National Bancshares 10-K 2003 FY Annual report

EXHIBIT 13

With the growth we experienced during the past few years, we’ve been actively restructuring a
number of areas of the bank to support current growth, and better position the
organization for future growth.

TABLE OF CONTENTS

EX-3.1 Amended Articles of Incorporation

EX-3.2 Code of Regulations

EX-13 Annual Report

EX-14 Code of Business Conduct and Ethics

EX-21 Subsidiaries of National Bancshares Corp.

EX-23 Consent of Independent Auditors

EX-31.1 CEO 302 Cert

EX-31.2 CFO 302 Cert

EX-32 906 Certifications

FINANCIAL HIGHLIGHTS

These financial highlights are merely excerpts of and are not a substitute for National Bancshares Corporation’s consolidated financial statements, including notes, and other detailed financial information we provide elsewhere in this document. You should read the entire document, including the Financial Review and the consolidated financial statements and notes to the consolidated financial statements.

Financial Position

(Year End Balances)	2003		2002		Percentage Change
Total Assets	$	301,249,375	$	296,750,165		1.52	%
Deposits		242,847,291		239,297,227		1.48	%
Loans-Net		187,056,241		190,559,663		-1.84	%
Investment Securities		83,793,119		70,806,397		18.34	%
Shareholders’ Equity		34,804,735		33,190,050		4.86	%
Summary of Operations
Net Interest Income	$	11,303,793	$	11,013,379		2.64	%
Net Income		2,643,551		2,254,774		17.24	%
Regular Cash Dividends		1,296,004		1,203,946		7.65	%
Net Income Per Share		1.18		1.01		16.83	%
Cash Dividends Per Share		0.58		0.54		7.41	%
Book Value Per Share		15.58		14.85		4.92	%

National Bancshares Corporation is a one-bank holding company with assets of $301 million. First National Bank, its subsidiary, is headquartered in Orrville, Ohio. Serving Wayne County, southern Medina County, western Stark County and parts of Holmes County through fourteen banking offices, First National Bank offers a variety of personal and commercial deposit and lending services.

DEAR SHAREHOLDERS

     The year 2003 brought continued growth for National Bancshares with total assets reaching over $300 million. Total deposits increased over $3.5 million while net loans decreased $3.5 million, compared to the end of the previous year. With the low interest rate environment that existed throughout the past year, many customers elected to refinance their home mortgage loans. During this time, many fixed rate mortgage loans were paid off, refinanced, or sold into the secondary market. Having acquired primarily fixed rate residential mortgage loans from the acquisition of Peoples Financial Corporation in 2002, this mortgage activity assisted us in repositioning our balance sheet by shifting certain loan exposure from fixed rate mortgages to variable rate commercial loans. This should have a positive impact on our earnings in an increasing interest rate environment. Net income increased by over $388 thousand or 17.2% above the year 2002.

     THIS GROWTH EXEMPLIFIES THE LONG-TERM TREND OF INCREASING CASH DIVIDENDS, WHICH HAS CONTINUED FOR OVER 35 CONSECUTIVE YEARS.

     Total cash dividends declared during 2003 amounted to 58¢ per share. This is a 7.4% increase over the total cash dividends declared in 2002. This growth exemplifies the long-term trend of increasing cash dividends, which has continued for over 35 consecutive years. The market value of our common stock has also continued to increase during the past year, finishing the year approximately 10.2% above the end of the previous year. The Over The Counter (OTC) market, upon which our stock is listed, did not dissolve this past year as NASDAQ had planned. NASDAQ operates the Over The Counter market and has decided to embrace this market for trading small company stocks. We continue to trade on this market since we have found good, ongoing liquidity for our stock there.

     With the growth we experienced during the past few years, we have been actively restructuring a number of areas of the bank to support current growth, and better position the organization for future growth. Additional lending and support staff have been hired. We have also embarked upon extensive staff training on sales and problem solving. New systems are being put into place to more

effectively manage a larger and growing organization.

     To gain operational efficiencies while supporting an expanding organization, we have embraced the use of a number of technological advancements available in the industry. Recently, we have upgraded computers and added servers within the organization. Deposit documentation software has been upgraded to keep in step with the ever-changing regulatory environment. In the fourth quarter of this past year we completed installation and testing of check imaging. This service is being introduced to our customers in January of 2004. The time efficiency for information retrieval on checks will be greatly enhanced with this service. Check imaging also positions us to more efficiently meet the upcoming changes the Federal Reserve will begin implementing in 2004 regarding check truncation. In order to move check clearing information across the country faster and more efficiently, the Federal Reserve will be implementing a new system of capturing check information electronically at the first Federal Reserve Bank a check is processed through. The information will then be forwarded through a clearing system electronically while the physical check is retained, and eventually destroyed by the Federal Reserve Bank that first processed the paper check. Banks will then receive and process incoming checks electronically rather than by paper. This new system should help to speed the processing of checks across the country.

     IN LOOKING AHEAD TO 2004, WE FACE THESE CHALLENGES, AND THE OPPORTUNITIES THEY MAY CREATE FOR US, WITH OPTIMISM.

     As we enter 2004, the economy is showing definite signs of improvement. Interest rates appear to have bottomed and stabilized. The Federal Open Market Committee has given indications they will not move short-term rates early in 2004. Only time will tell if and when a rate movement will take place. We remain optimistic that the economy will continue to improve throughout next year. The challenges presented by a struggling economy, along with an ever-increasing regulatory and competitive environment, created a rather interesting year. In looking ahead to 2004, we face these challenges, and the opportunities they may create for us, with optimism. We thank you for your support and hope we may have the opportunity to serve your financial needs.

Charles J. Dolezal

President and Chairman

NATIONAL BANCSHARES CORPORATION

112 West Market Street
Orrville, Ohio 44667

2003 ANNUAL REPORT

December 31, 2003

TABLE OF CONTENTS

	PAGE
SELECTED FINANCIAL DATA		4
FINANCIAL REVIEW		6
CONSOLIDATED BALANCE SHEETS		29
CONSOLIDATED STATEMENTS OF INCOME		30
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY		31
CONSOLIDATED STATEMENTS OF CASH FLOWS		32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS		33
REPORT OF INDEPENDENT AUDITORS		54
PRICE RANGE OF COMMON STOCK		57
DIRECTORS AND OFFICERS		58
OFFICE LOCATIONS		59

3

SELECTED FINANCIAL DATA

     The summary financial information to follow is not a substitute for National Bancshares Corporation’s consolidated financial statements, notes to the consolidated financial statements, and other detailed financial information we provide elsewhere in this document. You should read the entire document, including the consolidated financial statements, the notes to the consolidated financial statements, and the Financial Review. We derived the following data from National Bancshares’ consolidated financial statements for the fiscal years ended December 31, 1999 through 2003.

	As of or For the Years Ended December 31,
	2003		2002		2001		2000		1999
Income Statement Data:
Interest Income	$	15,043,809	$	15,941,153	$	13,556,747	$	14,214,579	$	13,382,607
Interest Expense		3,740,016		4,927,774		4,954,357		5,410,266		4,748,609
Net Interest Income		11,303,793		11,013,379		8,602,390		8,804,313		8,633,998
Provision for Loan Losses		245,000		1,569,402		40,000		62,500		120,000
Net Interest Income After Provision for Loan Losses		11,058,793		9,443,977		8,562,390		8,741,813		8,513,998
Noninterest Income		1,532,020		1,458,031		1,145,238		849,467		836,598
Noninterest Expense		9,140,516		7,998,774		6,403,105		6,318,759		6,199,427
Income Before Income Taxes		3,450,297		2,903,234		3,304,523		3,272,521		3,151,169
Income Tax Expense		806,746		648,460		777,320		717,250		634,183
Net Income	$	2,643,551	$	2,254,774	$	2,527,203	$	2,555,271	$	2,516,986
Balance Sheet Data:
Cash and Due from Banks	$	11,506,999	$	10,010,654	$	6,935,082	$	7,077,797	$	8,538,351
Investment Securities		83,793,119		70,806,397		60,843,655		68,021,052		70,214,050
Loans-Net		187,056,241		190,559,663		116,880,804		107,551,674		99,531,223
Deposits		242,847,291		239,297,227		159,519,295		162,013,585		160,435,348
Borrowings		20,140,702		21,211,964		5,741,697		8,010,869		8,663,682
Shareholders’ Equity		34,804,735		33,190,050		30,922,188		28,939,329		26,856,195
Total Assets		301,249,375		296,750,165		197,763,446		200,792,706		197,402,543
Per Common Share Data:
Net Income	$	1.18	$	1.01	$	1.13	$	1.14	$	1.12
Cash Dividends		0.58		0.54		0.52		0.50		0.48
Book Value		15.58		14.85		13.93		12.93		12.01
Weighted Average Number of Shares Outstanding		2,234,488		2,228,510		2,230,013		2,240,534		2,253,650

4

	As of or For the Years Ended December 31,
	2003			2002			2001			2000			1999
Selected Data:
Return on Average Equity		7.58	%		7.01	%		8.17	%		9.08	%		9.22	%
Return on Average Assets		0.90	%		0.85	%		1.27	%		1.30	%		1.30	%
Dividend Payout Percentage		49.03	%		53.40	%		45.85	%		43.82	%		42.84	%
Efficiency Ratio(1)		71.21	%		64.14	%		65.69	%		65.45	%		65.46	%
Full Time Equivalent Staff		133			122			103			103			101
Average Total Assets to Full Time Equivalent Staff	$	2,209,383		$	2,166,827		$	1,938,835		$	1,902,022		$	1,917,411
Asset Quality Ratios:
Allowance for Loan Losses to Ending Total Loans		0.85	%		0.83	%		1.12	%		1.23	%		1.29	%
Net Loan Charge-offs to Average Loans		0.13	%		0.89	%		0.06	%		0.03	%		0.11	%
Capital Ratios:
Average Equity to Average Assets		11.86	%		12.17	%		15.49	%		14.36	%		14.10	%
Leverage Ratio(2)		9.04	%		8.61	%		14.98	%		14.53	%		13.83	%
Total Risk-Based Capital Ratio(2)		13.59	%		13.58	%		22.71	%		22.22	%		21.81	%

(1)	The efficiency ratio is calculated by dividing noninterest expenses by the sum of net interest income and non-interest income.
(2)	Computed in accordance with Comptroller of the Currency and FDIC guidelines.

     The following table shows quarterly results of operations for 2003 and 2002.

							Income (Loss)
					Provision		Before			Net			Basic and Diluted
	Interest		Net Interest		For Loan		Income			Income			Earnings
(Unaudited)	Income		Income		Losses		Taxes			(Loss)			(Loss) Per Share
2003
First quarter	$	3,974,571	$	2,992,145	$	35,000	$	1,073,950		$	806,646		$	0.36
Second quarter		3,926,619		2,926,329		50,000		1,076,993			799,626			0.36
Third quarter		3,744,193		2,839,220		70,000		826,683			636,946			0.28
Fourth quarter		3,398,426		2,546,099		90,000		472,671			400,333			0.18
2002
First quarter	$	3,007,388	$	2,153,796	$	20,000	$	933,340		$	729,777		$	0.33
Second quarter		4,397,461		2,898,126		95,000		976,131			680,516			0.31
Third quarter		4,291,593		2,943,490		25,000		1,175,006			874,757			0.39
Fourth quarter		4,244,711		3,017,967		1,429,402		(181,243	)		(30,276	)		-0.02

     During the fourth quarter of 2002, management charged off one large commercial credit and identified other losses in the portfolio, which required an additional provision. This was the primary reason for the decline in 2002 fourth quarter income before income taxes, net income and earnings per share.

     During the fourth quarter of 2003, the Corporation accelerated the purchase accounting adjustment on loans related to the acquisition in 2002 by approximately $450,000. This impacted the Corporation’s net interest income, income before income taxes, net income and earnings per share for the fourth quarter of 2003.

5

FINANCIAL REVIEW

     This financial review is intended to assist the reader in evaluating the performance of National Bancshares Corporation for the years ended December 31, 2003, 2002 and 2001. This information should be read in conjunction with the consolidated financial statements and accompanying notes to the financial statements.

Forward Looking Statement

     The Private Securities Litigation Reform Act of 1995 contains safe harbor provisions regarding forward-looking statements. Forward-looking statements can be identified by terminology such as “believes,” “expects,” “anticipates,” “estimates,” “intends,” “should,” “will,” “plans,” “potential” and similar words. Forward-looking statements are also statements that are not statements of historical fact. Forward-looking statements necessarily involve risks and uncertainties. They are merely predictive or statements of probabilities, involving known and unknown risks, uncertainties and other factors. If one or more of these risks or uncertainties occurs or if the underlying assumptions prove incorrect, actual results in 2004 and beyond could differ materially from those expressed in or implied by the forward-looking statements.

     Forward-looking statements are based upon a variety of estimates and assumptions. The estimates and assumptions involve judgments about a number of things, including future economic, competitive, and financial market conditions and future business decisions. These matters are inherently subject to significant business, economic, and competitive uncertainties, all of which are difficult to predict and many of which are beyond National Bancshares Corporation’s control. Although we believe the estimates and assumptions are reasonable, actual results could vary materially from those shown. Inclusion of forward-looking information does not constitute a representation by National Bancshares or any other person that the indicated results will be achieved. You are cautioned not to place undue reliance on forward-looking information.

Financial Condition

     Loans. National Bancshares’ total assets increased by 1.5%, while net loans decreased by 1.8% from 2002 to 2003, principally due to the $17.5 million or 14.8% decrease in residential real estate loans. With low interest rates during 2003, many customers elected to refinance their homes. The Bank experienced a net decline in residential real estate mortgages due to payoffs, pay downs and loan sales of approximately $5.4 million. At the end of 2002 residential mortgage loans secured by 1-4 family real estate constituted 62% of First National Bank’s total loans, compared to 54% by the end of 2003.

     With the acquisition of Peoples Financial Corporation in 2002, and its subsidiary, Peoples Federal Savings and Loan Association of Massillon (Peoples Federal), located in Stark County, the Bank entered a new market. Peoples Federal’s primary lending activity consisted of the origination of conventional mortgage loans secured by one-to-four family homes. To diversify the loan portfolio and take advantage of the opportunities in the market place, the Bank hired seasoned commercial loan officers to focus on our current and new market areas. By year-end 2003, commercial real estate loans increased $10.6 million or 36.9% over year-end 2002.

     First National Bank’s loan policy provides that loans in any one of five broad categories of lending products may constitute up to 60% of the total loan portfolio: commercial loans, real estate loans, agricultural loans, commercial real estate loans, and consumer loans. As noted above, the major changes in the loan portfolio were an increase in commercial real estate loans, offset by a decline in residential real estate loans. Home equity and construction loans also increased; offset by declines in consumer, commercial, credit cards and other loans. Home equity loans increased $1.5 million or 11.6% as we made changes to this product to make it more competitive in the marketplace. Construction loans, which are short term by nature, increased by $3.1 million or 148.4%. At the end of the construction period a construction loan migrates from the construction loan category to another, such as commercial real estate, if First National Bank provides permanent financing. The sharp decline in real estate construction loans by the end of the year 2002 is attributable principally to a large commercial construction loan that was written off in 2002. Other loans, which consist mostly of tax-free industrial development bond loans, decreased $0.7 million or 29.2% to $1.8 million due to paydowns. The composition of the bank’s loan portfolio in dollar amounts and in percentages at the end of each of the last five fiscal years was as follows.

6

	Loan Portfolio Composition at December 31,
	2003						2002						2001
	$			%			$			%			$			%
Type of Loan:
Collateralized by real estate:
Commercial	$	39,349,045			21	%	$	28,747,949			15	%	$	23,933,475			20	%
Residential		101,291,447			54	%		118,834,883			62	%		53,522,228			45	%
Home equity		14,008,018			7	%		12,555,738			6	%		9,426,924			8	%
Construction		5,131,685			3	%		2,065,964			1	%		4,769,337			4	%
		159,780,195			85	%		162,204,534			84	%		91,651,964			77	%
Other:
Consumer		4,828,644			3	%		4,847,264			3	%		5,224,468			5	%
Commercial		21,374,911			11	%		21,631,567			11	%		18,050,801			15	%
Credit cards - unsecured		1,263,565			0	%		1,276,587			1	%		1,227,172			1	%
Other		1,821,016			1	%		2,570,767			1	%		2,249,271			2	%
Total Loans		189,068,331			100	%		192,530,719			100	%		118,403,676			100	%
Less:
Unearned and deferred income		(408,522	)					(366,856	)					(201,720	)
Allowance for loan losses		(1,603,568	)					(1,604,200	)					(1,321,152	)
Net Loans	$	187,056,241					$	190,559,663					$	116,880,804
Net loans as a percent of total assets		62.09	%					64.22	%					59.10	%

[Additional columns below]

[Continued from above table, first column(s) repeated]

	Loan Portfolio Composition at December 31,
	2000						1999
	$			%			$			%
Type of Loan:
Collateralized by real estate:
Commercial	$	27,005,236			25	%	$	25,030,907			25	%
Residential		42,063,386			38	%		39,206,446			39	%
Home equity		8,612,004			8	%		6,334,052			6	%
Construction		1,011,188			1	%		1,225,265			1	%
		78,691,814			72	%		71,796,670			71	%
Other:
Consumer		7,151,394			7	%		7,847,553			8	%
Commercial		19,850,559			18	%		17,851,661			18	%
Credit cards - unsecured		1,188,297			1	%		1,207,352			1	%
Other		2,273,180			2	%		2,452,641			2	%
Total Loans		109,155,244			100	%		101,155,877			100	%
Less:
Unearned and deferred income		(260,446	)					(316,024	)
Allowance for loan losses		(1,343,124	)					(1,308,630	)
Net Loans	$	107,551,674					$	99,531,223
Net loans as a percent of total assets		53.56	%					50.42	%

     At the end of 2003 total agricultural loans were not significant, amounting to approximately $4.6 million. About $4.4 million of that amount consists of loans collateralized by farmland, which is included in the $39.3 million commercial loans secured by real estate. The remainder, slightly less than $200 thousand, consists of loans for agricultural production and other loans to farmers, and that figure is included in the $21.4 million figure for commercial loans (not collateralized by real estate). Ranked by Standard Industry Classification – or SIC – codes, the industries most represented among First National Bank’s commercial borrowers include the restaurant, real estate agent, and holding company industries, in that order, accounting for approximately 2.83%, 2.36%, and 1.90% of the total loans at year-end 2003, respectively.

     Conventional mortgage loans secured by 1-4 family real estate are long-term assets and in many cases have a fixed interest rate. The vast majority of loans added to First National Bank’s portfolio by the acquisition of Peoples Federal were fixed-rate residential mortgage loans, but their number has declined since the merger as these fixed-rate loans have steadily been sold into the secondary market, have been refinanced elsewhere or paid off. Approximately 37% of the portfolio of conventional mortgage loans secured by 1-4 family and multifamily real estate at year-end 2003 was adjustable rate. First National Bank’s fixed-rate conventional mortgage loans are originated with loan documentation that permits their sale to Freddie Mac. However, the bank’s policy is generally to retain mortgage loans in its portfolio unless the bank’s loan-to-deposit ratio exceeds 90% or unless the bank’s fixed mortgages exceed 35% of total gross loans.

     The first table to follow presents maturity information for the loan portfolio at year-end 2003, without taking account of prepayments or unscheduled principal repayments. Loans are shown as maturing based on contractual maturities. The second table shows the dollar amount of all loans due after December 31, 2003 that have pre-determined interest rates and the dollar amount of all loans due after December 31, 2003 that have floating or adjustable rates.

7

	Loan Portfolio Maturity at December 31, 2003
					5 years
	0 to 1 year *		1 to 5 years		or more		Total
Amount due:
Collateralized by real estate:
Commercial	$	3,689,843	$	10,581,002	$	25,078,200	$	39,349,045
Residential		8,728,895		18,707,237		73,855,315		101,291,447
Home equity		146,660		32,131		13,829,227		14,008,018
Construction		3,144,569		1,235,888		751,228		5,131,685
Consumer		1,717,897		3,074,754		35,993		4,828,644
Commercial		15,921,934		4,761,752		691,225		21,374,911
Credit cards		1,263,565		0		0		1,263,565
Other		572,398		601,952		646,666		1,821,016
Total amount due	$	35,185,761	$	38,994,716	$	114,887,854	$	189,068,331

     *  Loans due on demand and overdrafts are included in the amount due in one year or less.

	Fixed Rate		Adjustable Rate		Total
Collateralized by real estate:
Commercial	$	5,726,621	$	33,622,424	$	39,349,045
Residential		63,374,047		37,917,400		101,291,447
Home equity		0		14,008,018		14,008,018
Construction		4,050,901		1,080,784		5,131,685
Consumer		4,532,962		295,682		4,828,644
Commercial		3,649,177		17,725,734		21,374,911
Credit cards		1,008,744		254,821		1,263,565
Other		1,552,249		268,767		1,821,016
Total	$	83,894,701	$	105,173,630	$	189,068,331

     Allowance for Loan Losses. As explained in Note 1 of the consolidated financial statements, the allowance for loan losses is a valuation allowance for probable incurred credit losses that have not yet been confirmed, increased by the provision for credit losses and decreased by charge-offs less recoveries. The allowance for loan losses is the sum of components recognized and measured either: (1) according to Statement of Financial Accounting Standards (SFAS) 5, “Accounting for Contingencies,” for pools of homogenous loans, or (2) according to SFAS 114, “Accounting by Creditors for Impairment of a Loan,” for loans the bank considers impaired based upon individual loan review. Management determines the necessary allowance balance using the bank’s loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

     Loans Analyzed Individually. Determining the loan loss allowance begins with the bank’s assessment of credit risk for loans analyzed individually. Individual loans are assigned credit-risk grades based on the bank’s assessment of conditions affecting a borrower’s ability to satisfy its contractual obligation under the loan agreement. The assessment process includes reviewing a borrower’s current financial information, historical payment experience, credit documentation, public information, and other information specific to each borrower. Loans reviewed individually are reviewed at least annually, or more frequently if management becomes aware of information affecting a borrower’s ability to fulfill its obligation. All loans over $200 thousand or to customers whose aggregate total loans exceed $200 thousand are reviewed individually, except for first mortgage loans on a borrower’s personal residence. Loans or customers with balances under $200 thousand may also be reviewed individually if considered necessary by the board or management. Likewise, all commercial lending relationships over $200 thousand are ranked according to risk at least annually, but a risk ranking may change at any point during the year if the credit relationship changes. Loans analyzed individually are ranked as follows –

8

Passloans are loans that are considered satisfactory, with lower than average risk and low probability of serious financial deterioration on the borrower’s part

Special-Mentionloans have more than average risk, with identified potential weaknesses that deserve management’s close attention. Left uncorrected, the potential weaknesses could result in deterioration of repayment prospects. In the case of a commercial borrower for example, potential weaknesses could include adverse trends in the borrower’s operations or adverse economic or market conditions that could affect the borrower in the future

Doubtfulloans have all the weaknesses inherent in those classified as substandard, with the added characteristic that existing facts, conditions, and values make collection or liquidation in full highly questionable and improbable. The possibility of loss is extremely high, but because of factors that could work to the borrower’s advantage classification of the “doubtful” loan as “loss” is deferred

Watchloans are loans that are performing according to the terms of the loan agreement but that nevertheless require enhanced management supervision because of factors such as an unusual payment history or a weakened financial condition on the borrower’s part

Substandardloans are inadequately protected by the current financial condition and paying capacity of the borrower or by any collateral securing the loan. Substandard loans have a well-defined weakness or weaknesses jeopardizing collection of the debt in full, with a distinct possibility of loss if the weakness or weaknesses are not corrected. Although a loan may be classified substandard even if payments are not 90 days or more past due, if payments are 90 days or more past due the loan will be classified as substandard at best, if not ranked even lower

Loans classified asLossare those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. When a bank classifies an asset as “loss,” the bank is required either to establish an allowance for losses equal to 100% of that portion of the asset so classified or to charge off that amount

     If it is probable that the bank will be unable to collect all principal and interest due on a loan – and that the loan is therefore impaired – management measures the amount of impairment using the loan’s expected future cash flows (discounted at the loan’s effective interest rate), or the fair value of the underlying collateral if loan repayment is expected to come from the sale or operation of the collateral. First National Bank considers larger loans ranked doubtful or loss to be impaired. Substandard, special mention, and watch loans are not considered impaired. Impairment is evaluated in total for smaller-balance loans of similar nature – such as residential mortgage, consumer, and credit card loans – and on an individual loan basis for other loans. If a loan is impaired, a portion of the loan loss allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

     Increases in the allowance for loan losses are made by charges to the provision for loan losses. No specific provision for loan losses results if an individually reviewed loan is ranked “pass” or “watch”, but they are included in the pools of loans analyzed under SFAS 5. Loans classified special mention or substandard, and smaller-balance loans classified doubtful are assigned a provision based upon a historical migration analysis performed on classified loans. The migration analysis identifies the percentage of classified loans by category that has historically been ultimately charged-off. The migration percentages are reviewed and adjusted by management to reflect various factors such as the growth and change in mix of the loan portfolio and the regulator’s guidelines. Loans ranked loss are of course charged off in their entirety because at that point the unconfirmed loss that the loan loss allowance is intended to approximate is considered to be confirmed.

9

     As of December 31, 2003, 2002, and 2001 classified assets were as follows –

	Classified assets at December 31,
	2003					2002					2001
			Percent of					Percent of					Percent of
	Amount		total loans			Amount		total loans			Amount		total loans
Classified loans:
Special mention	$	3,126,131		1.7	%	$	2,333,281		1.2	%	$	—		0.0	%
Substandard		3,994,474		2.1	%		4,351,773		2.3	%		3,762,681		3.2	%
Doubtful		383,495		0.2	%		9,878		0.0	%		92,144		0.1	%
Loss		—		0.0	%		6,512		0.0	%		1,665		0.0	%
Total classified loans	$	7,504,100		4.0	%	$	6,701,444		3.5	%	$	3,856,490		3.3	%
Other classified assets		—		0.0	%		—		0.0	%		—		0.0	%
Total classified assets	$	7,504,100		4.0	%	$	6,701,444		3.5	%	$	3,856,490		3.3	%

     Pools of Homogenous Loans Analyzed under SFAS 5. The total loan loss allowance is derived both from analysis of individual impaired loans under SFAS 114 and analysis of aggregated pools of loans under SFAS 5. Smaller balance loans (such as automobile or home equity loans, for example), homogenous groups of loans (such as residential mortgage loans), and less severely classified loans reviewed individually may be analyzed on an aggregated or pooled basis under SFAS 5.

     Under SFAS 5, loans are segmented into groups of loans having similar risk characteristics based on purpose, loan type, and collateral, for example commercial loans, residential mortgage loans, home equity loans, and consumer loans. Losses inherent in pools of loans are estimated using average historical losses over a period of years for loans of those types, but with adjustments to account for changes in loan policies, changes in underwriting or loan recovery practices, changes in prevailing economic conditions, changes in the nature or volume of the loan portfolio, and changes in other internal and external factors. Loans secured by real estate – particularly residential mortgage loans – generally have less credit risk than other types of loans. Representing a significant portion of the bank’s loan portfolio before the acquisition of Peoples Financial, loans secured by real estate are still a dominant portion of the portfolio.

     Changes in the Allowance for Loan Losses and Classified Assets. A proper loan review function is vital to establishment of an appropriate loan loss allowance. Loan officers and the bank’s credit analysts are responsible for the assignment of risk ratings for loans reviewed individually. The bank’s internal auditor provides another level of review for selected loans of $200 thousand or more, annually reviewing the credit assignments and the financial analyses performed by credit analysts. Each month a committee consisting of the bank’s President, Controller, and Chief Loan Officer evaluates the loan loss allowance and reports the results of its evaluation to the bank’s board. Finally, the bank adjusts its loan loss allowance methodologies retrospectively as well, making adjustments in its estimates and assumptions as necessary to account for variances of estimated loan losses from actual loan loss experience. The bank’s determination about classification of its assets and the amount of its allowances is subject to review by the Office of the Comptroller of the Currency (OCC), which may order the establishment of additional loss allowances.

     First National Bank’s allowance for loan losses as a percentage of total loans declined significantly in 2002, and increased slightly in 2003. The ratio of the loan loss allowance to loan losses also declined in 2002 with an increase in 2003. The ratio of classified assets to the sum of tier 1 capital plus the allowance for loans losses increased in 2002 and 2003. The reduction in the allowance for loan losses as a percentage of total loans from 1.12% at year-end 2001 to 0.83% at year-end 2002 and 0.85% at year-end 2003 was due mainly to the 63% increase in total loans arising out of the acquisition of Peoples Financial in 2002, which maintained a relatively small loan loss allowance because the vast majority of its loan assets consisted of residential mortgage loans. The ratio of the loan loss allowance to loan losses declined from about 15:1 at the end of 2001 to almost 1:1 by the end of 2002, then increased to approximately 6:1 at the end of 2003. The ratio dropped significantly in 2002 because of a $1.5 million charge-off of a commercial real estate construction loan, which occurred in the fourth quarter of 2002. During 2003 the ratio was impacted by a $200 thousand commercial loan that was charged-off. The ratio of classified assets to the sum of tier 1 capital plus the allowance for loans losses increased from about 12% at the end of 2001 to 25% at the end of 2002, and 26% at the end of 2003 for two principal reasons. First, continued weakness in the local

10

economy and deterioration in the financial circumstances of some of the bank’s commercial borrowers has led to more loans being classified. Secondly, the acquisition of Peoples Federal reduced the bank’s capital ratios.

     First National Bank modified its methodology for analyzing loans under SFAS 5 in 2001. Until 2001 the bank used peer group loan loss experience to estimate the loan loss allowance for this portion of the portfolio. But as the bank accumulated more loan loss experience during periods of strong loan growth, management felt by 2001 that it was appropriate to start using its own loan loss experience to assess the adequacy of the loan loss reserve. This resulted in a lower required reserve balance at year-end 2001 compared to prior periods because First National Bank’s loss rates were lower than peer loss rates. However, the ending reserve balance in 2001 was comparable to 2000 due to additional specific reserves on problem loans. Taking into account the bank’s rapid growth resulting from the April 2002 acquisition of Peoples Financial, the bank’s expansion in the Stark County market, the growing financial stress on borrowers that can result from deteriorating economic conditions such as occurred in 2001 through 2003, and the late 2002 charge off of a large construction loan, the bank is taking actions to improve and make more systematic its loan administration functions, including loan review and monitoring. Loan review and monitoring is vital not only to establishment of an appropriate loan loss allowance but also to proper credit administration and risk management generally. Bank growth outpaced the evolution of the bank’s credit administration and oversight functions, which developed over time in a somewhat informal way as many community banking organizations’ functions do. Until the Peoples Financial acquisition, First National Bank was a community banking organization in the truest sense, with many of the bank’s customers known to the bank’s management by name. In a typical community bank, management is personally familiar with the credit factors that support customers’ loans, including the financial circumstances of commercial borrowers’ organizations, the quality of real estate collateral supporting loans, and similar factors. Although First National Bank remains a community banking organization, management recognizes that – as a significantly larger institution having a broader geographic reach than its historical core market in Orrville – the bank must make more formal and systematic its credit administration, loan review, and associated functions. As part of this ongoing effort, an additional credit analyst was engaged in 2003, and loan reporting and documentation processes are being enhanced to instill greater discipline into the credit administration and oversight functions

     Loans deemed uncollectible are charged against the allowance for loan losses. But even after a loan is charged off, the bank nevertheless attempts recovery when possible. Recoveries of previously charged-off amounts are credited to the allowance for loan losses. Transactions in the allowance for loan losses are summarized as follows –

11

	Year Ended December 31,
	2003			2002			2001			2000			1999
Loan loss allowance, beginning of period	$	1,604,200		$	1,321,152		$	1,343,124		$	1,308,630		$	1,296,513
Loans charged off:
Collateralized by real estate:
Commercial		—			—			20,007			—			—
Residential		—			—			—			—			—
Home equity		—			—			—			—			—
Construction		—			1,475,906			—			—			—
Consumer		9,923			21,943			21,006			34,510			83,039
Commercial		237,526			23,431			38,730			8,720			57,568
Credit cards		20,036			24,706			6,439			13,507			5,352
Other		—			—			—			—			—
Total loans charged off		267,485			1,545,986			86,182			56,737			145,959
Recoveries of loans previously charged off:
Collateralized by real estate:
Commercial		—			—			—			—			—
Residential		—			—			1,451			707			6,407
Home equity		—			—			—			—			—
Construction		—			—			—			—			—
Consumer		8,840			12,151			20,937			24,986			16,894
Commercial		7,320			2,300			1,218			2,002			13,263
Credit cards		5,693			652			604			1,036			1,512
Other		—			—			—			—			—
Total recoveries		21,853			15,103			24,210			28,731			38,076
Net loans recovered (charged off)		(245,632	)		(1,530,883	)		(61,972	)		(28,006	)		(107,883	)
Provision charged to operations		245,000			1,569,402			40,000			62,500			120,000
Allowance of acquired institution		—			244,529			—			—			—
Loan loss allowance, end of period	$	1,603,568		$	1,604,200		$	1,321,152		$	1,343,124		$	1,308,630
Loans outstanding:
Average		187,180,000			172,159,000			110,418,000			104,856,000			97,438,000
End of period		189,068,331			192,530,719			118,403,676			109,155,244			101,155,877
Ratio of allowance for loan losses to total loans outstanding at end of period		0.85	%		0.83	%		1.12	%		1.23	%		1.29	%
Net recoveries (charge offs) to average loans		-0.13	%		-0.89	%		-0.06	%		-0.03	%		-0.11	%

     The allowance for loan losses is allocated among loan categories as shown in the table to follow. The allocation of the allowance to each category is not necessarily indicative of future loss in a particular category. Although a bank considers inherent losses in individual loans and categories of similar loans when it establishes the loan loss allowance, the allowance is a general reserve available to absorb all credit losses in the portfolio. No part of the allowance is segregated for or dedicated to any particular asset or group of assets.

12

	Allocation of the Allowance for Loan Losses at December 31,
	2003					2002					2001
			Percent of					Percent of					Percent of
			loans in					loans in					loans in
			each					each					each
			category to					category to					category to
	Amount		total loans			Amount		total loans			Amount		total loans
Collateralized by real estate:
Commercial	$	462,667		21	%	$	277,776		15	%	$	171,388		20	%
Residential		56,624		54	%		258,377		62	%		74,396		45	%
Home equity		5,592		7	%		14,623		6	%		13,103		8	%
Construction		—		3	%		40,789		1	%		763,783		4	%
Consumer		7,976		3	%		20,497		3	%		58,732		5	%
Commercial		964,121		11	%		967,182		11	%		177,538		15	%
Credit cards		21,760		0	%		24,956		1	%		51,691		1	%
Other		—		1	%		—		1	%		—		2	%
Unallocated		84,828		N/A			—		N/A			10,521		N/A
Total	$	1,603,568		100	%	$	1,604,200		100	%	$	1,321,152		100	%

[Additional columns below]

[Continued from above table, first column(s) repeated]

	Allocation of the Allowance for Loan Losses at December 31,
	2000					1999
			Percent of					Percent of
			loans in					loans in
			each					each
			category to					category to
	Amount		total loans			Amount		total loans
Collateralized by real estate:
Commercial	$	354,665		25	%	$	270,161		25	%
Residential		139,598		38	%		137,223		39	%
Home equity		52,900		8	%		22,169		6	%
Construction		6,067		1	%		12,253		1	%
Consumer		95,309		7	%		119,568		8	%
Commercial		227,919		18	%		273,354		18	%
Credit cards		148,562		1	%		20,309		1	%
Other		—		2	%		—		2	%
Unallocated		318,104		N/A			453,593		N/A
Total	$	1,343,124		100	%	$	1,308,630		100	%

     Management reviews problem loans for unfavorable collectibility factors and assesses the requirement for specific reserves on those credits. Management considers any loan past due 90 days or more and any loan on non-accrual to be a problem loan. Any loan 90 days or more past due that is not both adequately collateralized and in a positive cash-flow position and any loan of a borrower experiencing serious financial deterioration may be placed on non-accrual by the Chief Lending Officer. Interest received on non-accrual loans – also referred to as nonperforming loans – is recorded as a reduction of principal. The table to follow summarizes problem loans and other problem assets by category.

13

	Problem Assets at December 31,
	2003			2002			2001			2000			1999
Collateralized by real estate:
Commercial:
Non-accrual	$	—		$	—		$	142,803		$	93,007		$	90,739
Past due 90 days or more		—			—			—			105,616			138,268
Residential:
Non-accrual		567,590			171,482			103,152			40,137			89,050
Past due 90 days or more		28,578			76,752			71,942			—			57,786
Home equity:
Non-accrual		—			—			12,823			—			—
Past due 90 days or more		23,172			—			—			—			—
Construction:
Non-accrual		125,502			140,000			—			—			—
Past due 90 days or more		—			—			—			—			—
Not collateralized by real estate:
Consumer:
Non-accrual		—			4,964			—			10,987			27,384
Past due 90 days or more		—			—			13,232			5,497			8,560
Commercial:
Non-accrual		677,777			1,841,922			—			—			42,697
Past due 90 days or more		—			252,331			58,749			—			20,011
Credit cards:
Non-accrual		8,989			—			—			—			—
Past due 90 days or more		—			5,690			4,012			980			1,279
Total problem loans		1,431,608			2,493,141			406,713			256,224			475,774
Other real estate owned		—			—			—			—			—
Total problem assets	$	1,431,608		$	2,493,141		$	406,713		$	256,224		$	475,774
Loans outstanding, net	$	187,056,241		$	190,559,663		$	116,880,804		$	107,551,674		$	99,531,223
Problem loans to total net loans		0.77	%		1.31	%		0.35	%		0.24	%		0.48	%
Problem loans to total assets		0.48	%		0.84	%		0.21	%		0.13	%		0.24	%
Allowance for loan losses to total loans		0.85	%		0.83	%		1.12	%		1.23	%		1.29	%
Allowance for loan losses to problem loans		112.01	%		64.34	%		324.84	%		524.20	%		275.05	%

     Securities. To assist in local development, the bank actively purchases bonds issued by local municipalities, school systems, and other public entities when opportunities arise. Other securities are primarily comprised of corporate bonds and notes as well as equity securities of approximately $900 thousand. Investment securities are classified either as held to maturity or as available for sale. The bank does not hold any securities for trading purposes. If management has the intent and the bank has the ability at the time of purchase to hold a security until maturity or on a long-term basis, the security is classified as held-to-maturity and it is reflected on the balance sheet at historical cost. Securities to be held for indefinite periods and not intended to be held to maturity or on a long-term basis are classified as available-for-sale, and they are reflected on the balance sheet at their market value. Management determines the appropriate classification at the time of purchase. At year-end 2003, 2002 and 2001 there was no single issuer of securities where the total book value of such securities exceeded 10% of shareholders’ equity except for United States’ government and agency obligations.

14

     The following table shows the amortized cost and estimated fair value of the bank’s investment portfolio at the dates indicated.

Investment Portfolio Amortized Cost and Fair Value at December 31,

	2003									2002
			Gross		Gross							Gross		Gross
	Amortized		unrealized		unrealized			Fair		Amortized		unrealized		unrealized			Fair
	cost		gains		tosses			value		cost		gains		losses			value
Available for Sale:
U.S. Government and federal agency	$	26,046,048	$	1,047,855	$	(19,375	)	$	27,074,528	$	19,774,745	$	1,244,835	$	(317	)	$	21,019,283
State and municipal		2,261,802		175,194					2,436,996		2,273,996		146,698					2,420,694
Corporate bonds and notes		34,981,032		1,924,041		(79,437	)		36,825,636		25,471,382		1,589,612		(158,648	)		26,902,346
Equity securities		859,940		26,013		(33,550	)		852,403		2,208,602		85,673		(271,766	)		2,022,409
Total available for sale		64,148,822		3,173,103		(132,362	)		67,189,563		49,728,725		3,066,718		(430,731	)		52,364,712
Held to Maturity:
State and municipal		16,603,556		712,328		(15,800	)		17,300,084		18,441,685		668,144		(144,264	)		18,985,565
Total Investment Securities	$	80,752,378	$	3,885,431	$	(148,162	)	$	84,489,647	$	68,170,410	$	3,754,862	$	(574,996	)	$	71,350,277

[Additional columns below]

[Continued from above table, first column(s) repeated]

	2001
			Gross		Gross
	Amortized		unrealized		unrealized			Fair
	cost		gains		losses			value
Available for Sale:
U.S. Government and federal agency	$	16,030,295	$	540,133	$	(2,618	)	$	16,567,812
State and municipal		2,285,595		55,614					2,341,209
Corporate bonds and notes		25,848,708		864,269		(186,053	)		26,326,912
Equity securities		2,356,379		144,125		(227,133	)		2,273,371
Total available for sale		46,320,975		1,604,131		(415,802	)		47,509,304
Held to Maturity:
State and municipal		13,334,351		479,921		(7,694	)		13,806,578
Total Investment Securities	$	59,655,326	$	2,084,052	$	(423,496	)	$	61,315,882

15

The contractual maturity of investment securities at December 31, 2003 is shown below.

	December 31, 2003
						More than one to five					More than five to ten
	One year or less					years					years
	Carrying		Average			Carrying		Average			Carrying		Average
	value		yield			value		yield			value		yield
Available for Sale:
U.S. Government and federal agency	$	1,975,540		8.50	%	$	2,025,000		4.21	%	$	15,488,486		5.37	%
State and political subdivisions:
Tax-exempt		—					—					221,358		7.50	%
Mortgage-backed		2,336		10.05	%		65,382		9.10	%		77,506		8.90	%
Corporate bonds and notes		2,295,391		6.72	%		19,524,438		5.54	%		14,855,013		5.49	%
Total debt securities		4,273,267		7.55	%		21,614,820		5.42	%		30,642,363		5.45	%
Equity securities		—					—					—
Total available for sale		4,273,267		7.55	%		21,614,820		5.42	%		30,642,363		5.45	%
Held to Maturity:
State and political subdivisions:
Tax-exempt		361,973		9.03	%		2,601,577		7.94	%		4,769,951		7.02	%
Total investment securities	$	4,635,240		7.66	%	$	24,216,397		5.69	%	$	35,412,314		5.66	%

[Additional columns below]

[Continued from above table, first column(s) repeated]

	December 31, 2003
						Total investment securities and
	More than ten years					mortgage-backed securities
	Carrying		Average			Carrying		Average			Market
	value		yield			value		yield			value
Available for Sale:
U.S. Government and federal agency	$	5,463,036		6.41	%	$	24,952,062		5.75	%	$	24,952,062
State and political subdivisions:
Tax-exempt		2,215,638		7.84	%		2,436,996		7.81	%		2,436,996
Mortgage-backed		1,977,242		7.86	%		2,122,466		7.94	%		2,122,466
Corporate bonds and notes		150,794		7.47	%		36,825,636		5.60	%		36,825,636
Total debt securities		9,806,710		7.04	%	$	66,337,160		5.81	%		66,337,160
Equity securities		852,403		3.37	%		852,403		3.37	%		852,403
Total available for sale		10,659,113		6.75	%		67,189,563		5.78	%		67,189,563
Held to Maturity:
State and political subdivisions:							—					—
Tax-exempt		8,870,055		6.70	%		16,603,556		7.04	%		17,300,084
Total investment securities	$	19,529,168		6.72	%	$	83,793,119		6.03	%	$	84,489,647

Expected maturities of investment securities could differ from contractual maturities because the borrower, or issuer, could have the right to call or prepay obligations with or without call or prepayment penalties. At year-end 2003, approximately 28% of the bank’s securities portfolio was represented by securities that could be called or prepaid without penalty.

16

     Federal Bank Stock. As of December 31, 2003, the bank held 20,599 shares of $100 par value Federal Home Loan Bank of Cincinnati stock, which are restricted securities. FHLB stock represents an equity interest in the FHLB, but it does not have a readily determinable market value. The stock can be sold at its par value only, and only to the FHLB or to another member institution. Member institutions are required to maintain a minimum stock investment in the FHLB, based on total assets, total mortgages, and total mortgage-backed securities.

     Deposits. Deposits increased 1.5% during 2003, with growth concentrated in demand and savings deposits, offset by a decline in time deposits. First National Bank’s savings accounts include passbook and statement savings, as well as Preferred Savings accounts tiered to pay higher rates for higher balances. First National Bank does not solicit brokered deposits. Savings accounts increased $4.5 million or 5.5% from the end of 2002 to the end of 2003. Noninterest bearing demand deposits, consisting of regular checking accounts, increased $3.0 million or 8.3% and interest bearing demand deposits, which includes Negotiable Order of Withdrawal accounts and Money Market Deposit Accounts, increased $4.5 million or 13.2% during 2003. With certificates of deposit rates declining during 2003, customers moved funds from time deposits into demand and savings accounts. Time deposits under $100,000 decreased $7.9 million or 10.6% during 2003. Time deposits of $100,000 and more decreased by $549 thousand or 4.7% by the end of 2003. The table below shows the amount of time deposits (certificates of deposit) of $100,000 or more by time remaining until maturity as of December 31, 2003.

	Maturity of Time Deposits of
	$100,000 or More at
	December 31, 2003
			Percent of
Time Remaining to Maturity	Amount		total
Three months or less	$	3,676,071		32.8	%
Over three through 12 months		4,790,196		42.7	%
Over one year through 3 years		2,104,573		18.8	%
Over 3 years		640,044		5.7	%
Total	$	11,210,884		100.0	%

     Deposits are the primary sources of funds for lending activities and other general business purposes. Our core deposits at year-end 2003 were approximately $164 million, consisting of demand and savings deposits. This represented 61% of total long-term assets, compared to 59% at year-end 2002. Our net non-core funding dependence ratio was 9.3% at year-end 2003 and 7.9% at year-end 2002. We use the net non-core funding dependence ratio to measure the bank’s dependence on high-cost funding sources to support long-term assets, meaning funding sources other than core funding sources like retail customer deposits. The net non-core funding dependence ratio is calculated as noncore liabilities, such as time deposits over $100,000, repurchase agreements and Federal Home Loan Bank advances, less short-term investments, divided by total long-term investments. One of our goals is to increase the percentage of core or nonmaturity deposits relative to the bank’s long-term assets, enhancing the bank’s liquidity and management of interest-rate risk by increasing the level of low-cost and stable funding sources for the bank’s long-term assets.

     Liquidity and Capital Resources. A bank’s liquidity risk is the risk associated with having to satisfy current and future financial obligations in a timely manner. The bank considers core earnings, strong capital ratios, and credit quality essential for maintaining high credit ratings, which allow the bank cost-effective access to market-based liquidity. Both short- and long-term liquidity needs are addressed by maturities and sales of unpledged investment securities, loan repayments and maturities, sales of loans that are not pledged as security for FHLB borrowings, and transactions in cash and cash equivalents, such as federal funds sold. The use of these resources, combined with access to credit, provide funds for satisfying depositor, borrower, and creditor needs. Management considers the bank to have satisfactory liquidity, with the ability to satisfy the demands of customers and the local economy. Liquidity may be adversely affected by unexpected deposit outflows, excessive interest rates paid by competitors, and similar factors. Management monitors projected liquidity needs and establishes a desirable level based in part on the bank’s commitment to make loans as well as management’s assessment of the bank’s ability to generate funds.

     The most liquid assets are cash and cash equivalents, which at year-end 2003 consisted of $11.5 million in cash and due from banks. At year-end 2002 cash and cash equivalents consisted of $10.0 million in cash and due from banks and $6.3 million in federal funds sold. Federal funds sold are overnight investments with correspondent

17

banks, an investment and liquidity tool that are used to maximize earning assets. Investment securities classified as available for sale that are not pledged are another source of liquidity. In addition to the net non-core funding dependence ratio, we also consider the bank’s loans-to-deposits ratio to assess liquidity, seeking to cap the ratio of loans to deposits at 90%. The ratio of total loans to deposits at year-end 2003 was 78%. At the end of 2003 the fair value of securities available for sale was approximately $67 million, while the total carrying value of securities pledged was approximately $26 million, representing securities pledged to secure public deposits and repurchase agreements. In 2001, securities with a fair value of approximately $30.7 million were transferred from the held to maturity category to available for sale, with the result that most of the bank’s securities, which were once held to maturity, are now available for sale. A new accounting standard that became effective for National Bancshares in 2001 requires companies to record derivatives on the balance sheet as assets and liabilities measured at fair value. The new accounting standard also prohibits classifying as held to maturity any security held for hedging purposes, but companies were permitted to reclassify any security from held to maturity upon adoption of the pronouncement if they desired to be able to hedge the security in the future. In January 2001, National Bancshares adopted the new standard and transferred securities with an amortized cost of approximately $30.5 million and a fair value of approximately $30.7 million from the held to maturity to the available for sale category to take advantage of the flexibility provided by this classification.

     Operating activities provided net cash of $3.4 million in 2003, $3.2 million in 2002, and $2.4 million in 2001, generated principally from net income in those years, but the unusually large $1.6 million provision for loan losses taken in 2002 also contributed to net cash from operations because the provision is a non-cash charge against earnings. Investing activities consist primarily of loan originations, sales, and repayments, along with investment securities purchases, sales, and maturities. In 2001 the approximately $22 million of proceeds from securities maturities and repayments was nearly equally offset by additional securities purchases and net loan originations in that year. After the acquisition of Peoples Federal in 2002, interest rates continued the decline that began in 2000. As mortgage borrowers did nationwide, many of Peoples Federal’s mortgage borrowers took advantage of historically low interest rates to refinance their debt. However, more so than other First National Bank mortgage customers, these former Peoples Federal customers tended to refinance their mortgage borrowings at other institutions. As a consequence, although new loan originations remained robust, loan repayments and maturities exceeded loan originations in 2002 by about $4.6 million. In 2003 investing activities used cash of $9.5 million as investment purchases exceeded investment maturities, repayments and sales and proceeds from sale of loans by approximately $7.0 million. Loan originations by category in the last three years were as follows –

	2003		2002		2001
Collateralized by real estate:
Commercial	$	11,406,806	$	7,424,626	$	6,424,502
Residential		42,976,105		33,609,861		23,139,725
Home equity		2,288,240		1,696,849		2,011,281
Construction		2,567,017		968,832		2,013,334
Consumer		3,447,668		3,315,190		2,851,082
Commercial		9,478,041		11,786,741		8,101,818
Credit cards		504,700		291,900		217,850
Other		317,891		948,473		578,947
Total	$	72,986,468	$	60,042,472	$	45,338,539

     Financing activities include the solicitation and repayment of customer deposits, borrowings and repayments, treasury stock activity, and the payment of dividends. The bank had $17 million of borrowings outstanding with the Federal Home Loan Bank (FHLB) of Cincinnati at the end of 2003, maturing in 2010 and 2011. We had assumed $19.4 million in FHLB advances when we acquired Peoples Financial Corporation in April 2002. First National Bank has approximately $57 million available in short-term funding arrangements with its correspondent banks and the FHLB. Additional information concerning FHLB borrowings and bank obligations under repurchase agreements is contained in Notes 7 and 8 of the consolidated financial statements of National Bancshares. The outstanding balances and related information about short-term borrowings, which consists almost entirely of securities sold under agreements to repurchase are summarized as follows –

18

	Year Ended December 31,
	2003			2002			2001
Balance at year end	$	2,786,848		$	3,006,221		$	3,422,657
Average balance outstanding		2,845,520			3,919,776			3,649,427
Maximum month-end balance		3,385,869			4,775,461			4,700,114
Weighted-average rate at year end		0.10	%		0.12	%		0.25	%
Weighted-average rate during the year		0.13	%		0.17	%		2.22	%

     National Bancshares and the bank are subject to federal regulations imposing minimum capital requirements. We monitor total risk-based, tier I risk-based, and tier I leverage capital ratios to assure compliance with regulatory capital requirements. At December 31, 2003 both National Bancshares and the bank exceeded minimum risk-based and leverage capital ratio requirements. The bank’s ratio of total capital to risk-based assets was 13.09% on December 31, 2003. The minimum required ratio is 8%. Additional information concerning capital ratios at year-end 2003 and 2002 is contained in Note 12 of the consolidated financial statements.

     Contractual Obligations. As discussed in the notes to National Bancshares’ consolidated financial statements, we have obligations to make payments under contracts, including borrowings. At December 31, 2003, the aggregate contractual obligations are –

	Payment due by period
			Less than 1						More than
Contractual Obligations	Total		year		1 - 3 years		3 - 5 years		5 years
Long-term obligations	$	17,034,291	$	—	$	—	$	—	$	17,034,291
Capital lease obligations		—		—		—		—		—
Operating lease obligations		205,916		63,322		86,694		31,200		24,700
Purchase obligations		—		—		—		—		—
Other long-term liabilities reflected on National Bancshares Corporation’s balance sheet under GAAP		—		—		—		—		—
Total	$	17,240,207	$	63,322	$	86,694	$	31,200	$	17,058,991

     Off-Balance Sheet and Contingent Liabilities. Some financial instruments, such as loan commitments, credit lines, and letters of credit are issued to satisfy customers’ financing needs. Ordinarily having fixed expiration dates, these are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are satisfied. Off-balance-sheet risk in the form of potential credit loss exists up to the face amount of these instruments, although we do not expect material losses. We use the same credit policies to make these commitments that we use to make loans, including obtaining collateral at exercise of the commitment. Funding commitments by expiration period were as follows at year-end 2003 –

	Expiration of Funding Commitments
	One year		Over one
	and less		year		Total
Unused loan commitments	$	25,837,109	$	20,479,191	$	46,316,300
Letters of credit		821,000		—		821,000
Total	$	26,658,109	$	20,479,191	$	47,137,300

     Of the unused loan commitments, approximately $5.0 million pertain to fixed-rate commitments and approximately $41.3 million pertain to variable-rate commitments. Rates on unused loan commitments range from 3.0% to 16.9%. Because our experience demonstrates that a large percentage of funding commitments expire unused or only partially used, we believe that the total funding commitments shown in the table above do not necessarily represent actual future cash requirements. The bank earns fees when it issues funding commitments, which are recorded in the consolidated statements of income as interest on loans, including fees. The bank also earns fees from customer overdrafts, which fees are included in checking account fees.

19

     The bank is required by reserve regulations of the Federal Reserve Board to maintain cash on hand or on deposit with the Federal Reserve Bank. Reserve requirements vary according to the amount of a bank’s transaction accounts, checking accounts principally. Reserve balances do not earn interest. First National Bank was required to have cash on hand or on deposit with the Federal Reserve Bank of $3.0 million at year-end 2003 and $2.7 million at year-end 2002.

     The bank occasionally sells loans it originates, particularly conventional residential mortgage loans. These loans are not sold with recourse. The bank has retained mortgage-servicing rights on approximately $5.7 million of residential mortgage loans sold.

     Shareholders’ Equity. The 4.9% increase in shareholders’ equity from year-end 2002 to year-end 2003 is attributable to retained earnings and increased accumulated other comprehensive income, which benefited from the general improvement in the market value of investments available for sale. Accumulated other comprehensive income represents the unrealized appreciation or depreciation (net of taxes) in the market value of debt and equity investments available for sale. Because of interest rate volatility, accumulated other comprehensive income could materially fluctuate for each interim and year-end period, depending on economic and interest rate conditions.

     Because National Bancshares is dependent on the bank for earnings and funds necessary to pay dividends, the ability of National Bancshares to pay dividends to its shareholders is subject to bank regulatory restrictions. According to the National Bank Act and Office of the Comptroller of the Currency (OCC) Rule 5.64, a national bank may never pay a cash dividend without advance OCC approval if the amount of the dividend exceeds retained net income for the year and for the two preceding years (after any required transfers to surplus). To provide funds to National Bancshares for the April 2002 acquisition of Peoples Financial Corporation, First National Bank obtained OCC approval to pay a $12 million special dividend, which exceeded the Rule 5.64 formula amount. As a result, First National Bank may pay no additional cash dividends to National Bancshares through the end of 2004 without additional OCC approval. We believe National Bancshares’ cash resources will allow National Bancshares to continue paying its regular quarterly cash dividend to shareholders through the first half of 2004 without having to obtain OCC approval of a cash dividend from First National Bank. But we expect that OCC approval of one or more dividends from the bank to the holding company will be necessary to continue the regular quarterly cash dividend to shareholders during the second half of 2004. Although we expect that OCC approval can be obtained, taking the bank’s capital position and its continued earnings into account, we cannot assure that the OCC will approve the bank dividend. Assuming First National Bank continues to achieve net earnings in 2004 and into 2005; the requirement to obtain OCC approval for bank dividends should lapse beginning in 2005.

     Interest-Rate Sensitivity. Like other financial institutions, the bank is subject to interest rate risk, which management considers to be the bank’s most significant market risk. Interest rate sensitivity, or interest rate risk, relates to the effect of changing interest rates on net interest income. Interest-earning assets with interest rates tied to the prime rate for example, or that mature in relatively short time periods, are considered interest-rate sensitive. Interest-bearing liabilities with interest rates that can be repriced in a discretionary manner, or that mature in relatively short periods of time, are also considered interest-rate sensitive. The differences between interest-sensitive assets and interest-sensitive liabilities over various time horizons are commonly referred to as sensitivity gaps. As interest rates change, a sensitivity gap will have either a favorable effect or an adverse effect on net interest income. A negative gap – with liabilities repricing more rapidly than assets – generally has a favorable effect when interest rates are falling, and an adverse effect when rates are rising. A positive gap – with assets repricing more rapidly than liabilities – generally has the opposite effect: an adverse effect when rates are falling and a favorable effect when rates are rising. National Bancshares and the bank do not own any trading assets and are not subject to foreign currency exchange or commodity price risk.

     Interest rate risk in total is a product of risks such as repricing risk, option risk, and basis risk. Repricing risk results from differences in the maturity, or repricing, of asset and liability portfolios. Most residential mortgage and consumer loans give consumers the right to prepay with little or no prepayment penalty, and because of competitive pressures commercial lenders might choose not to enforce prepayment penalties on commercial loans. Although First National Bank’s fixed-rate conventional mortgage loans are originated with loan documentation that permits their sale to Freddie Mac, the bank’s policy is generally to retain mortgage loans in its portfolio. A loan prepayment right is, like the right of a depositor to early withdrawal without penalty, a form of embedded option giving the customer the opportunity to benefit when market interest rates change, ordinarily at a bank’s expense in the form of higher costs or lower revenue. Because of the acquisition of Peoples Federal and its loan portfolio dominated by conventional residential mortgage loans, First National Bank’s option risk increased significantly in 2002. This risk declined during 2003 as a substantial number of the mortgage loans acquired from Peoples Federal were refinanced or paid off. Although residential mortgage loans tend to have lower credit risk than other forms of

20

lending, they tend also to have higher option risk and interest rate risk because of this prepayment feature and their long-term nature. Option risk in the form of prepayments also affects the value of mortgage-backed securities. Basis risk refers to the potential for changes in the underlying relationship between market rates and indices, which can result in a narrowing of the profit spread on an earning asset or liability. Basis risk also exists in administered rate liabilities, such as NOW accounts, savings accounts, and money market accounts, whose historical pricing relationships to market rates may change due to the level or directional change in market interest rates.

     Management’s goal is to manage interest rate risk by maintaining the one-year ratio of interest-earning assets to interest-bearing liabilities within a range between 50% and 150%. At year-end 2003 the bank had a negative one-year cumulative gap of -30% of total assets, and a ratio of interest-earning assets to interest-bearing liabilities of 50%. During 2003 the bank changed its classification of savings accounts from repricing in the over one year category to repricing within three months. This created a large negative one-year GAP, but more accurately reflected the bank’s ability to reprice savings accounts. After adjusting prior year’s saving accounts’ classification, this compares to a negative one-year cumulative gap of -26% of total assets at December 31, 2002. The April 2002 acquisition of Peoples Financial and its portfolio of residential mortgage loans increased the percentage of First National Bank’s long-term assets relative to total assets, meaning assets repricing in five or more years. At year-end 2003 long-term interest-earning assets represent 34% of total assets, compared to 32% at year-end 2002. This increases the exposure to interest rate risk. We are taking actions to shorten the maturities of the bank’s assets and lengthen the maturities of the bank’s liabilities, including offering attractive rates on variable rate loans and offering certificate of deposit specials maturing in longer than twelve months.

     The table below shows the maturities or repricing of the bank’s assets and liabilities at year-end 2003 based upon the contractual maturity or contractual repricing dates of loans and the contractual maturities of time deposits. Demand loans, loans having no stated schedule of repayments and no stated maturity, and overdrafts are reported as due in one year or less. Allocation of deposits other than time deposits to the various maturity and repricing periods is based upon management’s best estimate.

21

	Maturing or Repricing Periods
	Within			4 - 12			1 - 5			Over 5
	3 Months			Months			Years			Years			Total
Interest-earning assets:
Interest-bearing deposits in other institutions	$	—		$	999,048		$	—		$	—		$	999,048
Investment securities		1,816,405			5,442,092			27,007,655			49,526,967			83,793,119
Federal bank stock		—			—			—			2,771,350			2,771,350
Loans collateralized by real estate:
Commercial (1)		9,417,501			8,223,114			18,725,133			2,983,297			39,349,045
Residential (1)		7,911,092			17,846,465			29,124,041			46,409,849			101,291,447
Home equity (1)		14,008,018			—			—			—			14,008,018
Construction (1)		2,728,636			244,274			1,755,447			403,328			5,131,685
Consumer loans (1)		593,051			1,300,046			2,934,275			1,272			4,828,644
Commercial (1)		16,365,830			2,074,933			2,928,148			6,000			21,374,911
Credit cards (1)		315,891			947,674			—			—			1,263,565
Other (1)		354,993			325,483			520,519			620,021			1,821,016
Total interest-earning assets	$	53,511,417		$	37,403,129		$	82,995,218		$	102,722,084		$	276,631,848
Interest-bearing liabilities:
Interest-bearing demand	$	31,223,878		$	—		$	—		$	—		$	31,223,878
Money market		7,699,095			—			—			—			7,699,095
Savings		86,636,381			—			—			—			86,636,381
Time		16,805,721			35,780,649			25,774,606			105,675			78,466,651
Short-term borrowings		3,106,411			—			—			—			3,106,411
Other borrowings		—			—			—			17,034,291			17,034,291
Total interest-bearing liabilities	$	145,471,486		$	35,780,649		$	25,774,606		$	17,139,966		$	224,166,707
Interest-sensitivity gap	$	(91,960,069	)	$	1,622,480		$	57,220,612		$	85,582,118		$	52,465,141
Cumulative interest sensitivity gap	$	(91,960,069	)	$	(90,337,589	)	$	(33,116,977	)	$	52,465,141
Cumulative interest sensitivity gap as a percent of total equity		-264.22	%		-259.56	%		-95.15	%		150.74	%
Cumulative interest sensitivity gap as a percent of total assets		-30.53	%		-29.99	%		-10.99	%		17.42	%

(1) For purposes of the gap analysis, loans are not reduced by the allowance for loan losses.

     One way to minimize interest rate risk is to maintain a balanced or matched interest-rate sensitivity position. However, profits are not always maximized by matched funding. To increase net interest income, the bank selectively mismatches asset and liability repricing to take advantage of short-term interest rate movements. The magnitude of the mismatch depends on management’s assessment of the risks presented by forecasted interest rate movements.

     Interest rates change daily on federal funds purchased and sold. Federal funds are therefore the most sensitive to the market and have the most stable fair values. Loans and deposits tied to indices such as the prime rate or federal discount rate are also market sensitive, with stable fair values. The least sensitive instruments include long-term, fixed-rate loans and securities, which have the least stable fair value. Management of maturity distributions of assets and liabilities between these extremes is as important as the balances maintained. Management of maturity distributions involves matching interest rate maturities as well as principal maturities, which can influence net interest income significantly. In periods of rapidly changing interest rates, a negative or positive gap can cause major fluctuations in net interest income and earnings. Managing asset and liability sensitivities to enhance growth regardless of changes in market conditions is one of the objectives of the bank’s asset/liability management strategy.

22

     Management attempts to maintain consistent growth in net interest income and net income while managing interest rate risk within board-approved policy limits. Evaluating the bank’s exposure to changes in interest rates is the responsibility of the Asset/Liability Management Committee, a committee of bank officers meeting monthly and reporting directly to the board. The Asset/Liability Management Committee assesses both the adequacy of the management process used to control interest rate risk and the quantitative level of exposure, monitoring and managing interest rate risk to control the effect of changing interest rates on net interest income and net income. Evaluating the quantitative level of interest rate risk exposure requires assessment of existing and potential effects of changes in interest rates on the bank’s financial condition, including capital adequacy, earnings, liquidity, and asset quality. The Asset/Liability Management Committee also monitors the bank’s liquidity levels. Interest rate risk exposure is reviewed in monthly meetings of the Asset/Liability Committee. Risk is mitigated by matching maturities or repricing opportunities.

     Gap analysis has limitations because it cannot measure the effect of interest rate movements and competitive pressures on the repricing and maturity characteristics of interest-earning assets and interest-bearing liabilities. The static gap analysis is based on assumptions concerning such matters as when assets and liabilities will reprice in a changing interest rate environment. The model assumes that certain assets and liabilities of similar maturity or repricing opportunities will react the same to changes in interest rates. However, certain assets and liabilities indicated as maturing or repricing within a stated period might actually mature or reprice at different times and at different volumes from those estimated. Actual results can differ significantly from simulated results if, for example, market conditions and management strategies vary from the assumptions used in the analysis. The actual prepayments and withdrawals experienced by the bank after a change in interest rates could deviate significantly from those assumed in calculating the data shown in the table. Adjustable-rate loans, for example, commonly have provisions limiting changes in interest rates each time the interest rate changes and on a cumulative basis over the life of the loan. Also, the renewal or repricing of some assets and liabilities can be discretionary and subject to competitive and other pressures. The ability of borrowers to service their debt could diminish after an interest rate increase. Therefore, the gap table above does not and cannot necessarily indicate the actual future impact of general interest movements on net interest income.

     Management also uses an earnings simulation model to assess interest rate sensitivity, which estimates the effect on net interest income and net income assuming various interest rate changes – or “rate shocks” – such as changes of plus or minus 100 basis points or plus 200 basis points. As noted above, during 2003 the bank changed its classification of savings accounts from repricing in the over the one year category to repricing within three months. This change moved the bank from an asset–sensitive position to a liability-sensitive position in the one-year time frame. The bank also incorporated caps and floors on rates into the simulation model to more accurately reflect interest rate movements. Consequently, at year-end 2003 the earnings simulation model predicts a decrease in net interest income and net income assuming interest rates increase, and a slight increase if rates decrease. Being in a liability-sensitive position would dictate an earnings decrease if rates rise. With interest rates at historical lows, and floors set on deposit rates, the model predicts a slight earnings increase if rates drop 100 basis points. Prior year’s model did not incorporate caps and floors and considered savings rates as non-sensitive within a one-year time frame. The bank’s goal is to limit earnings at risk to 15% of projected net income over a one year time period assuming a plus or minus shift of 100 basis points in interest rates. The table to follow shows the predicted effect on net income over one year under the earnings simulation model assuming interest rate changes of plus or minus 100 and plus 200 basis points. This analysis is based on numerous assumptions, including relative levels of market interest rates, loan prepayments, and reactions of depositors to changes in interest rates. The earnings simulation model’s predictions of the effect of rate changes on net income must not be relied upon as being indicative of actual results. Further, it does not necessarily contemplate all actions we might undertake in response to interest rate changes. Management continues to seek non-interest income opportunities and seeks to control expenses in an effort to offset these possible fluctuations in net income.

	Effect of a Change in Interest Rates on Net Income Over a 12-Month Period
(Dollars in thousands)	2003					2002
+ 200 basis points	$	(364	)	-11.8	%	$	286		9.7	%
+ 100 basis points	$	(239	)	-7.7	%	$	187		6.3	%
- 100 basis points	$	6		0.2	%	$	(208	)	-7.0	%

23

     First National Bank also has longer-term interest rate risk exposure, which may not be appropriately measured by earnings sensitivity analysis. Longer-term interest rate risk exposure can be measured using an “economic value of equity” sensitivity analysis. The economic value of equity sensitivity analysis involves discounting cash flows on the balance sheet to present value assuming various interest rate levels. The discounted present value of all cash flows represents the bank’s economic value of equity. The analysis requires modifying the expected cash flows in each interest rate scenario, which affects the discounted present value. We have not performed economic value of equity sensitivity analyses in the past. We are in the process of establishing limits for economic value of equity at risk, and we expect to incorporate this sensitivity analysis into our asset/liability function in 2004 and beyond.

Results of Operations

     First National Bank derives substantially all of its income from banking and bank-related services, including interest earnings on residential real estate, commercial real estate, commercial, and consumer loans and investment securities along with fee income from deposit services. National Bancshares Corporation’s business consists almost exclusively of acting as holding company for the bank. First National Bank’s business is not complex: the bank gathers deposits and it makes loans, principally in Wayne, Stark, and Medina Counties, Ohio. With the acquisition of Peoples Financial completed in April 2002, First National Bank is now solidly established in Stark County.

     Net income declined 10.8% from 2001 to 2002, and increased 17.2% from 2002 to 2003. The principal difference between 2001 and 2002 was the continued decline in interest rates and the acquisition of Peoples Federal in April 2002, which has already been discussed at length. These factors also affected the bank in 2003. The acquisition of Peoples Federal not only increased First National Bank’s total assets and its total loans and deposits, it also contributed to an increase in many expense categories, including salary and benefits for the additional staff, data processing fees and net occupancy expenses, and depreciation expense, as well as increased professional fees included in the “other” expense category. The other most noteworthy factor about 2002 was the write off a large commercial construction credit, which occurred in the fourth quarter of 2002. That accounts for the increase in the provision for loan losses from $40 thousand in 2001 to $1.6 million in 2002.

     Interest and fees on loans increased $2.9 million or 32.5% in 2002 because of the higher average loan volumes attributable to the April 2002 addition of Peoples Federal’s loan portfolio to First National Bank’s. Despite higher average volume in 2003, interest and fees on loans decreased $1.1 million or 9.5% as average yields dropped from 6.96% to 5.79%. Interest and fees on loans in 2003 was also negatively impacted by a $450 thousand acceleration of a purchase accounting adjustment (PAA) related to Peoples Federals’ loans. A PAA was made at the time of the acquisition to adjust the loans acquired from Peoples Federal to market. The PAA is amortized over the average life of the acquired loans. As more Peoples Federal’s loans were paid off or refinanced during 2003 than expected, the PAA was adjusted. Interest on taxable investment securities declined 5.7% in 2002 and increased 6.9% in 2003. The decline in 2002 was due to a decrease in average volume. The increase in 2003 was due principally to higher average volume. Interest on nontaxable obligations of states and political subdivisions also declined in 2002 and increased in 2003. While rates continued to fall during 2002 and 2003, the average volume of nontaxable obligations increased during 2003. The steady decline of interest rates to historically low levels in 2002 and 2003 also affected the bank’s interest expense on deposits, which declined in both of those years. Interest expense on borrowings increased by 197% in 2002 and 35% in 2003 because of the FHLB advances assumed by First National Bank in the April 2002 acquisition of Peoples Federal. Net interest income increased 28% in 2002 and 2.6% in 2003. The Peoples Federal acquisition contributed greatly to the 28% increase in net interest income in 2002. Continued decreases in rates in 2002 and 2003 contributed to the reduction in net yield on interest-earning assets from 4.89% in 2001 to 4.69% in 2002 and 4.34% in 2003.

     Average Balances, Interest Rates and Yields. The average balances of our interest-earning assets and interest-bearing liabilities, interest earned on assets and interest cost of liabilities for the periods indicated, and the average yields earned and rates paid are presented in the table to follow. Yields are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods presented. Average balances are daily averages.

24

	Year Ended December 31,
	2003							2002							2001
	Daily							Daily							Daily
	Average				Average			Average				Average			Average				Average
(Dollars in Thousands)	Balance		Interest		Yield/cost (3)			Balance		Interest		Yield/cost (3)			Balance		Interest		Yield/cost (3)
Assets
Interest earning assets:
Investment securities:
Taxable	$	55,445	$	3,124		5.94	%	$	46,075	$	2,893		6.52	%	$	47,532	$	3,039		6.53	%
Nontaxable (tax equivalent basis)		19,742		1,421		7.26	%		15,826		1,288		8.19	%		18,253		1,523		8.37	%
Federal funds sold		8,233		86		1.04	%		8,614		136		1.58	%		8,469		354		4.18	%
Interest bearing deposits		998		62		6.21	%		1,434		88		6.14	%		1,991		122		6.13	%
Net loans (including nonaccrual loans)		187,180		10,834		5.79	%		172,159		11,974		6.96	%		110,418		9,037		8.18	%
Total interest earning assets		271,598		15,527		5.72	%		244,108		16,379		6.71	%		186,663		14,075		7.54	%
All other assets		22,250							20,245							13,037
Total Assets	$	293,848						$	264,353						$	199,700
Liabilities and Shareholders’ Equity
Interest bearing liabilities
Deposits:
Interest bearing checking	$	35,072	$	207		0.59	%	$	32,431	$	366		1.13	%	$	29,163	$	427		1.46	%
Savings		84,620		844		1.00	%		68,618		1,348		1.96	%		44,117		1,119		2.54	%
Time, $100,000 and over		11,286		362		3.21	%		12,895		464		3.60	%		12,581		654		5.20	%
Time, other		70,699		1,603		2.27	%		68,125		2,207		3.24	%		48,092		2,477		5.15	%
Other funds purchased		20,342		724		3.56	%		17,432		543		3.11	%		6,917		277		4.00	%
Total interest bearing liabilities		222,019		3,740		1.68	%		199,501		4,928		2.47	%		140,870		4,954		3.52	%
Demand deposits		33,807							29,675							26,344
Other liablities		3,165							3,004							1,543
Shareholders’ equity		34,857							32,173							30,943
Total Liabilities and Shareholders’ Equity	$	293,848						$	264,353						$	199,700
Net interest income (tax equivalent basis)			$	11,787						$	11,451						$	9,121
Interest rate spread (1)						4.04	%						4.24	%						4.02	%
Net yield on interest-earning assets (2)						4.34	%						4.69	%						4.89	%
Ratio of average interest-earning assets to average interest-bearing liabilities						122.33	%						122.36	%						132.51	%

(1) Interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities.

(2) Net yield on interest-earning assets represents net interest income as a percentage of average interest-earning assets.

(3) Average yields are computed using annualized interest income and expense for the periods.

25

     Rate/Volume Analysis. Changes in interest income and interest expense attributable to (1) changes in volume (changes in average volume multiplied by prior year rate), and (2) changes in rates (changes in rate multiplied by prior year average volume) are shown in the table to follow. Increases and decreases due to both rate and volume have been allocated proportionally to the change due to volume and the change due to rate.

	Changes in net interest income									Changes in net interest income
	for the year ended									for the year ended
	December 31,2003									December 31,2002
	2003 versus 2002									2002 versus 2001
	Increase (Decrease)									Increase (Decrease)
	Due to Changes In									Due to Changes In
							Net									Net
(Dollars in thousands)	Volume			Rate			Change			Volume			Rate			Change
Interest Income
Investment securities:
Taxable	$	588		($	357	)	$	231		($	93	)	($	53	)	($	146	)
Nontaxable (tax equivalent basis)*		319			(186	)		133			(203	)		(32	)		(235	)
Federal funds sold		(6	)		(44	)		(50	)		6			(224	)		(218	)
Interest bearing deposits		(27	)		1			(26	)		(34	)		0			(34	)
Loans (including nonaccrual loans)		1,045			(2,185	)		(1,140	)		5,053			(2,116	)		2,937
Total interest Income (tax equivalent basis)*	$	1,919		($	2,771	)	($	852	)	$	4,729		($	2,425	)	$	2,304
Interest Expense
Deposits
Interest bearing checking	$	30		($	189	)	($	159	)	$	48		($	109	)	($	61	)
Savings		314			(818	)		(504	)		621			(392	)		229
Time, $100,000 and over		(58	)		(44	)		(102	)		16			(206	)		(190	)
Time, other		83			(687	)		(604	)		1,032			(1,302	)		(270	)
Other funds purchased		91			90			181			421			(155	)		266
Total interest Expense	$	460		($	1,648	)	($	1,188	)	$	2,138		($	2,164	)	($	26	)
Changes in net interest income (tax equivalent basis)*	$	1,459		($	1,123	)	$	336		$	2,591		($	261	)	$	2,330

* Tax equivalence based on highest statutory tax rates of 34%

     Noninterest income grew both in 2002 and in 2003, but at a significantly lower rate in 2003. Occasional sales of investment securities and loans contribute to noninterest income, but in First National Bank’s case the largest consistent contributors to noninterest income are fees charged on checking accounts and “other” noninterest income, which includes safety deposit box rents and other miscellaneous fees and collections.

26

     Noninterest expenses are the cost of doing business. They include salaries and employee benefits, data processing fees, occupancy and depreciation and maintenance expenses, along with miscellaneous other expenses. Noninterest expenses grew 23.4% in 2002 compared to 2001, attributable to higher salary and employee benefit, data processing, net occupancy, and other expenses related to the acquisition of Peoples Financial Corporation. Noninterest expenses grew by 14.3% in 2003 compared to 2002, due mainly to higher salaries and benefits, amortization of intangibles and other miscellaneous expenses. The bank restructured a number of areas during 2003 to support current growth, and better position the organization for future growth. This involved hiring additional lending and support staff. Our efficiency ratio for 2001 was 65.7%, improving slightly to 64.1% in 2002 and increasing to 71.2% in 2003. The efficiency ratio is essentially a measurement of how much it costs to produce an additional dollar of net income. A bank can manage interest rate changes but it cannot control them. A bank can, however, exercise some control over its noninterest expenses. Although there isn’t universal agreement about how an efficiency ratio should be calculated, with slight variations from one user to the next, we calculate our efficiency ratio simply by dividing noninterest expenses by the sum of net interest income and non-interest income. An efficiency ratio of 71% means it costs about 71 cents to produce an additional dollar of net income. Achieving the optimal efficiency ratio (the lower the better) requires careful control of noninterest expenses, but perhaps even more importantly it requires active capitalization on the banking franchise those noninterest expenses support, including robust loan growth and accumulation of low-cost deposits.

Critical Accounting Policies

     National Bancshares’ consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America – GAAP – and follow general practices within the industry in which it operates. Application of these principles requires management to make estimates, assumptions, and judgments based on information available as of the date of the consolidated financial statements, affecting the amounts reported in the financial statements and accompanying notes. Certain policies necessarily require greater reliance on the use of estimates, assumptions, and judgments. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the consolidated financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management, including the use of internal cash-flow modeling techniques. National Bancshares’ most significant accounting policies are presented in Note 1 of the consolidated financial statements. Management considers the allowance for loan losses and the valuation of securities to be the most subjective and the most susceptible to change as circumstances and economic conditions change.

     Allowance for Loan Losses. An allowance for loan losses recorded under GAAP is an institution’s best estimate within a range of the probable amount of loans that – based on current information and events – the institution will be unable to collect. The amount of the allowance is a product of management’s judgment and it is inevitably imprecise. Estimating the allowance requires significant judgment and the use of estimates related to many factors, including the amount and timing of future cash flows on problem loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which are susceptible to significant change. Although management believes that the allowance for loan losses was adequate at December 31, 2003, future adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making the initial determinations. A downturn in the local economy and employment could result in increased levels of nonperforming assets and charge-offs, increased loan loss provisions, and reductions in income. Additionally, as an integral part of the examination process bank regulatory agencies periodically review a bank’s loan loss allowance. The Office of the Comptroller of the Currency (OCC) could require the recognition of additions to the loan loss allowance based on the OCC’s judgment of information available to it at the time of its examination of First National Bank.

     Valuation of Securities. The portfolio of available-for-sale securities is reported at fair value. The fair value of a security is determined based on quoted market prices. If quoted market prices are not available, fair value is determined based on quoted prices of similar instruments. Available-for-sale and held-to-maturity securities are reviewed quarterly for possible other-than-temporary impairment. The review includes an analysis of the facts and circumstances of each individual investment, such as the length of time the fair value has been below cost, the expectation for that security’s performance, the credit worthiness of the issuer, and the bank’s ability to hold the security to maturity. A decline in value that is considered to be other-than-temporary would be recorded as a loss within noninterest income in the consolidated statements of income.

27

New Accounting Pronouncements

     Adoption of New Accounting Standards: During 2003, the Company adopted FASB Statement 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities, FASB Statement 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities, FASB Statement 132 (revised 2003),Employers’ Disclosures about Pensions and Other Postretirement Benefits, FASB Interpretation 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, and FASB Interpretation 46,Consolidation of Variable Interest Entities. Adoption of the new standards did not materially affect the Company’s operating results or financial condition.

     Statement 149 indicates that commitments to make mortgage loans should be accounted for as derivatives if the loans are to be held for sale, because the commitment represents a written option and accordingly is recorded at the fair value of the option liability.

     Statement 150 requires reporting mandatorily redeemable shares as liabilities, as well as obligations not in the form of shares to repurchase shares that may require cash payment and some obligations that may be settled by issuing a variable number of equity shares.

     Statement 132 (revised 2003) requires additional disclosures about the assets, obligations, cash flows of defined benefit pension and post-retirement plans, as well as the expense recorded for such plans.

     Interpretation 45 requires recognizing the fair value of guarantees made and information about the maximum potential payments that might be required, as well as the collateral or other recourse obtainable.Interpretation 45 covers guarantees such as standby letters of credit, performance guarantees, and direct or indirect guarantees of the indebtedness of others, but not guarantees of funding.

     Interpretation 46, as revised in December 2003, changes the accounting model for consolidation from one based on consideration of control through voting interests. Whether to consolidate an entity will now also consider whether that entity has sufficient equity at risk to enable it to operate without additional financial support, whether the equity owners in that entity lack the obligation to absorb expected losses or the right to receive residual returns of the entity, or whether voting rights in the entity are not proportional to the equity interest and substantially all the entity’s activities are conducted for an investor with few voting rights.

28

CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002

	2003			2002
ASSETS
Cash and due from the banks	$	11,506,999		$	10,010,654
Federal funds sold		—			6,315,000
Total cash and cash equivalents		11,506,999			16,325,654
Interest-bearing time deposits with other banks		999,048			997,185
Securities available for sale		67,189,563			52,364,712
Securities held to maturity (fair value: 2003 - $17,300,084; 2002 - $18,985,565)		16,603,556			18,441,685
Federal bank stock		2,771,350			2,689,450
Loans, net of allowance for loan losses: 2003 - $1,603,568; 2002 - $1,604,200		187,056,241			190,559,663
Premises and equipment, net		4,737,018			4,816,253
Goodwill		4,723,075			4,723,075
Identified intangible assets		1,654,086			1,929,734
Accrued interest receivable		1,622,090			1,495,506
Other assets		2,386,349			2,407,248
	$	301,249,375		$	296,750,165
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing	$	38,821,286		$	35,852,184
Interest-bearing		204,026,005			203,445,043
Total deposits		242,847,291			239,297,227
Repurchase agreements		2,786,848			3,006,221
Federal Reserve note account		319,563			1,000,000
Federal Home Loan Bank advances		17,034,291			17,205,743
Accrued expenses and other liabilities		3,456,647			3,050,924
Total liabilities		266,444,640			263,560,115
Shareholders’ equity
Common stock, no par value; 6,000,000 shares authorized; 2,289,528 shares issued		11,447,640			11,447,640
Additional paid-in capital		4,689,800			4,689,800
Accumulated other comprehensive income		2,006,889			1,739,751
Retained earnings		17,849,899			16,502,352
Treasury stock, at cost (55,040 shares)		(1,189,493	)		(1,189,493	)
Total shareholders’ equity		34,804,735			33,190,050
	$	301,249,375		$	296,750,165

See accompanying notes to consolidated financial statements.

29

CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2003, 2002 and 2001

	2003		2002		2001
Interest and dividend income
Loans, including fees	$	10,833,688	$	11,974,356	$	9,036,841
Federal funds sold		85,635		136,263		353,756
Securities:
Taxable		3,186,618		2,980,610		3,160,784
Nontaxable		937,868		849,924		1,005,366
Total interest and dividend income		15,043,809		15,941,153		13,556,747
Interest expense
Deposits		3,016,172		4,384,154		4,677,652
Short-term borrowings		6,996		13,551		98,275
Federal Home Loan Bank advances		716,848		530,069		178,430
Total interest expense		3,740,016		4,927,774		4,954,357
Net interest income		11,303,793		11,013,379		8,602,390
Provision for loan losses		245,000		1,569,402		40,000
Net interest income after provision for loan losses		11,058,793		9,443,977		8,562,390
Noninterest income
Checking account fees		752,833		754,341		656,441
Gain on sale of loans		115,982		8,409		43,750
Securities gains, net		72,290		182,324		97,003
Other		590,915		512,957		348,044
Total noninterest income		1,532,020		1,458,031		1,145,238
Noninterest expense
Salaries and employee benefits		4,844,909		4,338,987		3,517,438
Data processing fees		794,932		738,643		627,799
Net occupancy expense		404,489		345,858		216,709
Depreciation - - furniture and fixtures		353,601		327,634		237,967
Franchise taxes		321,824		302,880		314,869
Maintenance and repairs		267,261		238,735		197,234
Amortization of intangibles		275,647		145,227		52,330
Other		1,877,853		1,560,810		1,238,759
Total noninterest expense		9,140,516		7,998,774		6,403,105
Income before income taxes		3,450,297		2,903,234		3,304,523
Income tax expense		806,746		648,460		777,320
Net income	$	2,643,551	$	2,254,774	$	2,527,203
Weighted average common shares outstanding		2,234,488		2,228,510		2,230,013
Basic and diluted earnings per common share	$	1.18	$	1.01	$	1.13

See accompanying notes to consolidated financial statements.

30

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years ended December 31, 2003, 2002 and 2001

						Accumulated
			Additional			Other									Total
	Common		Paid-in			Comprehensive			Retained			Treasury			Shareholders’
	Stock		Capital			Income			Earnings			Stock			Equity
Balance at January 1, 2001	$	11,447,640	$	4,689,800		$	(127,139	)	$	14,292,805		$	(1,363,777	)	$	28,939,329
Comprehensive income:
Net income										2,527,203						2,527,203
Other comprehensive income							911,436									911,436
Total comprehensive income																3,438,639
Cash dividends declared ($.52 per share)										(1,158,687	)					(1,158,687	)
Shares issued under dividend reinvestment plan (2,905 shares)										(40,386	)		87,738			47,352
Purchase of 20,856 treasury shares													(344,445	)		(344,445	)
Balance at December 31, 2001		11,447,640		4,689,800			784,297			15,620,935			(1,620,484	)		30,922,188
Comprehensive income:
Net income										2,254,774						2,254,774
Other comprehensive income							955,454									955,454
Total comprehensive income																3,210,228
Cash dividends declared ($.54 per share)										(1,203,946	)					(1,203,946	)
Shares issued under dividend reinvestment plan (14,295 shares)										(169,411	)		430,991			261,580
Balance at December 31, 2002		11,447,640		4,689,800			1,739,751			16,502,352			(1,189,493	)		33,190,050
Comprehensive income:
Net income										2,643,551						2,643,551
Other comprehensive income							267,138									267,138
Total comprehensive income																2,910,689
Cash dividends declared ($.58 per share)										(1,296,004	)					(1,296,004	)
Balance at December 31, 2003	$	11,447,640	$	4,689,800		$	2,006,889		$	17,849,899		$	(1,189,493	)	$	34,804,735
					��

See accompanying notes to consolidated financial statements

31

CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2003, 2002 and 2001

	2003			2002			2001
Cash flows from operating activities
Net income	$	2,643,551		$	2,254,774		$	2,527,203
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses		245,000			1,569,402			40,000
Depreciation, amortization and accretion		685,769			443,887			160,688
Federal Home Loan Bank stock dividend		(81,900	)		(64,300	)		(51,500	)
Gain on sale of loans		(115,982	)		(8,409	)		(43,750	)
Net security gains		(72,290	)		(182,324	)		(97,003	)
Change in other assets and liabilities		140,078			(771,589	)		(108,410	)
Net cash from operating activities		3,444,226			3,241,441			2,427,228
Cash flows from investing activities
Net change in interest-bearing deposits with banks		(1,863	)		996,826			(4,571	)
Securities held to maturity
Proceeds from maturities and repayments		2,412,599			3,610,036			4,581,349
Purchases		(636,911	)		(7,917,091	)		(504,500	)
Securities available for sale
Proceeds from maturities and repayments		8,442,092			9,881,758			17,576,405
Proceeds from sales		2,071,143			5,317,609			134,171
Purchases		(24,668,182	)		(13,587,788	)		(12,902,383	)
Purchase of Federal Bank Stock		—			(450,550	)		—
Cash paid for acquisition, net of cash received		—			(1,123,425	)		—
Capital expenditures		(461,306	)		(580,424	)		(691,077	)
Proceeds from sale of loans		5,432,154			1,195,026			1,598,277
Net change in loans to customers		(2,057,750	)		4,558,543			(10,923,657	)
Net cash from investing activities		(9,468,024	)		1,900,520			(1,135,986	)
Cash flow from financing activities
Net change in deposits		3,550,064			5,782,993			(2,494,290	)
Net change in short-term borrowings		(899,810	)		472,331			(1,030,893	)
Repayments of Federal Home Loan Bank advances		(171,452	)		(4,413,550	)		(1,238,279	)
Dividends paid		(1,273,659	)		(1,179,743	)		(1,183,402	)
Dividends reinvested		—			261,580			47,352
Purchase of treasury shares		—			—			(344,445	)
Net cash from financing activities		1,205,143			923,611			(6,243,957	)
Net change in cash and cash equivalents		(4,818,655	)		6,065,572			(4,952,715	)
Beginning cash and cash equivalents		16,325,654			10,260,082			15,212,797
Ending cash and cash equivalents	$	11,506,999		$	16,325,654		$	10,260,082
Supplemental disclosures
Cash paid for interest	$	3,817,233		$	4,964,995		$	5,329,612
Cash paid for income taxes, net of refunds		940,000			591,091			770,000
Non-cash items:
Securities transferred from held to maturity to available for sale	$	—		$	—		$	30,661,985

See accompanying notes to consolidated financial statements.

32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations and Principles of Consolidation: The consolidated financial statements include National Bancshares Corporation and its wholly-owned subsidiary, First National Bank, Orrville, Ohio, together referred to as “the Corporation.” Intercompany transactions and balances are eliminated in consolidation.

The Corporation provides financial services through its offices in Orrville, Ohio, and surrounding communities. Its primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are commercial and residential mortgage, commercial and consumer installment loans. Most loans are secured by specific items of collateral including business assets, consumer assets and real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by both residential and commercial real estate. Other financial instruments, which potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

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

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

Cash Flows: Cash and cash equivalents include cash, deposits with other financial institutions with original maturities under 90 days, and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, short-term borrowings and deposits with other banks.

Securities: Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income.

Federal bank stock in the consolidated financial statements consists of Federal Reserve Bank and Federal Home Loan Bank stock. These securities are carried at cost.

(Continued)

33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Interest income includes amortization of purchase premium or discount. Gains and losses on sales are based on the amortized cost of the security sold. Securities are written down to fair value when a decline in fair value is not temporary.

Loans: Loans are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses. Loans held for sale are reported at the lower of cost or fair value, on an aggregate basis.

Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Interest income is not reported when full loan repayment is in doubt, typically when the loan is impaired or payments are past due over 90 days unless the credit is well-secured and in process of collection. Payments received on such loans are reported as principal reductions.

All interest accrued but not received for loans placed on nonaccrual is reversed against income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

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

Foreclosed Assets: Assets acquired through or instead of loan foreclosure are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed.

(Continued)

34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 7 to 39 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 7 years.

Bank Owned Life Insurance: The Corporation has purchased life insurance policies on its directors. Life insurance is recorded at its cash surrender value, or the amount that can be realized.

Goodwill and Other Intangible Assets: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable assets. Under a new accounting pronouncement that became effective in 2002, goodwill is not amortized but rather is assessed at least annually for impairment and any such impairment will be recognized in the period identified.

Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank and branch acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives which is 10 years.

The Corporation also has intangible assets associated with a prior branch acquisition, including unidentified intangibles of $173,000 and $203,000 and core deposit value of $14,000 and $31,000 at year-end 2003 and 2002. Management does not believe that this purchase constituted a business combination and therefore is continuing to amortize the unidentified intangible asset.

Long-term Assets: These assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Repurchase Agreements: Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.

Benefit Plans: Retirement plan expense is the amount of required matching contributions plus any discretionary contributions to the Corporation’s 401(k) plan as determined by Board decision. Deferred compensation plan expense allocates the benefits over the estimated years of service.

(Continued)

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Income Taxes: Income tax expense is the total of the current-year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

Financial Instruments: Financial instruments include credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay.

Earnings Per Common Share: Earnings per common share are calculated based on the weighted average number of shares outstanding during the period. There are no potentially dilutive instruments.

Comprehensive Income: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, which is also recognized as a separate component of equity.

Loss Contingencies: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.

Dividend Restriction: Banking regulations require maintaining certain capital levels and limit the dividends paid by the bank to the holding company. Dividends paid by the bank to the holding company are the primary source of funds for dividends by the holding company to its shareholders.

Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

(Continued)

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

Adoption of New Accounting Standards: During 2003, the Company adopted FASB Statement 149,Amendment of Statement 133 on Derivative Instruments and Hedging Activities, FASB Statement 150,Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equities, FASB Statement 132 (revised 2003),Employers’ Disclosures about Pensions and Other Postretirement Benefits, FASB Interpretation 45,Guarantor’s Accounting and Disclosure Requirements for Guarantees, and FASB Interpretation 46,Consolidation of Variable Interest Entities. Adoption of the new standards did not materially affect the Company’s operating results or financial condition.

Statement 149 indicates that commitments to make mortgage loans should be accounted for as derivatives if the loans are to be held for sale, because the commitment represents a written option and accordingly is recorded at the fair value of the option liability.

Statement 150 requires reporting mandatorily redeemable shares as liabilities, as well as obligations not in the form of shares to repurchase shares that may require cash payment and some obligations that may be settled by issuing a variable number of equity shares.

Statement 132 (revised 2003) requires additional disclosures about the assets, obligations, cash flows of defined benefit pension and post-retirement plans, as well as the expense recorded for such plans.

Interpretation 45 requires recognizing the fair value of guarantees made and information about the maximum potential payments that might be required, as well as the collateral or other recourse obtainable. Interpretation 45 covers guarantees such as standby letters of credit, performance guarantees, and direct or indirect guarantees of the indebtedness of others, but not guarantees of funding.

Interpretation 46, as revised in December 2003, changes the accounting model for consolidation from one based on consideration of control through voting interests. Whether to consolidate an entity will now also consider whether that entity has sufficient equity at risk to enable it to operate without additional financial support, whether the equity owners in that entity lack the obligation to absorb expected losses or the right to receive residual returns of the entity, or whether voting rights in the entity are not proportional to the equity interest and substantially all the entity’s activities are conducted for an investor with few voting rights.

Reclassifications: Certain items in the prior year financial statements were reclassified to conform to the current presentation.

(Continued)

37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 2 - ACQUISITION

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

Identified intangible assets totaling $728,000 were recognized and have average useful lives of 7 to 10 years and the amortization is not tax deductible. Goodwill of $4,723,000 represents the acquisition cost in excess of book value of $5,561,000, less adjustment to reflect fair values of $1,154,000 net of tax, plus merger related expenses of $316,000.

NOTE 3 - SECURITIES

Year-end securities are as follows:

	Gross		Gross
	Unrealized		Unrealized			Fair
	Gains		Losses			Value
Available for Sale
2003
U.S. Government and federal agency	$	730,120	$	(19,375	)	$	24,952,062
State and municipal		175,194		—			2,436,996
Corporate bond and notes		1,924,041		(79,437	)		36,825,636
Mortgage backed		317,735		—			2,122,466
Total debt securities		3,147,090		(98,812	)		66,337,160
Equity securities		26,013		(33,550	)		852,403
Total	$	3,173,103	$	(132,362	)	$	67,189,563
2002
U.S. Government and federal agency	$	1,244,835	$	(317	)	$	21,019,263
State and municipal		146,698		—			2,420,694
Corporate bonds and notes		1,589,612		(158,648	)		26,902,346
Total debt securities		2,981,145		(158,965	)		50,342,303
Equity securities		85,573		(271,766	)		2,022,409
Total	$	3,066,718	$	(430,731	)	$	52,364,712

(Continued)

38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 3 - SECURITIES(Continued)

			Gross		Gross
	Carrying		Unrecognized		Unrecognized			Fair
	Value		Gains		Losses			Value
Held to Maturity
2003
State and municipal	$	16,603,556	$	712,328	$	(15,800	)	$	17,300,084
2002
State and municipal	$	18,441,685	$	688,144	$	(144,264	)	$	18,985,565

Sales of available for sale securities were as follows:

	2003		2002		2001
Proceeds	$	2,071,143	$	5,317,609	$	134,701
Gross gains		234,331		227,679		97,003
Gross losses		162,041		45,355		—

Contractual maturities of debt securities at year-end 2003 were as follows:

	Available for Sale		Held to Maturity
	Fair		Carrying		Fair
	Value		Value		Value
Due in one year or less	$	4,380,096	$	361,973	$	368,920
Due from one to five years		21,616,532		2,601,577		2,755,716
Due from five to ten years		30,642,362		4,769,947		4,990,198
Due after ten years		9,698,170		8,870,059		9,185,250
Total	$	66,337,160	$	16,603,556	$	17,300,084

(Continued)

39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 3 - SECURITIES(Continued)

Securities with unrealized losses at year end 2003 not recognized in income are as follows:

	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securities	Value		Loss			Value		Loss			Value		Loss
Government and Federal Agency	$	1,979,375	$	(19,375	)	$	—	$	—		$	1,979,375	$	(19,375	)
State and Municipal		316,346		(1,832	)		1,720,120		(13,968	)		2,036,466		(15,800	)
Corporate bonds and notes		10,645,436		(79,437	)		—		—			10,645,436		(79,437	)
Equity securities		—		—			213,642		(33,550	)		213,642		(33,550	)
Total temporarily impaired	$	12,941,157	$	(100,644	)	$	1,933,762	$	(47,518	)	$	14,874,919	$	(148,162	)

Unrealized losses have not been recognized into income because the issuer(s) securities are of high credit quality, management has the intent and ability to hold for the foreseeable future, and the decline in fair value is largely due to increases in market interest rates or normally expected market pricing fluctuations. The fair value of debt securities is expected to recover as the bond(s) approach their maturity date and/or market rates decline.

Securities pledged at year-end 2003 and 2002 had carrying values of $25,811,397 and $26,654,000, and were pledged to secure public deposits and repurchase agreements.

(Continued)

40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 4 - LOANS

Loans at year-end were as follows:

	2003			2002
Collateralized by real estate:
Commercial	$	39,349,045		$	28,747,949
Residential		101,291,447			118,834,883
Home equity		14,008,018			12,555,738
Construction		5,131,685			2,065,964
		159,780,195			162,204,534
Other:
Consumer		4,828,644			4,847,264
Commercial		21,374,911			21,631,567
Credit cards		1,263,565			1,276,587
Other		1,821,016			2,570,767
		189,068,331			192,530,719
Unearned and deferred income		(408,522	)		(366,856	)
Allowance for loan losses		(1,603,568	)		(1,604,200	)
Total	$	187,056,241		$	190,559,663

Activity in the allowance for loan losses for the year was as follows:

	2003			2002			2001
Beginning balance	$	1,604,200		$	1,321,152		$	1,343,124
Provision for loan losses		245,000			1,569,402			40,000
Loans charged-off		(267,485	)		(1,545,986	)		(86,182	)
Recoveries		21,853			15,103			24,210
Allowance of acquired institution		—			244,529			—
Ending balance	$	1,603,568		$	1,604,200		$	1,321,152

Loans charged off in 2002 consisted primarily of one commercial relationship which was determined to be uncollectible and charged off in the fourth quarter of 2002.

(Continued)

41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 4 - LOANS(Continued)

Impaired loans were as follows:

	2003		2002
Year-end loans with no allocated allowance for loan losses	$	125,502	$	—
Year-end loans with allocated allowance for loan losses		251,081		1,436,332
Amount of the allowance for loan losses allocated		100,000		215,450
Average of impaired loans during the year	$	837,670	$	571,240
Interest income recognized during impairment		362		26,104
Cash-basis interest income recognized		362		26,104

Loans past due over 90 days and still accruing interest at year-end 2003 and 2002 were $51,749 and $334,774. Nonaccrual loans for the same periods were $1,379,857 and $1,612,778. Non-performing loans consist primarily of residential real estate, commercial and consumer loans.

NOTE 5 - PREMISES AND EQUIPMENT

Year-end premises and equipment were as follows:

	2003		2002
Land	$	1,114,306	$	1,114,306
Buildings		5,418,947		5,355,995
Furniture, fixtures and equipment		4,525,832		4,550,729
		11,059,085		11,021,030
Less: Accumulated depreciation		6,322,067		6,204,777
	$	4,737,018	$	4,816,253

Depreciation included in noninterest expense was $540,541, $493,649 and $338,036 in 2003, 2002 and 2001.

(Continued)

42

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 6 - DEPOSITS

Year-end deposits were as follows:

	2003		2002
Demand, noninterest-bearing	$	38,821,286	$	35,852,184
Demand, interest-bearing		38,922,973		34,396,647
Savings		86,636,381		82,091,395
Time, $100,000 and over		11,210,884		11,760,381
Time, other		67,255,767		75,196,620
	$	242,847,291	$	239,297,227

A summary of time deposits at year-end 2003 by maturity follows:

2004	$	52,586,370
2005		13,252,701
2006		8,433,766
2007		4,000,598
2008 and thereafter		193,216
	$	78,466,651

NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES

     At year-end, advances from the Federal Home Loan Bank were as follows:

	2003		2002
Maturity in 2010, fixed rate at 6.26%, convertible to variable rate if 3-month LIBOR is at or above predetermined conversion rate level	$	1,000,000	$	1,000,000
Maturities in 2010 and 2011, fixed rate at 4.60% to 5.79%, convertible to variable rates at the option of the FHLB at various dates through 2004		16,034,291		16,205,743
Total	$	17,034,291	$	17,205,743

Each advance is payable at its maturity date; advances may be paid prior to maturity with a prepayment penalty. As collateral for the advances, the Bank has approximately $91,949,000 million of first mortgage loans available under a blanket lien arrangement at year-end 2003.

(Continued)

43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES(Continued)

Required principal payments are:

	Rate
2010		5.00 to 6.26	%	$	11,022,186
2011		4.60 to 5.12	%		6,012,105
				$	17,034,291

NOTE 8 - REPURCHASE AGREEMENTS

Repurchase agreements generally mature within thirty days from the transaction date. Information concerning repurchase agreements is summarized as follows:

	2003			2002
Average balance during the year	$	2,845,520		$	3,919,776
Average interest rate during the year		0.13	%		0.17	%
Maximum month-end balance during the year		3,385,869			4,775,461

NOTE 9 - BENEFIT PLANS

The Corporation has a 401(k) retirement plan that covers substantially all employees. The plan allows employees to contribute up to a predetermined amount, subject to certain limitations, with the Corporation matching 50% of contributions up to 6% of an employee’s pay. Discretionary contributions may also be made to the plan. Total matching and discretionary contributions made by the Corporation during 2003, 2002 and 2001 amounted to $137,656, $133,947 and $111,636.

The Corporation has an Employee Stock Purchase Incentive Plan for full-time and most part-time employees. Under the Plan, each employee is entitled to receive a cash payment equal to 20% of the purchase price of Corporation common stock acquired by the employee on the open market, up to a maximum of 100 shares per calendar year. Expense recognized in 2003, 2002 and 2001 amounted to $4,755, $2,256 and $3,011.

The Corporation has a director retirement and death benefit plan for the benefit of all members of the Board of Directors. The plan is designed to provide an annual retirement benefit to be paid to each director upon retirement from the Board and attaining age 70. The retirement benefit provided to each director is an annual benefit equal to $1,000 for each year of service on the Board from and after August 24, 1994. In addition, each director has the option of deferring

(Continued)

44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 9 - BENEFIT PLANS(Continued)

any portion of directors’ fees to a maximum of $5,000 per month until retirement. Expense recognized in 2003, 2002 and 2001 for the director retirement and death benefit plan was $48,898, $ 47,088 and $36,804.

NOTE 10 - INCOME TAXES

The components of deferred taxes were as follows:

			2003			2002
Deferred tax assets:
	Bad debts		$	385,083		$	360,332
	Deferred loan fees			136,631			122,036
	Core deposit intangibles			38,251			39,473
	Deferred compensation			207,369			178,971
	Investment in financial stock fund			19,900			—
		Total		787,234			700,812
Deferred tax liabilities:
	Securities accretion			57,305			65,726
	Depreciation			258,360			211,908
	Federal Home Loan Bank stock dividends			397,290			369,444
	Investment in financial stock fund			—			30,436
	Purchase accounting adjustments			717,083			820,687
	Unrealized securities gains			1,033,851			896,236
		Total		2,463,889			2,394,437
Net deferred tax asset (liabilities)			$	(1,676,655	)	$	(1,693,625	)

Federal income tax laws provided that the 2002 acquired entity could claim additional bad debt deductions through 1987, totaling $1.9 million. Accounting standards do not require a deferred tax liability to be recorded on this amount, which liability otherwise would total $646,000 at December 31, 2003. If First National were liquidated or otherwise ceases to be a bank or if tax laws were to change, this amount would be expensed.

(Continued)

45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 10 - INCOME TAXES(Continued)

The components of income tax expense are as follows:

		2003			2002		2001
Currently payable		$	961,331		$	474,567	$	760,750
Deferred			(154,585	)		173,893		16,570
	Total	$	806,746		$	648,460	$	777,320

The following is a reconciliation of income tax at the federal statutory rate to the effective rate of tax on the financial statements:

	Years Ended December 31,
	2003						2002						2001
	Rate			Amount			Rate			Amount			Rate			Amount
Tax at federal statutory rate		34	%	$	1,173,101			34	%	$	987,100			34	%	$	1,123,538
Tax-exempt income		(10	)		(331,423	)		(9	)		(300,078	)		(10	)		(339,366	)
Other		(1	)		(34,932	)		(1	)		(38,562	)		—			(6,852	)
Income tax expense		23	%	$	806,746			24	%	$	648,460			24	%	$	777,320

NOTE 11 - RELATED PARTY TRANSACTIONS

Loans to principal officers, directors, and their affiliates in 2003 were as follows:

Beginning balance	$	3,418,557
New loans		1,648,847
Repayments		(1,690,410	)
Ending balance	$	3,376,994

Unused commitments to these related parties totaled $2,255,000 at year-end 2003. Related party deposits totaled $4,347,000 and $5,327,000 at year-end 2003 and 2002.

(Continued)

46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 12 - REGULATORY MATTERS

The Bank is restricted by regulation in the amount of dividends it may pay to the holding company. As part of the acquisition of Peoples Financial in 2002, the Bank paid a special $12 million dividend to the holding company. As a result of this dividend, no additional Bank dividends to the parent company can be paid through at least the end of 2004 without prior regulatory approval.

The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action.

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions, asset growth and expansion are limited and capital restoration plans are required. The Corporation and the Bank are considered well capitalized for regulatory purposes. Management is not aware of any matters after December 31, 2003 that would cause its capital category to change.

(Continued)

47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 12 - REGULATORY MATTERS(Continued)

Actual and required capital amounts and ratios are presented below at year-end.

												To Be Well
												Capitalized Under
							For Capital					Prompt Corrective
		Actual					Adequacy Purposes					Action Provisions
(Dollars in thousands)		Amount		Ratio			Amount		Ratio			Amount		Ratio
2003
Total capital to risk-weighted assets
	Consolidated	$	28,013		13.59	%	$	16,487		8.00	%	$	20,609		10.00	%
	Bank		26,902		13.09			16,435		8.00			20,544		10.00
Tier 1 capital to risk-weighted assets
	Consolidated		26,398		12.81			8,243		4.00			12,365		6.00
	Bank		25,298		12.31			8,218		4.00			12,327		6.00
Tier 1 capital to average assets
	Consolidated		26,398		9.04			11,685		4.00			14,607		5.00
	Bank		25,298		8.68			11,657		4.00			14,571		5.00
2002
Total capital to risk-weighted assets
	Consolidated	$	26,527		13.58	%	$	15,628		8.00	%	$	19,535		10.00	%
	Bank		24,362		12.59			15,482		8.00			19,353		10.00
Tier 1 capital to risk-weighted assets
	Consolidated		24,923		12.76			7,814		4.00			11,721		6.00
	Bank		22,758		11.76			7,741		4.00			11,612		6.00
Tier 1 capital to average assets
	Consolidated		24,923		8.61			11,574		4.00			14,468		5.00
	Bank		22,758		7.91			11,503		4.00			14,379		5.00

(Continued)

48

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 13 - COMMITMENTS, CONTINGENCIES AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contract are met. These agreements usually have fixed expiration dates. Commitments may expire without being used. Off-balance-sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.

Financial instruments with off-balance-sheet risk were as follows at year-end:

	2003		2002
Unused lines of credit	$	46,316,300	$	35,860,000
Letters of credit		821,000		998,000

Of the above unused lines of credit for 2003, approximately $5,044,000 pertains to fixed-rate commitments, and variable-rate commitments account for approximately $41,273,000. In addition, rates on unused lines of credit range from 3.00% to 16.90%.

The Corporation was required to have approximately $2,961,000 and $2,705,000 of cash on hand or on deposit with the Federal Reserve Bank at year-end 2003 and 2002. These balances do not earn interest.

(Continued)

49

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 14 - FAIR VALUES OF FINANCIAL INSTRUMENTS

Carrying amount and estimated fair values of financial instruments were as follows at year-end:

		2003						2002
		Carrying			Fair			Carrying			Fair
		Amount			Value			Amount			Value
Financial assets
	Cash and cash equivalents	$	11,506,999		$	11,507,000		$	16,325,654		$	16,326,000
	Interest-bearing deposits		999,048			999,000			997,185			1,000,000
	Securities available for sale		67,189,563			67,190,000			52,364,712			52,365,000
	Securities held to maturity		16,603,556			17,300,000			18,441,685			18,986,000
	Federal bank stock		2,771,350			2,771,000			2,689,450			2,689,000
	Loans, net		187,056,241			187,116,000			190,559,663			195,398,000
	Accrued interest receivable		1,622,090			1,622,000			1,495,506			1,496,000
Financial liabilities
	Deposits		(242,847,291	)		(243,461,000	)		(239,297,227	)		(239,938,000	)
	Short-term borrowings		(3,106,411	)		(3,106,000	)		(4,006,221	)		(4,006,000	)
	Federal Home Loan Bank advances		(17,034,291	)		(18,373,000	)		(17,205,743	)		(17,546,000	)
	Accrued interest payable		(454,790	)		(455,000	)		(532,007	)		(532,000	)

The methods and assumptions used to estimate fair value are described as follows.

Carrying amount is the estimated fair value for cash and cash equivalents, short-term borrowings, Federal bank stock, accrued interest receivable and payable, demand and savings deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of loans held for sale is based on market quotes. Fair value of debt is based on current rates for similar financing. The fair value of off-balance-sheet items, based on the current fees or cost that would be charged to enter into or terminate such arrangements, is not material.

(Continued)

50

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 15 — OTHER COMPREHENSIVE INCOME

Other comprehensive income components and related taxes were as follows.

	2003			2002			2001
Unrealized holding gains on available-for-sale securities	$	477,045		$	1,629,982		$	1,343,599
Cumulative effect of adopting new accounting standard		—			—			134,368
Less reclassification adjustment for gains later recognized in income		(72,290	)		(182,324	)		(97,003	)
Net unrealized gains		404,755			1,447,658			1,380,964
Tax effect		(137,617	)		(492,204	)		(469,528	)
Other comprehensive income	$	267,138		$	955,454		$	911,436

NOTE 16 — PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION

Condensed financial statements for National Bancshares Corporation (parent only) are as follows:

BALANCE SHEETS

			December 31,
			2003		2002
Assets
	Cash		$	781,087	$	600,316
	Investment in Bank subsidiary			33,704,009		31,025,731
	Securities available for sale			660,711		1,817,490
	Other assets			—		59,341
		Total assets	$	35,145,807	$	33,502,878
Liabilities and shareholders’ equity
	Dividends payable		$	335,173	$	312,828
	Other liabilities			5,899		—
	Shareholders’ equity			34,804,735		33,190,050
		Total liabilities and shareholders’ equity	$	35,145,807	$	33,502,878

(Continued)

51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 16 - PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
(Continued)

STATEMENTS OF INCOME

			Years ended December 31,
			2003			2002			2001
Income
	Dividends from Bank subsidiary		$	—		$	12,200,000		$	2,851,398
	Other dividends			25,210			25,970			28,715
	Securities gains, net			110,607			148,002			97,003
		Total income		135,817			12,373,972			2,977,116
Expenses
	Miscellaneous expense			(30,049	)		(52,296	)		(33,100	)
Undistributed equity in (distributions in excess of) net income of Bank subsidiary				2,537,783			(10,066,902	)		(416,813	)
	Net income		$	2,643,551		$	2,254,774		$	2,527,203

STATEMENTS OF CASH FLOWS

			Years ended December 31,
			2003			2002			2001
Cash flows from operating activities
	Net income		$	2,643,551		$	2,254,774		$	2,527,203
	Adjustments to reconcile net income to net cash from operating activities:
		Distributions in excess of (equity in undistributed) net income of Bank subsidiary		(2,537,783	)		10,066,902			416,813
		Net security gains		(110,607	)		(148,002	)		(97,003	)
		Change in other assets and liabilities		—			141,192			(141,192	)
		Net cash from operating activities		(4,839	)		12,314,866			2,705,821
Cash flows from investing activities
	Purchase of securities			—			—			(112,500	)
	Sales of securities			1,459,269			227,562			134,171
	Cash paid for acquisition (net of cash received)			—			(14,733,013	)		—
		Net cash from investing activities		1,459,269			(14,505,451	)		21,671
Cash flows from financing activities
	Dividends paid			(1,273,659	)		(1,179,743	)		(1,183,402	)
	Dividends reinvested			—			261,580			47,352
	Purchase of treasury shares			—			—			(344,445	)
		Net cash from financing activities		(1,273,659	)		(918,163	)		(1,480,495	)
Net increase (decrease) in cash				180,771			(3,108,748	)		1,246,997
Cash, beginning of year				600,316			3,709,064			2,462,067
Cash, end of year			$	781,087		$	600,316		$	3,709,064

(Continued)

52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002 and 2001

NOTE 17 - QUARTERLY FINANCIAL DATA(UNAUDITED)

									Basic and
									Diluted
		Interest		Net Interest		Net			Earnings
		Income		Income		Income			per share
2003
	First quarter	$	3,974,571	$	2,992,145	$	806,646		$	0.36
	Second quarter		3,926,619		2,926,329		799,626			0.36
	Third quarter		3,744,193		2,839,220		636,946			0.28
	Fourth quarter		3,398,426		2,546,099		400,333			0.18
2002
	First quarter	$	3,007,388	$	2,153,796	$	729,777		$	0.33
	Second quarter		4,397,461		2,898,126		680,516			0.31
	Third quarter		4,291,593		2,943,490		874,757			0.39
	Fourth quarter		4,244,711		3,017,967		(30,276	)		(0.02	)

During the fourth quarter 2002, management charged off one large commercial credit and identified other losses in the portfolio which required an additional provision. This was the primary reason for the decline in 2002 fourth quarter net income and earnings per share.

During the fourth quarter of 2003, the Company accelerated the purchase accounting adjustment on loans related to the acquisition in 2002 by approximately $450,000. This impacted the Company’s net interest income, net income and earnings per share for the fourth quarter of 2003.

53

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Shareholders
National Bancshares Corporation
Orrville, Ohio

We have audited the accompanying consolidated balance sheets of National Bancshares Corporation as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of National Bancshares Corporation as of December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.

Crowe Chizek and Company LLC

Columbus, Ohio
January 27, 2004

54

Price Range of Common Stock

     National Bancshares common stock is traded on the OTC Bulletin Board® under the symbol “NBOH.” The OTC Bulletin Board® is a regulated quotation service that displays real-time quotes, last-sale prices, and volume information in over-the-counter equity securities. A summary of the high and low prices of and cash dividends paid on National Bancshares common stock in 2002 and 2003 follows. This information does not reflect retail mark-up, mark-down or commissions, and does not necessarily represent actual transactions.

2003	High		Low		Dividends Per Share
First Quarter	$	23.00	$	21.75	$	.14
Second Quarter		22.65		21.85		.14
Third Quarter		25.05		23.00		.15
Fourth Quarter		25.00		23.25		.15

2002	High		Low		Dividends Per Share
First Quarter	$	17.50	$	15.00	$	.13
Second Quarter		21,00		17.25		.13
Third Quarter		20.50		19.20		.14
Fourth Quarter		22.75		19.85		.14

     Information regarding the limitations on dividends available to be paid is located in Note 12 to the Consolidated Financial Statements included herein.

Shareholder Information

Corporate Office
National Bancshares Corporation
112 West Market Street, P.O. Box 57
Orrville, OH 44667
www.fnborrville.com

Stock Trading Information

The shares of common stock of National Bancshares Corporation are traded on the OTC Bulletin Board^® The ticker symbol for National Bancshares Corporation is “NBOH,” The Corporation had 973 shareholders of record as of December 31, 2003.

Form 10-K

A copy of the Corporation’s 2003 Annual Report on Form 10-K as filed with the SEC will be furnished free of charge to shareholders upon written request to the company.

Shareholder Assistance

National Bancshares Corporation
Shareholder Services Department
(330) 682-1030
egerber@fnborrville.com

Transfer Agent
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016
1-800-368-5948
invrelations@rtco.com
www.rtco.com

     National Bancshares Corporation has a Dividend Reinvestment Plan and a Dividend Direct Deposit Plan available at no cost. Please contact Registrar and Transfer Company for enrollment.

DIRECTORS

Charles J. Dolezal
Chairman, President,
Chief Executive Officer
National Bancshares
Corporation
First National Bank

Sara Steinbrenner Balzarini
Former Member of
Management Committee
Contours, Ltd.

Bobbi Douglas
Executive Director
STEPS at Liberty Center
Every Woman’s House

John W. Kropf
Attorney
Kropf., Wagner,
Hohenberger & Lutz, L.L.P.

Steve Schmid
President
Smith Daily Products, Inc.

John E. Sprunger
President
Kidron Auction, Inc.

Howard J. Wenger
President
Wenger Excavating, Inc.
Lake Region Oil, Inc.
Northstar Asphalt, Inc.

James F. Woolley
Chief Executive Officer
R.W. Screw Products, Inc.

Albert Yeagley
Director, Corporate
Quality Assurance
The J.M. Smucker Company

Robert F. Gumz
Director Emeritus

OFFICERS

National Bancshares Corporation

Charles J. Dolezal
President

Kenneth R. VanSickle
Senior Vice President, Secretary

Lawrence Cardinal, Jr.
Vice President, Treasurer

First National Bank

Charles J. Dolezal
President

CONTROL
Lawrence Cardinal, Jr.
Vice President & Controller

Jim Huntsberger
Assistant Vice President,
Asset/Liability Manager

Angela Smith
Assistant Controller

LENDING
Scott Holmes
Assistant Vice President,
Mortgage Loan
Department Manager

Suzanne Hudson
Credit Analyst

Dean Karhan
Assistant Vice President,
Commercial Loan Officer

Patty Massaro
Loan Officer

Steve Riddick
Vice President,
Commercial Banking

Darrell Smucker
Vice President,
Commercial Banking

Kenneth R. VanSickle
Senior Vice President.
Chief Loan Officer

Carol Yoder
Assistant Vice President,
Consumer Loan
Department Manager

OPERATIONS
Robert Woodruff
Vice President & Cashier

Jan Zacharias
Operations Officer

HUMAN RESOURCES
Jane Miller
Administrative Officer,
Human Resources

Jackie Samsa
Assistant Vice President,
Manager of
Human Resources

SALES & BUSINESS
DEVELOPMENT

Harold D. Berkey
Vice President of
Customer Services

Vanessa Brower
Director of Sales Training
and Development

John D. Shultz, Jr.
Vice President,
Commercial Banking
Downtown Massillon Office

Vicki Slater
Director of Marketing

INTERNAL AUDIT
Tammy Starkey
Auditor

SECURITY/ COMPLIANCE

Ron Armentroul
Assistant Vice President,
Security Officer,
Compliance Officer

OFFICE
ADMINISTRATION

Kathy Barnes
Assistant Vice President,
Mortgage Loan Originator
Midway Office

Paul Bayus
Assistant Vice President,
Manager Lodi Office

Carolyn Forrer
Administrative Officer,
Manager Main Office Lobby

Karen Haueter
Assistant Vice President,
Manager Smithville and
Midway Offices

Michelle Kieffaber
Loan Officer, Dalton Office

James Kuschmeader
Assistant Vice President,
Manager Seville Office

Susan Kutz
Administrative Officer,
Manager West High Office

Betty Lyon
Assistant Vice President,
Manager Dalton Office

Matt Miller
Assistant Vice President,
Manager Mt. Eaton Office

Linda Ricker
Assistant Vice President,
Loan Officer
Downtown Massillon Office

Jerry Schmidt
Loan Officer
Downtown Massillon Office

Valerie Stein
Assistant Vice President,
Manager Kidron Office

Cindy Wagner
Assistant Vice President,
Manager Downtown
Massillon Office

Sue Weygandt
Assistant Vice President,
Manager Mayflower Office

OFFICES

Main Office
112 West Market St.
Orrville
(330) 682-1010

West High Office
1320 West High St.
Orrville
(330) 682-2881

Northside Office
1720 North Main St.
Orrville
(330) 682-2342

Cleveland Road Office
1725 Cleveland Rd.
Wooster
(330) 263-1725

Dalton Office
12 West Main St.
Dalton
(330) 828-2227

Kidron Office
4934 Kidron Rd.
Kidron
(330) 857-3101

Lodi Office
06 Ainsworth St.
Lodi
(330) 948-1414

Downtown Massillon Office
211 Lincoln Way East
Massillon
(330) 832-7441

Mayflower Office
2312 Lincoln Way N.W.
Massillon
(330) 833-1622

Massillon Marketplace Office
1 Massillon Marketplace Dr. S.W.
Massillon
(330) 837-2582

Midway Office
U.S. Rt. 30 at Co. Rd. 44
Apple Creek
(330) 264-8070

Mt. Eaton Office
15974 East Main St.
Mt. Eaton
(330) 857-4301 or
(330) 359-5476

Seville Office
121 Greenwich Rd.
Seville
(330) 769-3105

Smithville Office
153 East Main St.
Smithville
(330) 669-2611

112 West Market Street

Orrville, Ohio 44667

(330) 682-1010

www.fnborrville.com

Member FDIC
Equal Housing Lender