thousand over year-end 2010 as a result of decreased deposits.

As of June 30, 2011, total deposits were $213.0 million down 1.8% or $4.0 million compared to year-end 2010. Non-interest-bearing core deposits increased to $28.4 million as compared to $28.3 million at year-end 2010. Interest-bearing deposits decreased 2.2% or $4.1 million to $184.6 million. Deposits greater than $100 thousand amounted to $52.6 million at June 30, 2011 as compared to $60.9 million at year-end 2010.

Stockholders’ equity was $32.6 million as of June 30, 2011 compared to $31.9 million as of December 31, 2010. Net income of $644 thousand for the period combined with an increase in accumulated other comprehensive income of $213 thousand less dividends paid of $123 thousand accounted for the increase in stockholders’ equity.

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RESULTS OF OPERATIONS

Net income for the six months ended June 30, 2011 was $644 thousand, an increase of 9.0% compared to $591 thousand for the six months ended June 30, 2010. Net income for the three months ended June 30, 2011 was $321 thousand, a decrease of 31.8% compared to $471 thousand for the three months ended June 30, 2010. Diluted earnings per share increased 7.7% to $.42 for the six months ended June 30, 2011. Diluted earnings per share for the same period a year earlier was $.39. Diluted earnings per share decreased 32.3% to $.21 for the three months ended June 30, 2011. Diluted earnings per share for the same period a year earlier was $.31. The provision for loan losses was $439 thousand during the six months ended June 30, 2011, representing an increase of $168 thousand over the same period for the previous year. The provision for loan losses was $253 thousand during the three months ended June 30, 2011, representing an increase of $362 thousand over the same period for the previous year. In addition, for the six months ended June 30, 2011, interest expense decreased $705 thousand due to decreased rates paid on deposits, non-interest income decreased $23 thousand due to decreased net realized gains on sales of securities, and non-interest expense increased $173 thousand due to a $73 increase in salaries and employee benefits, loss on sale of other real estate owned of $34 thousand and a loss on sale of fixed assets of $82 thousand due to the sale of the Tanglewood Branch and replacement of ATM’s. During the three months ended June 30, 2011, interest expense decreased $361 thousand due to decreased rates on paid on deposits, non-interest income decreased $16 thousand due to decreased net realized gains on sales of securities, and non-interest expense increased $37 thousand due to loss on sale of other real estate of $27 thousand and loss on replacement of ATM’s of $12 thousand.

Total interest income for the six months ended June 30, 2011 decreased $233 thousand to $5.2 million, a decrease of 4.3% over the same prior year period. This resulted from decreased income on loans and fees on loans as the loan portfolio decreased due to continued poor economic conditions. Total interest income for the three months ended June 30, 2011, decreased $187 thousand to $2.5 million, a decrease of 6.9% over the same prior year period.

Due to increased earnings for the six months ended June 30, 2011, an income tax expense of $89 thousand was incurred versus and income tax expense of $34 thousand for the same period in the previous year. Due to decreased earnings during the three months ended June 30, 2011, an income tax expense of $15 thousand was incurred versus and income tax expense of $106 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 six months of 2011 the provision for loan losses was $439 thousand as compared to $271 thousand provision for the same period in 2010. 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 2011 maintains the allowance at a level adequate to cover potential losses.

The allowance for loan losses totaled $3.1 million at June 30, 2011. The allowance for loan losses to period end loans was 2.15% at June 30, 2011 compared to 2.06% and 1.96% at December 31, 2010 and June 30, 2010, respectively. The Company recovered balances previously charged off on loans in the amount of $10 thousand during the first six months of 2011. This compares with recoveries for the six months ended June 30, 2010 of $5 thousand. The Company charged-off loans in the amount of $468 thousand during the first six months of 2011 as compared to $24 thousand in charge-offs for the same six months of 2010.

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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 $8.7 million as of June 30, 2011 compared to $8.0 million as of December 31, 2010. The increase in nonperforming assets occurred as a result of a net increase in the nonaccrual loans of $715 thousand, which included write-offs of $418 thousand and a decrease in other real estate owned due to sale of $230 thousand. Management is taking aggressive actions to mitigate any material losses related to nonperforming assets. As of June 30, 2011 the Company’s impaired loans with a valuation allowance amounted to $5.0 million, an increase of $626 thousand from December 31, 2010. The valuation allowance related to the impaired loans was $1.4 million at June 30, 2011 and $1.4 million at December 31, 2010.

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 $32.2 million at June 30, 2011, or 20.72% of risk-weighted assets. Total risk-based capital was $34.2 million or 21.98% 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 June 30, 2011.

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 June 30, 2011, the Company’s leverage capital ratio was 13.02%.

During the first six months of 2011 Cardinal Bankshares has seen a decline in deposits, loans and 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
101	–	The following materials from the Company’s 10-Q Report for the quarterly period ended June 30, 2011, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Changes in Shareholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) the Notes to the Condensed Consolidated Financial Statements, tagged as blocks of text.* * Furnished, not filed

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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

Chief Financial Officer & Vice President

Date: August 4, 2011

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