National Bancshares 10-Q 2006 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2006

OR

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

Commission File Number 0-14773

NATIONAL BANCSHARES CORPORATION

exact name of registrant as specified in its charter

Ohio	34-1518564
State of incorporation	IRS Employer Identification No.

112 West Market Street, Orrville, Ohio 44667
Address of principal executive offices

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

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesþ Noo

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filero      Accelerated filero      Non-accelerated filerþ

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
Yeso Noþ

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of August 5, 2006.

Common Stock, Without Par Value: 2,234,488 Shares Outstanding

National Bancshares Corporation

Index

			Page
			Number
Part I. Financial Information
	Item 1.	Financial Statements
		Consolidated Balance Sheets as of June 30, 2006 (Unaudited) and December 31, 2005	3
		Consolidated Statements of Income and Comprehensive Income for the three and six months ended June 30, 2006 and 2005 (Unaudited)	4
		Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005 (Unaudited)	5
		Notes to Consolidated Financial Statements (Unaudited)	6 - 8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9 - 13
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	13
	Item 4.	Controls and Procedures	13 – 14
Part II. Other Information			15
	Item 1.	Legal Proceedings — None
	Item 1A.	Risk Factors
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds — None
	Item 3.	Defaults Upon Senior Securities — None
	Item 4.	Submission of Matters to a Vote of Security Holders
	Item 5.	Other Information — None
	Item 6.	Exhibits
Signatures			16
Exhibits			17 – 29
EX-10.4
EX-31.1
EX-31.2
EX-32

2

NATIONAL BANCSHARES CORPORATION

CONSOLIDATED BALANCE SHEETS (Unaudited)

	6/30/06			12/31/05
ASSETS
Cash and due from banks	$	9,872,781		$	10,985,160
Federal funds sold		5,230,000			8,780,000
Total cash and cash equivalents		15,102,781			19,765,160
Securities available for sale		65,767,433			60,091,913
Securities held to maturity (fair value: June 30, 2006 — $16,928,352; December 31, 2005 — $17,115,020)		16,888,358			16,917,133
Federal bank stock		3,051,650			2,987,050
Loans held for sale		160,900			—
Loans, net of allowance for loan losses: June 30, 2006 — $1,878,683; December 31, 2005 — $1,902,828		186,058,277			191,538,419
Premises and equipment, net		5,167,474			5,201,211
Other real estate owned		133,018			103,334
Goodwill		4,722,775			4,722,775
Identified intangible assets		1,013,624			1,136,613
Accrued interest receivable		1,658,257			1,621,306
Cash surrender value of life insurance		2,455,431			2,415,910
Other assets		1,173,418			380,184
	$	303,353,396		$	306,881,008
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing	$	44,234,393		$	47,143,340
Interest-bearing		202,448,797			202,344,481
Total deposits		246,683,190			249,487,821
Repurchase agreements		4,961,694			2,359,521
Federal Reserve note account		92,687			592,763
Federal Home Loan Bank advances		15,000,000			17,000,000
Accrued expenses and other liabilities		2,814,783			2,787,478
Total liabilities		269,552,354			272,227,583
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
Retained earnings		20,019,363			20,067,339
Treasury stock, at cost (55,040 shares)		(1,189,493	)		(1,189,493	)
Accumulated other comprehensive loss		(1,166,268	)		(361,861	)
Total shareholders’ equity		33,801,042			34,653,425
	$	303,353,396		$	306,881,008

See accompanying notes to consolidated financial statements.

3

NATIONAL BANCSHARES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME (Unaudited)

	Three months ended						Six months ended
	6/30/06			6/30/05			6/30/06			6/30/05
INTEREST AND DIVIDEND INCOME:
Loans, including fees	$	3,035,826		$	3,025,318		$	6,159,403		$	5,912,359
Federal funds sold		120,251			39,611			195,771			47,670
Securities:
Taxable		829,302			698,664			1,594,831			1,421,065
Nontaxable		201,408			211,955			402,482			422,745
Total interest and dividend income		4,186,787			3,975,548			8,352,487			7,803,839
INTEREST EXPENSE:
Deposits		1,206,176			720,170			2,232,866			1,348,596
Short-term borrowings		54,936			17,746			80,263			31,150
Federal Home Loan Bank advances		204,579			224,874			423,612			447,313
Total interest expense		1,465,691			962,790			2,736,741			1,827,059
Net interest income		2,721,096			3,012,758			5,615,746			5,976,780
PROVISION FOR LOAN LOSSES		—			212,500			—			292,500
Net interest income after provision for loan losses		2,721,096			2,800,258			5,615,746			5,684,280
NONINTEREST INCOME:
Checking account fees		259,570			243,847			486,298			435,373
Visa check card interchange fees		48,300			44,505			95,436			84,663
Loss on sale of other real estate owned		(28,602	)		—			(28,602	)		—
Deposit and miscellaneous service fees		43,704			45,718			89,620			104,182
Securities gains (loss), net		38			(6,895	)		38,098			96,537
Gain (loss) on sale of loans		(6,307	)		37,059			3,929			21,980
Other		61,368			69,616			127,282			140,484
Total noninterest income		378,071			433,850			812,061			883,219
NONINTEREST EXPENSE:
Salaries and employee benefits		1,505,199			1,429,787			2,934,279			2,903,862
Data processing		226,864			218,688			451,318			431,302
Marketing		218,648			60,555			348,276			127,750
Franchise tax		93,000			93,083			186,000			189,250
Maintenance and repairs		102,257			85,831			158,353			156,399
Depreciation — furniture and fixtures		71,044			80,791			149,333			160,687
Director fees and pension		69,658			68,125			133,790			134,175
Net occupancy		62,975			81,661			125,409			161,265
Amortization of intangibles		61,495			62,491			122,989			124,982
Telephone		59,076			54,625			119,570			108,910
Stationary, printing and office supplies		70,825			60,113			116,915			103,261
Dues, subscriptions and fees		52,688			44,110			110,686			96,602
Postage, express and freight		41,946			41,412			85,029			82,076
Utilities		32,134			26,966			76,629			64,787
Consulting fees		43,353			48,540			75,576			89,540
Equipment service & rental		35,445			26,755			65,945			57,773
Other		229,953			241,441			433,182			420,948
Total noninterest expense		2,976,560			2,724,974			5,693,279			5,413,569
INCOME BEFORE INCOME TAXES		122,607			509,134			734,528			1,153,930
Income tax expense (benefit)		(36,333	)		77,195			67,468			201,192
NET INCOME		158,940			431,939			667,060			952,738
OTHER COMPREHENSIVE INCOME (LOSS):
Unrealized appreciation (depreciation) in fair value of securities available for sale, net of tax		(539,050	)		284,100			(779,262	)		(622,756	)
Reclassification adjustment for realized (gains) losses included in earnings, net of tax		(25	)		4,551			(25,145	)		(63,714	)
		(539,075	)		288,651			(804,407	)		(686,470	)
COMPREHENSIVE INCOME (LOSS)	$	(380,135	)	$	720,590		$	(137,347	)	$	266,268
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING		2,234,488			2,234,488			2,234,488			2,234,488
BASIC AND DILUTED EARNINGS PER COMMON SHARE	$	0.07		$	0.19		$	0.30		$	0.43
DIVIDENDS DECLARED PER COMMON SHARE	$	0.16		$	0.16		$	0.32		$	0.32

See accompanying notes to consolidated financial statements.

4

NATIONAL BANCSHARES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

	Six Months Ended
	6/30/06			6/30/05
Net Cash From Operating Activities	$	341,762		$	1,435,855
Cash Flows From Investing Activities:
Securities Held to Maturity
Proceeds from Maturities and Repayments		8,700			158,200
Purchases		—			(799,590	)
Securities Available for Sale
Proceeds from Maturities and Repayments		2,421,482			3,481,621
Proceeds from Sales		278,351			15,895,986
Purchases		(9,590,940	)		(9,142,545	)
Capital Expenditures		(79,948	)		(1,111,563	)
Proceeds on the sale of Other Real Estate Owned		75,876			—
Net Change in Loans to Customers		5,299,908			(2,643,716	)
Net Cash From Investing Activities		(1,586,571	)		5,838,393
Cash Flows from Financing Activities:
Net Change in Demand and Savings Accounts		(11,619,078	)		(5,372,502	)
Net Change in Time Deposits		8,814,447			1,912,918
Net Change in Short-Term Borrowings		2,102,097			(344,031	)
Repayments on Federal Home Loan Bank Advances		(2,000,000	)		—
Dividends Paid		(715,036	)		(715,035	)
Net Cash From Financing Activities		(3,417,570	)		(4,518,650	)
Net Change in Cash and Cash Equivalents		(4,662,379	)		2,755,598
Beginning Cash and Cash Equivalents		19,765,160			17,826,454
Ending Cash and Cash Equivalents	$	15,102,781		$	20,582,052
Supplemental Disclosures
Cash Paid for Interest	$	2,592,973		$	1,759,296
Cash Paid for Income Taxes	$	332,372		$	455,000
Non-cash transfer of Other Real Estate Owned	$	134,163		$	—

See accompanying notes to consolidated financial statements.

5

National Bancshares Corporation

Notes to Consolidated Financial Statements (Unaudited)

Note 1. Basis of Presentation

     The accompanying consolidated financial statements include the accounts of National Bancshares Corporation (the “Company”) and its wholly owned subsidiary, First National Bank, Orrville, Ohio (the “Bank”). All significant intercompany transactions and balances have been eliminated. The consolidated balance sheet as of June 30, 2006, the consolidated statements of income and comprehensive income for the three and six-month periods ended June 30, 2006 and 2005, and the condensed consolidated statements of cash flows for the six-month periods ended June 30, 2006 and 2005 have been prepared by the Company without audit. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.

     The consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q, but do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. These statements should be read in conjunction with the consolidated financial statements and footnotes in the Company’s annual report on Form 10-K for the year ended December 31, 2005. Operating results for the six months ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006.

     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 actual results could differ. The allowance for loan losses and fair values of certain securities are particularly subject to change.

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

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

Note 2. Regulatory Matters

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

											To Be Well Capitalized
						For Capital					Under Prompt Corrective
June 30, 2006	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital to risk—weighted assets
Consolidated	$	31,100		14.69	%	$	16,935		8.00	%		N/A		N/A
Bank		30,032		14.19	%		16,935		8.00	%	$	21,169		10.00	%
Tier 1 (core) capital to risk—weighted assets
Consolidated		29,222		13.80	%		8,467		4.00	%		N/A		N/A
Bank		28,154		13.30	%		8,467		4.00	%		12,701		6.00	%
Tier 1 (core) capital to average assets
Consolidated		29,222		9.82	%		11,905		4.00	%		N/A		N/A
Bank		28,154		9.46	%		11,905		4.00	%		14,882		5.00	%

6

											To Be Well Capitalized
						For Capital					Under Prompt Corrective
December 31, 2005	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total capital to risk-weighted assets
Consolidated	$	31,051		14.45	%	$	17,187		8.00	%		N/A		N/A
Bank		29,261		13.62	%		17,184		8.00	%	$	21,480		10.00	%
Tier 1 (core) capital to risk-weighted assets
Consolidated		29,148		13.57	%		8,593		4.00	%		N/A		N/A
Bank		27,358		12.74	%		8,592		4.00	%		12,888		6.00	%
Tier 1 (core) capital to average assets
Consolidated		29,148		9.76	%		11,943		4.00	%		N/A		N/A
Bank		27,358		9.16	%		11,941		4.00	%		14,927		5.00	%

Note 3. Loans

Loans at June 30, 2006 and December 31, 2005 were as follows:

	6/30/06			12/31/05
Collateralized by real estate:
Commercial		44,685,878			47,638,035
Residential		87,101,289			91,591,798
Home Equity		19,843,447			19,044,581
Construction		7,677,989			6,440,000
		159,308,603			164,714,414
Other:
Consumer		6,662,438			6,205,096
Commercial		19,047,541			20,045,739
Credit Cards		1,419,147			1,405,708
Other		1,983,039			1,565,995
		188,420,768			193,936,952
Unearned and deferred income		(483,808	)		(495,705	)
Allowance for loan losses		(1,878,683	)		(1,902,828	)
Total		186,058,277			191,538,419

The activity in the allowance for loan losses for the first six months of 2006 and 2005 was as follows:

	2006			2005
Beginning balance	$	1,902,828		$	1,763,298
Provision for loan losses		—			292,500
Loans charged-off		(85,121	)		(23,493	)
Recoveries		60,976			4,406
Ending balance	$	1,878,683		$	2,036,711

Impaired loans at June 30, 2006 and December 31, 2005 were as follows:

	6/30/06		12/31/05
Loans with no allocated allowance for loan losses	$	—	$	—
Loans with allocated allowance for loan losses		385,219		1,177,688
Amount of the allowance for loan losses allocated		138,680		273,438

	6/30/06		6/30/05
Average of impaired loans during the first six months of 2006 and 2005	$	952,696	$	429,565
Interest income recognized during impairment		3,443		—
Cash-basis interest income recognized		3,443		—

7

     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.

8

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

     FORWARD-LOOKING INFORMATION

     This Form 10-Q contains forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. The Company cautions that any forward-looking statements contained in this report, in a report incorporated by reference to this report or made by management of the Company, involve risk and uncertainties, and are subject to change based on various important factors. When used herein, the terms “anticipates,” “plans,” “expects,” “believes,” and similar expressions as they relate to the Company or its management are intended to identify such forward looking statements. Actual results could differ materially from those expressed or implied. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations, and rapidly changing technology affecting financial services. The Company disclaims any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information, or otherwise.

     FINANCIAL CONDITION

     Balance Sheets

     Total assets decreased $3.5 million or 1.1% from December 31, 2005 principally due to the decrease in total deposits and payoff of Federal Home Loan Bank advances. Total securities increased by $5.6 million or 7.3% from December 31, 2005 mainly due to loan payoffs during the first half of 2006 and the sale of fixed rate mortgages to secondary markets. Federal funds sold were $5.2 million at June 30, 2006, representing overnight funds available for loan demand or deposit withdrawals. Federal funds sold has declined $3.6 million or 40.4% from December 31, 2005 due to purchasing securities available for sale that result in a greater return than Federal funds sold.

     Net loans decreased by $5.5 million or 2.9% from December 31, 2005. Commercial real estate loans decreased $3.0 million, residential real estate mortgages decreased $4.5 million and commercial loans decreased $1.0 million. The decrease in both the commercial loans and commercial real estate loans is attributed to a combination of loan payoff and our competition offering attractive loan pricing. Management continues to believe there is ample loan opportunity in the markets we serve, however, we are cautious of providing too low of pricing and compromising our credit standards and net interest margin. The decrease in residential real estate mortgages is due to principal pay downs and a large decline in originations due to the increase in mortgage interest rates. Meanwhile, construction loans increased by $1.2 million, home equity increased by $799 thousand, consumer loans increased $457 thousand and other loans increase $417 thousand. The increase in construction loans is due to demand for this type of loan and the increase in home equity loans was the result of a favorable spring promotion.

     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 the following methodology. All problem, past due and non-performing loans are closely monitored and analyzed by management on a regular basis. Management assigns a classification rating to these loans based on information about specific borrower situations and estimated collateral values. Management determines the loss that exists on each significant problem, past due and non-performing loan. Problem loans that are not analyzed individually are assigned a provision based upon a historical migration analysis. The migration analysis identifies the percentage of problem loans that have 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 Comptroller of the Currency regulatory guidance. Past due loans that are not analyzed individually are pooled and evaluated by loan type. The probable loss that exists on past due loans is estimated using past loan loss experience. All other loans are pooled by loan type and evaluated based upon past loan loss experience. National and local economic conditions and other factors

9

are also considered in determining an adequate level for the allowance for loan losses. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Management reviews the allowance for loan losses on a regular basis to determine the adequacy of the reserve.

     The allowance for loan losses to total loans outstanding was 1.00% as of June 30, 2006 compared to 0.98% for December 31, 2005. On an annualized basis, net charge-offs (recoveries) to total average loans were 0.02% for the first six months of 2006 and 0.02% for the first six months of 2005. The ratio of non-performing loans to total loans was 1.29% ($2,420,347) for June 30, 2006 compared to 1.20% ($2,324,484) for December 31, 2005. Non-performing loans consist of loans that have been placed on nonaccrual status and loans past due over 90 days and still accruing interest.

     Other assets increased $793 thousand or 208.6% from December 31, 2005. This increase is primarily attributed to the deferred tax impact of the increase in unrealized losses on available for sale investments.

     Total deposits decreased $2.8 million or 1.1% from December 31, 2005. Noninterest-bearing demand accounts decreased by $2.9 million or 6.2%, while savings and NOW accounts decreased $8.7 million or 7.0%, and time deposits increased $8.8 million or 11.3%. Noninterest-bearing demand accounts will fluctuate based upon the liquidity needs of our customers. Historically, there has been fluctuation in the level of these accounts during first half of the year due to customers paying taxes and/or reducing debt. During the first quarter 2006, non-interest bearing demand accounts decreased $3.8 million, while in the second quarter these accounts increased $0.9 million. Regarding the decrease in savings and NOW accounts, although NOW increased by $4.5 million, passbook and statement savings accounts decreased by $13.2 million. The decrease in passbook and statement savings is due to money that moved to time deposits, NOW accounts, and repurchase agreements. The increase in time deposits is attributed to market driven rates. Recently, the Bank has been offering very competitive short-term time deposits, including a special 125-day certificate of deposit and a twelve month certificate of deposit. The increase in repurchase agreements of $2.6 million or 110.3% is primarily attributable to one commercial customer moving funds from savings to a sweep account.

     The Federal Reserve note account decreased $500 thousand or 84.4% from December 31, 2005. This decrease is the result of timing of calls by the Federal Reserve Bank. These funds represent treasury, tax and loan deposits.

     The Federal Home Loan Bank advances decreased by $2.0 million or 11.8% from December 31, 2005. The decrease is attributed to the payoff of various Federal Home Loan bank advances during the second quarter of 2006. The payoffs were a result of the Federal Home Loan bank electing to convert these loans to a variable rate of interest. As a result, the Bank was able to repay the borrowings without incurring a prepayment penalty.

     Total shareholders’ equity decreased $852 thousand or 2.5% from December 31, 2005 due mainly to a decrease in accumulated other comprehensive loss.

     Statements of Cash Flows

     Net cash from operating activities for the first six months of 2006 was $342 thousand compared to $1.4 million for the first six months of 2005. Although the current year’s operating activities includes originations of mortgage loans held for sale and proceeds from the sale of mortgage loans held for sale of approximately $3.0 million, the decrease net cash from operating activity versus prior year was due to changes in other assets and liabilities. Net cash from investing activities for the first six months of 2006 was ($1.6) million, compared to $5.8 million for the first six months of 2005. The decrease is due to the purchases of various investment securities. Net cash used for financing activities was ($3.4) million for the first six months of 2006 compared to ($4.5) million for the first six months of 2005. The change was primarily due to the net change in demand and savings and repayments on Federal Home Loan Advances, offset by growth in time deposits. Total cash and cash equivalents decreased $4.7 million during the first six months of 2006. With

10

total cash and cash equivalents of $15.1 million as of June 30, 2006, the Company’s liquidity ratios continue to remain favorable.

COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTH PERIODS ENDED JUNE 30, 2006 AND 2005

     Net income was $159 thousand for the three months ended June 30, 2006 or 63.2% below the same quarter of 2005. The decrease was due primarily to a decline in the Bank’s loan portfolio and the related fees, an increase in the Bank’s cost of funds and the effect of increased non-interest expenses.

     Interest and dividend income totaled $4.2 million, which reflects an increase of $211 thousand or 5.3% for the three-months ended June 30, 2006 as compared to the same period in 2005. The increase is primarily attributed to an increase of earned interest related to US government agency and corporate investment securities, and an increase in interest earned on home equity loans. These two categories increased 94.0% and 26.6%, respectively, for the three-months ended June 30, 2006 as compared to the same period in 2005. However, offsetting part of this increase was the reversal of $145 thousand in interest income related to non-accrual loans. During the 2nd quarter of 2006, management, in conjunction with guidance from the OCC, corrected an immaterial accounting issue related to the recognition of interest income associated with certain non-accrual loans. In prior periods, when non-accrual loans had improved sufficiently to be reinstated as accrual loans, payments made during the prior nonaccrual period were re-evaluated and applied to interest income. Regulatory guidance suggests that these payments should be applied to loan principal reduction. Approximately $83 thousand of this reversal was attributable to 2005 with $37 thousand and $25 thousand attributable to the first and second quarters of 2006, respectively. Management evaluated the impact of this accounting issue and concluded the impact was not material to prior quarterly or annual periods. Accordingly, an adjustment was recorded in the second quarter of 2006 to correct the cumulative impact of this issue.

     Interest expense was $1.5 million for the three-months ended June 30, 2006 or 52.2% higher than 2005. When comparing June 30, 2006 to June 30, 2005, interest on certificate of deposits increased by $308 thousand or 71.1%, while interest on NOW accounts increased by $122 thousand or 147.3%. In both cases, the increases are primarily a result of rising interest rates, customers moving funds from lower interest earning deposit accounts and a result of competition for deposits in our market area.

     As a result of the above, the Bank experienced a decrease of $292 thousand, or 9.7% in net interest income for the three-month period ended June 30, 2006 as compared to June 30, 2005.

     There was no provision for loan losses for the three months ended June 30, 2006 compared to $213 thousand for the same period in 2005. The portion of the provision that is directly associated with classified loans has increased slightly since December 31, 2005, however the need to increase the balance of the allowance for loan losses was negated by a decline in the balance of our loan portfolio. Commercial loan volume decreased during the second quarter of 2006. This category carries a higher risk than other types of loans. Additionally, real estate loan volume declined during the second quarter of 2006. Non-performing loans also decreased during the second quarter of 2006 compared to the second quarter of 2005 from 1.48% of loans to 1.29% of loans. During the first half of 2005, nonperforming loans increased from 0.75% of loans to 1.48% of loans. Each quarter, management reviews the adequacy of the allowance for loan losses by reviewing the overall quality and risk profile of the Company’s loan portfolio, by reviewing specific problem credits and assessing the incurred losses based on expected cash flows or collateral values, by reviewing trends in problem loan levels, by updating loss history for the Company’s loans, by analyzing the growth and change in mix of the portfolio, and by analyzing economic trends that are believed to impact the Company’s borrowers. For the second quarter of 2006, management reviewed all of these factors and determined the quarterly allowance for loan losses was adequate, without any additional provision.

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     Noninterest income was $378 thousand for the three months ended June 30, 2006 or approximately 12.9% below the same period in 2005, due mainly to the securities gains recognized during the second quarter of 2005 and the loss on the sale of other real estate owned.

     Noninterest expense was $3.0 million for the three months ended June 30, 2006 or approximately 9.2% above the same period in 2005, due to higher salaries and benefits, marketing expenses, and maintenance and repairs. The increase in salaries and benefits is due to the required accrual associated with a separation agreement (Exhibit 10.4 of this filing). The increase in marketing expenditures is fueling a strategic re-alignment of our marketing efforts to target long run benefits from these initiatives. Lastly, the increase in repairs was necessitated by the need to repair various branch parking lots.

     Income tax benefit was $36 thousand for the three months ended June 30, 2006 or approximately 147.1% below the same period in 2005, due to decreased earnings during the second quarter and the tax affect of the non-accrual to accrual loan adjustment mentioned previously. This adjustment reduced our tax expense by $49 thousand.

     Net unrealized appreciation (depreciation) on securities available for sale was ($539) thousand for the three months ended June 30, 2006 compared to $284 thousand or the three months ended June 30, 2005. The market value of securities in the available for sale portfolio decreased during the second quarter of 2006 due to an increase in interest rates. Comprehensive income (loss) was ($380) thousand for the three months ended June 30, 2006 compared to $721 thousand for the same period in 2005.

COMPARISON OF RESULTS OF OPERATIONS FOR THE SIX MONTH PERIODS ENDED JUNE 30, 2006 AND 2005

     Net income was $667 thousand for the six months ended June 30, 2006 or 30.0% below the first six months of 2005. The decrease was due primarily to a decline in the Bank’s loan portfolio and the related fees, an increase in the Bank’s cost of funds and the effect of increased non-interest expenses.

     Interest and dividend income totaled $8.4 million for the six-months ended June 30, 2006, an increase of $549 thousand or 7.0% when compared to the six-months ended June 30, 2005. Of this increase, $274 thousand relates to increased income resulting from interest on US government agencies and corporate investment securities. This is due to increased investment securities in this category. Commercial loan interest increased by $169 thousand during this time period, due to rising rates associated with the loans. Additionally, home equity interest increased by $164 thousand due to the positive results of the Bank’s home equity promotion and the affect of rising interest rates. As noted previously, interest income was reduced for loans that related to nonaccrual status.

     Interest expense was $2.7 million for the six-months ended June 30, 2006, an increase of $910 thousand or 49.8% when compared to the six-months ended June 30, 2005. The increase year-over-year is directly attributed to rising interest rates. More specifically, interest on certificates of deposits increased $536 thousand or 64.9% during this period, and interest on NOW accounts increased $252 thousand or 197.0% during this period. Adding to the year-over-year increase in interest expense is the fact that the Bank has experienced many customers moving funds from low interest bearing deposit accounts to these higher earning deposit accounts.

     As a result of the above, net interest income for the six-months ended June 30, 2006, decreased $361 thousand or 6.0%. Year-to-date interest income increased mainly due to higher yields on earning assets, which increased from 5.77% to 6.12%. The volume of average-earning assets increased from $278.6 million to $279.9 million. Year-to-date interest expense increased due to higher average costs, which increased from 1.66% to 2.47%. As a result, net interest margin declined from 4.46% to 4.17% as of June 30, 2005 and June 30, 2006, respectively.

     There was no provision for loan losses for the six months ended June 30, 2006 compared to $293 thousand for the same period in 2005. As discussed earlier, the need to increase the provision for loan losses was negated by the declining balance of the Bank’s loan portfolio.

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Commercial loan volume decreased during 2006, which carries higher risk than other types of loans, and real estate loan volume also decreased. Net charge-offs (recoveries) for the six months ended June 30, 2006 were $24 thousand compared to $19 thousand for the same period in 2005.

     Noninterest income was $812 thousand for the six months ended June 30, 2006 or 8.1% below the same period in 2005, due mainly to securities gains taken in 2005, the affect of the loss on the sale of other real estate owned and lower deposit service fees. The increase in checking account fees is a result of the overdraft protection services that was implemented in April 2005.

     Noninterest expense was $5.7 million for the six months ended June 30, 2006 or approximately 5.2% above the same period in 2005, primarily due to higher marketing expenses, salaries and benefits, and data processing expenses. A portion of this increase in noninterest expense has been offset by a decline in net occupancy and consulting fees. As mentioned above, the increase in marketing expenditures is fueling a strategic re-alignment of our marketing efforts to target long run benefits from these initiatives. These marketing efforts are undertaken to increase bank and product identity within the markets we serve. Additionally, the increase in salaries and benefits is due to the required accrual associated with a separation agreement (Exhibit 10.4 of this filing), with the Bank president. However, offsetting much of this accrual is the benefit of previous staff reorganizations that resulted in reduced salary and wage expense. The increase in data processing is the affect of increased volume in the number of deposit accounts. Over the past year, the Bank has incurred an increase in deposit accounts, while the average balance for these accounts has declined. The decline in net occupancy expenses is the result of the May 31, 2005 closure of our MarketPlace office. Consulting fees have declined due to decreased fees related to Sarbanes Oxley implementation.

     Regarding the separation agreement with Mr. Dolezal mentioned above, as of June 30, 2006, the financial statements reflect a charge of $73 thousand as separation pay. On an on-going basis, we anticipate the expenses related to this separation agreement will result in an additional accrual of $147 thousand by October 31, 2006. At October 31, 2006, there will be accrued severance pay of $220 thousand, in accordance with the separation agreement.

     Income tax expense was $67 thousand for the six months ended June 30, 2006 compared to $201 thousand for the six months ended June 30, 2005. The federal statutory rate for both years is 34% compared to an effective tax rate of approximately 9% for 2006 and 17% for 2005. The difference is due primarily to lower pretax income in 2006 and the impact of tax-exempt municipal investments.

     Year-to-date net unrealized depreciation on securities available for sale was $779 thousand for the six months ended June 30, 2006 compared to $623 million for the six months ended June 30, 2005. The market value of securities in the available for sale portfolio decreased during 2006 due primarily from an increase in interest rates. Comprehensive income (loss) was ($137) thousand for the six months ended June 30, 2006 compared to $266 thousand for the same period in 2005.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     Management uses an earnings simulation model to assess interest rate sensitivity, which estimates the effect on net income assuming various interest rate changes — or “rate shocks” — such as changes of plus 100 or 200 basis points. At year-end 2005, the model estimated the positive impact on net income of a 100 basis point increase in interest rates over a twelve-month period at 0.8%, compared to a negative impact of 4.3% on June 30, 2006. A positive impact on net income of a 200 basis point increase in interest rates was estimated at 10.6% on December 31, 2005 compared to a negative impact of 0.6% on June 30, 2006. In both the 100 and 200 basis “rate shocks”, the unfavorable variance from December 31, 2005 is a result of our short-term assets repricing more slowly than short-term liabilities. Specifically, this is due to a decline in loans as a result of a change in mix of the composition of fixed versus variable rate loans, the affect of the volume of certificate of deposits that are maturing during the current year and the affect of the deposit mix shifting from low yield deposit accounts to higher yield short term certificate of deposits.

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Item 4. Controls and Procedures

     As of the end of the period covered by this quarterly report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s President and Treasurer (Principal Financial Officer), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, the President and Treasurer concluded that the Company’s disclosure controls and procedures were effective as of the date of their evaluation in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in this Quarterly Report.

     Other than the non-accrual to accrual issue mentioned previously, there were no changes in the Company’s internal controls over financial reporting during the quarter ended June 30, 2006 that materially affected or are reasonably likely to materially affect the Company’s internal controls over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings — None

Item 1A. Risk Factors — There have been no significant changes in the Company’s risk factors as outlined in the Company’s Form 10-K for the period ending December 31, 2005.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds — None

Item 3. Defaults Upon Senior Securities — None

Item 4. Submission of Matters to a Vote of Security Holders — The Company held its Annual Shareholders’ Meeting on April 27, 2006, for the purpose of electing three directors. Shareholders received proxy materials containing the information required by this item. Results of shareholder voting were as follows.

Election of Directors:	Bobbi E. Douglas		John E. Sprunger		Howard J. Wenger
For		1,569,162		1,710,748		1,710,748
Withheld		148,885		7,299		7,299
Shares not voted by Brokers		46,854		46,854		46,854

     The following directors continued their terms of office after the 2006 Annual Shareholders’ meeting: Sara Steinbrenner Balzarini, Steve Schmid, Albert W. Yeagley, John P. Cook, Charles J. Dolezal, John W. Kropf and James F. Woolley.

Item 5. Other Information — None

Item 6. Exhibits

Exhibit No.		If incorporated by Reference,
Under Reg.		Documents with Which Exhibit
S-K, Item 601	Description of Exhibits	Was Previously Filed with SEC
(3.1)	Amended Articles of Incorporation	Annual Report 10-K filed 3/26/04 File No. 000-14773
(3.2)	Code of Regulations	Annual Report 10-K filed 3/26/04 File No. 000-14773
(10.1)	Directors Defined Benefit Plan Agreement	Annual Report 10-K filed 3/29/01 File No. 000-14773
(10.2)	Special Separation Agreement entered into with Charles Dolezal and Kenneth VanSickle	Annual Report 10-K filed 3/29/01 File No. 000-14773
(10.3)	Form of Special Separation Agreement entered into with Marc Valentin	Quarterly Report 10-Q filed 11/15/04 File No. 000-14773
(10.4)	Separation and Release Agreement entered into by Mr. Charles Dolezal and National Bancshares Corporation and First National Bank
(11)	Computation of Earnings per Share	See Consolidated Statements of Income and Comprehensive Income, Page 4
(31.1)	Certification
(31.2)	Certification
(32)	Certification

No other exhibits are required to be filed herewith pursuant to Item 601 of Regulation S-K.

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Signatures

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

	National Bancshares Corporation
Date: August 14, 2006	/s/Charles J. Dolezal
	Charles J. Dolezal, President
Date: August 14, 2006	/s/Marc Valentin
	Marc Valentin, Treasurer
	(Principal Financial Officer)

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