National Bancshares 10-K 2011 FY Annual report

Exhibit 13

TABLE OF CONTENTS

3	Message to Shareholders
5	Financial Highlights
6	Selected Financial Data
8	Management’s Discussion and Analysis of Financial Condition and Results of Operations
27	Consolidated Balance Sheets
28	Consolidated Statements of Income
29	Consolidated Statements of Changes in Shareholders’ Equity
30	Consolidated Statements of Cash Flows
31	Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009
59	Report of Independent Registered Public Accounting Firm
61	Report of Management on the Corporation’s Internal Control Over Financial Reporting
63	Comparison of Five-Year Cumulative Total Return of National Bancshares Corporation,
	S&P 500 Stock Index, and S&P 500 Bank Index
64	Price Range of Common Stock
64	Shareholder Information
65	Officers
66	Directors
66	First National Bank Offices

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Dear Shareholders;

A strong community deserves a strong community bank. Our Bank’s directors and staff care about the communities we serve because we live, work and raise families in our community. We strive to provide our customers, neighbors and friends with a first-class banking experience. Responsive and knowledgeable loan officers, the best deposit products in the market and newly remodeled branch offices are just part of the First National Bank experience.

Today we are faced with a tough economic environment which impacts those who use our services. People without jobs struggle to make loan payments. Seniors and savers earn much less on their funds due to the low interest rate environment. Businesses that suffer a decline in sales struggle to make loan and rent payments. On top of all of those concerns, government officials continue to impose more regulations in an already over regulated economy.

The economy is improving gradually and in our market area, agriculture and small businesses have performed well and provide the local economy with a strong foundation for future growth. In 2010, the Bank formed a new Agribusiness and Community Banking Group to focus on agriculture lending, small business lending and cash management services. The six loan officers of the group generated $35.5 million in loans in 2011 and we are excited about their opportunities in 2012 and beyond.

Net income rose to $2.6 million in 2011, compared to $1.3 million in 2010. Basic and diluted earnings per share increased from $0.60 per share in 2010 to $1.18 per share in 2011. Earnings for 2011 were positively impacted by an increase in net interest income and a decrease in the provision for loan losses. Net interest income rose $1.1 million in 2011, due to an increase in loan interest income and a decline in the cost of funds due to the falling interest rate environment. The provision for loan losses was $600 thousand in 2011, compared to $2.2 million in 2010.

Total assets increased to $406.1 million as of December 31, 2011 from $374.1 million as of December 31, 2010. Loans, net of allowance for loan losses increased $23.5 million during 2011. Shareholder’s equity increased 9.7% to $42.7 million at the end of 2011, compared to $39.0 million at the end of 2010. Our Bank is well-capitalized and poised to help our customers succeed today and tomorrow. Please take time to review the financial statements and footnotes contained in this report for more details about our financial performance.

On behalf of the Board of Directors and our staff, it is my pleasure to express our appreciation for your continued confidence and investment in National Bancshares Corporation. We look forward to 2012 and the opportunity to serve our current customers and to build new banking relationships.

Mark R. Witmer

President and CEO

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A SPECIAL ACKNOWLEDGEMENT

National Bancshares Corporation announced its management succession plan in September 2011. David C. Vernon, President and Chief Executive Officer since November 2006, announced his retirement effective December 31, 2011 as part of the plan. Mr. Vernon will continue to provide consulting services to the Bank.

The Board of Directors, management team and employees sincerely appreciate Dave’s leadership and dedicated service over the past five years.

CHARITABLE GIVING COMMITTEE

In 2011, the Charitable Giving Committee of the Board of Directors approved gifts to the following organizations.

Boy Scouts of America	Orrville Public Library
Dalton Historical Society	Orrville Salvation Army
Every Woman’s House	Orrville School Multi-Purpose Facility
First National Bank Scholarship	Orrville United Way, Inc.
(Wayne County Community Foundation)	Smithville Community Historical Society
Harvest for Hunger	STEPS (FKA Wayne County Alcoholism
Hospice of Summit County	Services)
Hospice of Wayne County	STEPS Noble House Capital Fund
Kidron Community Historical Society	Tschantz Cabin
Kidron United Fund	United Way of Wayne and Holmes Counties
Main Street Orrville	United Way of Western Stark County
Main Street Wooster, Inc.	Village Network (FKA Boy’s Village)
Massillon Boys and Girls Club	Wayne County Capital Campaign
Massillon Chamber of Commerce	Wayne County Crippled Children’s Committee
Ohio Funding for Independent Colleges	Wayne Development Council
Orr Views	Wayne/Holmes Soap Box Derby
Orrville Area Boys and Girls Club	Wee Care Center, Inc.
Orrville Chamber of Commerce	Wooster Chamber of Commerce
Orrville-Dalton YMCA

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FINANCIAL HIGHLIGHTS

These financial highlights are 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 consolidated financial statements and notes to the consolidated financial statements.

Financial Position

(Dollar amounts in thousands, except per share data)

	2011		2010		Percentage Change
At December 31,
Total assets	$	406,086	$	374,096		8.6	%
Deposits		340,664		309,134		10.2	%
Loans, net		213,952		190,685		12.2	%
Securities		150,175		138,033		8.8	%
Shareholders’ equity		42,745		38,981		9.7	%
Book value per share		19.31		17.67		9.3	%
Year ended December 31,
Net interest income	$	13,363	$	12,282		8.8	%
Income before income taxes		3,056		1,396		118.9	%
Net income		2,612		1,325		97.1	%
Cash dividends declared		706		706		0.0	%
Net income per share		1.18		0.60		96.7	%
Cash dividends per share		0.32		0.32		0.0	%

National Bancshares Corporation is the holding company for First National Bank, a federally chartered national bank formed in Ohio in 1881. First National Bank has fourteen offices in Orrville, Massillon, Wooster, Apple Creek, Dalton, Fairlawn, Kidron, Lodi, Mt. Eaton, Seville and Smithville. Additional information is available atwww.discoverfirstnational.com.

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SELECTED FINANCIAL DATA

(Dollar amounts in thousands, except per share data)

				As of or for the years ended December 31,
	2011			2010			2009			2008			2007
Income statement data:
Interest income	$	15,413		$	15,501		$	16,465		$	17,071		$	17,832
Interest expense		2,050			3,219			4,237			5,785			6,968
Net interest income		13,363			12,282			12,228			11,286			10,864
Provision for loan losses		600			2,229			1,829			482			147
Net interest income after provision for loan losses		12,763			10,053			10,399			10,804			10,717
Noninterest income		3,032			3,190			2,972			2,333			1,990
Noninterest expense		12,739			11,847			11,364			10,173			10,500
Income before income taxes		3,056			1,396			2,007			2,964			2,207
Income taxes		444			71			398			770			496
Net income		2,612			1,325			1,609			2,194			1,711
Balance sheet data:
Cash and due from banks	$	15,213		$	12,837		$	8,124		$	11,001		$	11,842
Federal funds sold		—			—			—			—			443
Securities		150,175			138,033			130,241			127,248			84,514
Loans, net		213,952			190,685			194,071			179,831			191,488
Deposits		340,664			309,134			291,373			263,642			242,523
Borrowings		18,168			23,471			36,720			34,285			26,374
Shareholders’ equity		42,745			38,981			38,903			36,881			34,991
Total assets		406,086			374,096			370,228			338,002			306,651
Share and per share data:
Net income	$	1.18		$	0.60		$	0.73		$	1.00		$	0.77
Cash dividends		0.32			0.32			0.32			0.64			0.64
Book value at period end		19.31			17.67			17.64			16.75			15.85
Weighted average number of shares outstanding		2,211,508			2,205,973			2,202,457			2,203,218			2,231,369
Performance ratios:
Return on average equity		6.39	%		3.34	%		4.21	%		6.20	%		4.94	%
Return on average assets		0.66	%		0.35	%		0.46	%		0.70	%		0.56	%
Dividend payout percentage		27.03	%		53.28	%		43.82	%		64.00	%		83.58	%
Efficiency ratio(1)		77.70	%		76.56	%		74.76	%		74.70	%		81.69	%
Full-time equivalent staff		115			113			101			108			105
Average total assets to full-time equivalent staff	$	3,463		$	3,370		$	3,491		$	2,916		$	2,903
Asset quality ratios:
Allowance for loan losses to ending total loans		1.46	%		1.34	%		1.48	%		0.95	%		1.05	%
Net loan charge-offs to average loans		0.01	%		1.30	%		0.35	%		0.41	%		0.06	%
Capital ratios:
Average equity to average assets		10.26	%		10.40	%		10.84	%		11.24	%		11.35	%
Leverage ratio(2)		7.78	%		7.46	%		7.40	%		7.78	%		8.26	%
Total risk-based capital ratio(2)		13.85	%		13.59	%		12.46	%		12.60	%		12.78	%

(1) The efficiency ratio is calculated by dividing noninterest expenses by the sum of net interest income and noninterest income.

(2) First National Bank ratios computed in accordance with regulatory guidelines.

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SELECTED FINANCIAL DATA

The following table shows quarterly results of operations for 2011 and 2010.

	Interest income		Net interest income		Provision for loan losses		Income (loss) before income taxes			Net income		Basic and diluted earnings per share
			(Dollar amounts in thousands, except per share data)
2011
First quarter	$	3,675	$	3,097	$	147	$	536		$	487	$	0.22
Second quarter		3,892		3,370		150		693			589		0.27
Third quarter		3,920		3,439		150		950			762		0.34
Fourth quarter		3,926		3,457		153		877			774		0.35
2010
First quarter	$	3,958	$	3,112	$	507	$	301		$	293	$	0.13
Second quarter		3,920		3,101		615		96			158		0.07
Third quarter		3,919		3,120		228		1,154			866		0.39
Fourth quarter		3,704		2,949		879		(155	)		8		0.01

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

This section of the annual report is intended to assist the reader in evaluating the performance of National Bancshares Corporation for the years ended December 31, 2011, 2010 and 2009. 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 2012 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 Corporation or any other person that the indicated results will be achieved. You are cautioned not to place undue reliance on forward-looking information.

Management Strategy

The Corporation is a community-oriented financial institution offering a variety of financial services to meet the needs of the communities it serves. The Corporation attracts deposits from the general public and uses such deposits, together with borrowings and other funds, primarily to originate commercial and commercial real estate loans, single-family and multi-family residential mortgage loans, home equity loans and lines of credit and consumer loans.

During 2011, the Corporation operated under a strategic plan which is updated, modified and adopted annually by the Board of Directors. The plan calls for achieving an above peer return on equity, achieving a loan to asset ratio of 60%, reducing the net overhead ratio to 2.3%, maintaining cash-type deposits above 70%, achieving a net interest margin of at least 3.58%, maintaining a risk based capital ratio of at least 12% and holding the classification ratio at 20% or less.

Historically, the Corporation’s low loans-to-assets ratio has been detrimental to the net interest margin and return on equity. Accordingly, the Board and Management have established a goal of changing the Corporation’s asset mix by increasing the loan to asset ratio to 60%. On December 31, 2011, the loan-to-asset ratio was 53.5% and this change will take place over several years as growth in the loan portfolio is accomplished through the increased capacity of the Corporation’s lending divisions. Business bankers and mortgage originators have been added and office managers have undergone increased consumer loan training. An integral component of increasing the loan-to-asset ratio is credit underwriting. In 2010, the Bank added a new senior credit officer and two credit analysts to its underwriting staff. These additions have increased the credit administration staff to five and the result is improved credit underwriting and loan monitoring. Total loans have increased $20.1 million over the past two years.

Reducing the net overhead ratio, excluding securities gains and losses on the sale of other real estate owned from 2.48% to 2.30% will be accomplished as the loan-to-asset ratio is achieved without significantly adding to expenses. Lending divisions and support personnel are in place to support the $26.5 million increase in loan volume which will be required to reach the 60% loan-to-asset ratio. Negatively impacting the net overhead ratio is the high number of office locations relative to the small asset size of the offices. The personnel costs associated with expansion of the loan divisions also negatively impacts the overhead ratio since the increased number of bankers not yet managing the size of a fully developed portfolio of loans has increased. In other words, the cost of lending is too high given the size of the loan portfolio. That will be mitigated as growth in the loan portfolio is achieved.

The Corporation benefits from a cash-type deposit ratio of 82.6%. The goal of maintaining cash type deposits above 70% will be challenging but can be accomplished through the increased productivity of the Corporation’s retail office system which generates core funding cash-type deposits. The Corporation benefits from its strong core deposit base which is much higher than peer and its strong core deposit base significantly enhances value and makes it possible for assets to be supported by stable and relatively low cost funding. While the Corporation enjoys low cost of funds,

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this cost advantage comes at the price of increased overhead expenses discussed above which is a result of the relatively small size of many of its offices.

The Corporation’s net interest margin for 2011 was 3.66%. Maintaining a net interest margin of at least 3.58% in a falling rate environment, will be accomplished through loan growth which will result in the reduction of securities as a percentage of assets. The banking business starts with loans. Loans are supported by deposits and capital is needed to support the volume of loans and deposits. Without loans there is no need for deposits and certainly there is no need for capital. The Corporation has historically relied too heavily on income from its securities portfolio and that was a reasonable plan when the term structure of interest rates accommodated such a business plan. Unfortunately that reliance is misplaced in a nearly zero interest rate environment. In this low rate environment the only way to increase yield with securities is by extending the duration of the securities portfolio which is exactly the wrong action to take since longer duration securities will decline in value significantly should interest rates rise. Securities are of course needed for liquidity and income but the overreliance on securities as a source of interest income is inappropriate.

A Strong capital ratio is critical to the subsidiary Bank’s safety and soundness. A bank must have a risk-based capital ratio over 10% to be considered well capitalized by its regulators. The Corporation’s Board of Directors has established a goal of maintaining a risk-based capital ratio of 12% to protect the financial stability of the organization. The risk-based capital ratio was 13.85% as of December 31, 2011.

The classification ratio is calculated using total adversely classified assets (excluding special mention loans) divided by Tier 1 capital plus allowance for loan losses. The classification ratio was 21.1% and 32.0% as of December 31, 2011 and 2010. Prior to 2009, the classification ratio was consistently less than 20%. As the economy improves and the current number of classified loans is reduced through monitoring and working with borrowers, the classification ratio is expected to improve.

In 2011, loans, net of allowance for loan losses increased $23.3 million from year-end 2010. The volume of new commercial loans in 2011 remained strong at $60 million and fee income generated from commercial loans totaled $307 thousand. The Bank has been taking advantage of the opportunity to lend to businesses in search of a bank that will be responsive to their credit needs as other banks have tightened lending requirements.

In August 2010, the Bank formed a new Agribusiness and Community Banking Group. The new group is made up of six community bankers and focuses primarily on agriculture lending, small business lending and corporate services. The Bank has not historically been focused on agricultural-type lending and yet it is headquartered in an ideal market to do so. The volume of new loans in 2011 from this group was $35.5 million. Since January 2010, agriculture loans and loans secured by farmland have increased from $3.4 million to $15.3 million. The Agribusiness and Community Banking Group has been a bright spot, and continually development remains an important strategic objective of the Bank.

The securities portfolio is a significant source of income. However income from securities will decline unless interest rates rise significantly, as cash flow from maturing securities and cash flow from mortgage backed securities is reinvested at lower interest rates. Changing market conditions could affect the profitability of the portfolio, as well as the level of interest rate risk exposure. The Bank invests in securities it believes offer good relative value at the time of purchase, and it will reposition its securities portfolio as needed. In making its decisions to sell or purchase securities, the Bank considers credit ratings, call features, maturity dates, relative yields, current market factors, interest rate risk and other relevant factors. In 2011, the Bank increased the amortized cost of state and municipal bonds in the portfolio by $9.2 million. Attractive taxable-equivalent yields make state and municipal bonds an appealing alternative to U.S. Treasury, federal agency bonds and mortgage-backed securities in the current interest rate environment.

The average yield of the securities portfolio was 2.98% as of December 31, 2011. The portfolio duration was 2.1 years and based on current interest rates and payment assumptions, cash flows of $28.6 million are projected over the next twelve months. The yield on securities is expected to decline in 2012 as cash flows are reinvested in the current low interest rate environment. The Bank will continue to monitor market conditions and invest in securities with good relative value.

Platinum Checking, a high-interest checking account for clients with balances above $10 thousand accounted for $64.7 million or 19.0% of total deposits at December 31, 2011. Bonus Checking, an account that pays bonus interest to clients that use the Bank’s Visa debit card, receive their account statement online, and make at least one electronic direct deposit accounted for $22.5 million of deposits at December 31, 2011. In 2011 these two accounts grew 17% and 162% respectively. In March 2010, the Corporation introduced “Bonus Savings”, a high-yield savings account that is available to customers that have a Bonus Checking account. Bonus Savings accounted for $9.8 million as of

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December 31, 2011 an increase of $5.8 million since year end 2010. In 2011 total deposits grew $31.5 million or 10.2%.

Office of the Comptroller of the Currency (“OCC”) regulations require banks to maintain certain minimum levels of regulatory capital. Additionally, the regulations establish a framework for the classification of banks into five categories: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Generally, an institution is considered well-capitalized if it has a core (Tier 1) capital ratio of at least 5.0% (based on adjusted total assets); a core (Tier 1) risk-based capital ratio of a least 6.0%; and a total risk-based capital ratio of at least 10.0%. At December 31, 2011 the Bank is categorized as well capitalized under the regulatory framework for prompt corrective action and capital ratios were well above regulatory minimums.

The Corporation is not aware of any market or institutional trends, events or uncertainties that are expected to have a material effect on liquidity, capital resources or operations. The Corporation is not aware of any current recommendations by its regulators which would have a material effect if implemented. The Corporation has not engaged in sub-prime lending activities and does not plan to engage in those activities in the future.

Financial Condition

Total assets increased 8.6% to $406.1 million as of December 31, 2011, from $374.1 million at December 31, 2010. Securities available for sale totaled $150.2 million as of December 31, 2011, compared to $138.0 million at December 31, 2010. Loans, net of allowance for loan losses increased $23.3 million to $214.0 million as of December 31, 2011, compared to $190.7 million at December 31, 2010. Deposits increased 10.2% to $340.7 million as of December 31, 2011, compared to $309.1 million at December 31, 2010. Shareholders’ equity increased 9.7% to $42.7 million at the end of 2011, from $39.0 million at the end of 2010. Accumulated other comprehensive income increased to $3.6 million as of December 31, 2011, compared to $1.9 million as of December 31, 2010. The change in accumulated other comprehensive income was a result of an increase in unrealized gains on securities available for sale.

Loans

Total loans increased by $23.8 million or 12.3% from year-end 2011 to year-end 2010. The Bank continues to focus its efforts on attracting commercial loan business. Average loans, net of allowance for loan losses increased from $192.8 million in 2010 to $200.8 million in 2011.

First National Bank’s loan policy limits the balances of loans of certain loan categories as follows: up to 60% of total loans for commercial loans, up to 40% of total loans for consumer loans, up to 60% of total loans for residential real estate loans and up to 200% of total capital for commercial real estate loans. The loan to deposit ratio will not exceed 90%.

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	Loan portfolio composition at December 31,
	2011			2010			2009			2008			2007
				(Dollar amounts in thousands)
Real estate:
Commercial and land development	$	66,886		$	58,047		$	54,787		$	43,972		$	45,820
One-to-four family		56,917			47,204			50,390			54,924			80,113
Home equity		30,086			27,766			26,526			24,442			20,857
Multifamily		17,041			14,397			10,353			4,062			5,643
Real estate construction:
Commercial and land development		4,822			9,942			11,797			11,725			4,460
One-to-four family		683			301			598			1,121			3,907
Commercial		33,473			26,158			30,621			27,241			19,539
Consumer:
Auto:
Direct		2,065			2,474			3,171			3,171			4,392
Indirect		4,541			6,401			8,605			10,923			7,206
Credit cards		—			—			—			—			1,614
Other		980			989			567			260			390
Total loans		217,494			193,679			197,415			181,841			193,941
Less:
Unearned and deferred income		(379	)		(409	)		(438	)		(292	)		(425	)
Allowance for loan losses		(3,163	)		(2,585	)		(2,906	)		(1,718	)		(2,028	)
Net loans	$	213,952		$	190,685		$	194,071		$	179,831		$	191,488
Net loans as a percent of total assets		52.69	%		50.97	%		52.42	%		53.20	%		62.45	%

Ranked by North American Industry Classification System – or NAICS – codes, the industries most represented by First National Bank’s commercial borrowers include lessors of non-residential buildings and lessors of residential buildings and dwellings, in that order, accounting for 11.0% and 10.3% of the total loans at year-end 2011, respectively.

Approximately 42% of the conventional mortgage loans secured by one-to-four family and multifamily real estate are long term fixed interest rate loans. Approximately 58% of the portfolio of conventional mortgage loans secured by one-to-four family and multifamily real estate at year-end 2011 consisted of adjustable rate loans. First National Bank’s fixed-rate conventional mortgage loans are originated with loan documentation that permits their sale in the secondary market. The Bank’s policy is to classify all thirty year fixed-rate mortgage loans as “Held for Sale” or “Held for Portfolio” at the time the loans are originated within various scenarios and classifications set by the Bank. The classification is based upon several factors such as the Bank’s interest rate risk position, the loan’s interest rate and term, the Bank’s liquidity position, the interest rate environment and general economic conditions.

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, increased by the provision for loan losses and recoveries, and decreased by charge-offs. The allowance for loan losses is the sum of components recognized and measured either: (1) according to Accounting Standards Codification (ASC) 450-10-05, “Accounting for Contingencies,” for pools of homogenous loans, or (2) according to ASC 310-10-35, “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, current economic trends 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 $250 thousand or to borrower’s whose aggregate total borrowing exceeds $250 thousand

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are reviewed individually, except for first and second mortgage loans on a borrower’s personal residence. Loans or borrowers with balances under $250 thousand may also be reviewed individually if considered necessary by the board and management. A borrower’s risk rating may be downgraded at any point during the year if the creditworthiness of a borrower deteriorates. In addition, risk ratings are reviewed annually by a qualified independent third party. The independent third party reviews all aggregate loan relationships of $300 thousand or greater along with a sampling of loan relationships under $300 thousand. Loans analyzed individually are ranked as follows:

Loans Graded 1, 2, 3 and 4 are loans that are considered satisfactory, with lower than average risk and low probability of serious financial deterioration on the borrower’s part.

Loans Graded 5 (“Watch”) 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 deterioration in the borrower’s financial condition.

Loans Graded 6 (“Special Mention”) have more than average risk, with identified potential weaknesses that deserve management’s close attention. Left uncorrected, the potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. 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.

Loans Graded 7 (“Substandard”) are inadequately protected by the current financial condition and paying capacity of the borrower or by the 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. Loans may be classified substandard even if payments are not 90 days or more past due. Loans 90 days or more past due are classified as substandard or lower unless the loan is adequately collateralized and in the process of collection.

Loans Graded 8 (“Doubtful”) have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, condition and values, 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.

Loans Graded 9 (“Loss”)are those considered uncollectible or portions of loans that are considered uncollectable. Loans in this category are charged-off by management.

If it is probable that the Bank will be unable to collect all principal and interest due on a commercial or non-homogenous loan then that loan is considered impaired. The measure of impairment is based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the value of collateral less estimated costs to sell for collateral dependent loans, compared to the recorded investment in the loan (including accrued interest, net deferred loans fees or costs, and unamortized premium or discount). The Bank considers commercial or non-homogenous loans graded doubtful or loss to be impaired. Some loans graded substandard are considered impaired. Special mention and watch loans are not considered to be impaired. Impairment is evaluated in total for smaller-balance loans of similar type and purpose – such as residential mortgage and consumer, – and on an individual loan basis for other loans (other loans consists of loans to non-profit organizations and loans collateralized with cash). 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 expensing a provision for loan losses. No specific provision for loan losses expense would result if an individually reviewed loan is graded higher than “watch”, but such loans are included in the pools of loans analyzed under ASC 450-10-05. 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 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.

12

As of December 31, 2011, 2010 and 2009 classified assets were as follows:

	Classified assets at December 31,
	2011					2010					2009
	Amount		Percent of total loans			Amount		Percent of total loans			Amount		Percent of total loans
	(Dollar amounts in thousands)
Classified loans:
Special mention	$	4,887		2.3	%	$	2,667		1.4	%	$	2,841		1.4	%
Substandard		7,242		3.3	%		9,878		5.1	%		11,783		6.0	%
Doubtful		—		0.0	%		—		0.0	%		—		0.0	%
Loss		—		0.0	%		—		0.0	%		—		0.0	%
Total classified loans		12,129		5.6	%		12,545		6.5	%		14,624		7.4	%
Other real estate owned		18		0.0	%		58		0.0	%		104		0.1	%
Total classified assets	$	12,147		5.6	%	$	12,603		6.5	%	$	14,728		7.5	%

Total classified loans decreased from $12.5 million at December 31, 2010 to $12.1 million at December 31, 2011. The Bank’s classification ratio was 21.1% and 32.0% as of December 31, 2011 and December 31, 2010. The classification ratio is calculated using total adversely classified assets (excluding special mention loans) divided by Tier 1 capital plus allowance for loan losses.

Pools of Loans Analyzed under ASC 450

The total loan loss allowance is derived both from analysis of individual impaired loans under ASC 310-10-35 and analysis of aggregated pools of loans under ASC 450. Smaller balance loans (such as automobile or home equity loans, for example), 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 ASC 450.

Under ASC 450, loans are segmented into groups of loans having similar risk characteristics based on purpose, loan type, and collateral, for example 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.

Changes in the Allowance for Loan Losses and Classified Assets

An effective loan review function is vital to the 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. Each quarter, a committee consisting of the Bank’s Chief Financial Officer and Senior Credit Officer evaluates the loan loss allowance and reports the results of its evaluation to senior management and the Bank’s Board of Directors. The Bank may adjust its loan loss allowance methodology 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.

The allowance for loan losses increased from $2,585,000 as of December 31, 2010 to $3,163,000 at December 31, 2011, or from 1.34% of total loans at year-end 2010 to 1.46% at December 31, 2011. Net charge-offs decreased from $2,550,000 in 2010 to $22,000 in 2011. The provision for loan losses for 2011 was $600,000, compared to $2,229,000 in 2010. The increase in the allowance for loan losses in 2011 was primarily related to the increase in loans.

Total nonperforming loans decreased from $4.9 million as of December 31, 2010 to $4.0 million at December 31, 2011. Non-performing loans consist of loans placed on non-accrual status and loans past due 90 or more days and still accruing interest. Loans past due between 30 and 89 days decreased to $1.5 million at December 31, 2011 from $1.7 million as of December 31, 2010. In 2011, total classified loans decreased from $12.5 million to $12.1 million. Management believes the allowance for loan losses is adequate as of December 31, 2011.

Loan review and monitoring is integral to effective credit administration and risk management. In order to minimize the credit risk inherent in the lending process, management and the Board of Directors has adopted a more formal and systematic approach with credit administration and loan review. As part of this systematic approach, a qualified independent third party was engaged to perform loan reviews in 2011, 2010 and 2009. Management intends to continue this practice on an annual basis.

13

Loans deemed uncollectible are charged against the allowance for loan losses. After a loan is charged off, the Bank continues its efforts to recover the loss. Recoveries of previously charged-off amounts are credited to the allowance for loan losses. The charge-offs in 2010 relate primarily to two commercial loans totaling $1.7 million. The Bank recorded a $400 thousand partial charge-off of a $1.6 million commercial real estate loan in 2009. The Bank recorded a $676 thousand partial charge-off of a $1.7 million commercial real estate loan in 2008. Transactions in the allowance for loan losses are summarized in following table:

	Year ended December 31,
	2011			2010			2009			2008			2007
				(Dollar amounts in thousands)
Balance, beginning of period	$	2,585		$	2,906		$	1,718		$	2,028		$	1,993
Loans charged off:
Real estate:
Commercial and land development		—			340			—			688			—
One-to-four family		28			82			38			16			12
Home equity		26			45			25			9			—
Multifamily		—			—			—			—			—
Real estate construction:
Commercial and land development		—			272			400			—			—
One-to-four family		—			—			—			—			—
Commercial		—			1,797			—			42			67
Consumer		17			40			195			69			72
Credit cards		—			—			1			21			—
Total loans charged off		71			2,576			659			845			151
Recoveries of loans previously charged off:
Real estate:
Commercial and land development		—			—			—			5			—
One-to-four family		—			—			—			14			1
Home equity		1			2			2			2			—
Multifamily		—			—			—			—			—
Real estate construction:
Commercial and land development		1			—			—			—			—
One-to-four family		—			—			—			—			—
Commercial		25			—			1			20			—
Consumer		22			24			15			11			37
Credit cards		—			—			—			1			1
Total recoveries		49			26			18			53			39
Net loans charged off		(22	)		(2,550	)		(641	)		(792	)		(112	)
Provision charged to operations		600			2,229			1,829			482			147
Balance, end of period	$	3,163		$	2,585		$	2,906		$	1,718		$	2,028
Loans outstanding:
Average	$	203,669		$	195,730		$	184,965		$	192,472		$	187,888
End of period		217,115			193,270			196,977			181,549			193,941
Ratio of allowance for loan
losses to total loans outstanding at end of period		1.46	%		1.34	%		1.48	%		0.95	%		1.05	%
Net charge offs to average loans		0.01	%		1.30	%		0.35	%		0.41	%		0.06	%

14

The allowance for loan losses is allocated among loan categories as shown in the following table. Although the 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.

	Allocation of the allowance for loan losses at December 31,
	2011					2010					2009					2008					2007
	Amount		Percent(1)			Amount		Percent(1)			Amount		Percent(1)			Amount		Percent(1)			Amount		Percent(1)
								(Dollar amounts in thousands)
Real estate:
Commercial and land development	$	1,319		31	%	$	1,019		30	%	$	1,142		28	%	$	501		24	%	$	779		24	%
One-to-four family		627		26	%		510		24	%		163		26	%		283		30	%		321		41	%
Home equity		66		14	%		100		14	%		73		13	%		74		14	%		86		11	%
Multifamily		225		8	%		164		8	%		29		5	%		41		2	%		20		3	%
Real estate construction:
Commercial and land development		89		2	%		248		5	%		424		6	%		42		6	%		16		2	%
One-to-four family		9		0	%		1		0	%		2		0	%		4		1	%		14		2	%
Commercial		788		15	%		460		14	%		929		16	%		579		15	%		552		10	%
Consumer:
Auto:
Direct		10		1	%		13		1	%		37		2	%		43		2	%		60		2	%
Indirect		25		2	%		35		3	%		100		4	%		147		6	%		99		4	%
Other		5		1	%		5		1	%		7		0	%		4		0	%		5		1	%
Credit cards		—		0	%		—		0	%		—		0	%		—		0	%		48		0	%
Unallocated		—		0	%		30		0	%		—		0	%		—		0	%		28		0	%
Total	$	3,163		100	%	$	2,585		100	%	$	2,906		100	%	$	1,718		100	%	$	2,028		100	%

(1) - Percent of loans in each category to total loans.

15

Management reviews nonperforming assets on a regular basis and assesses the requirement for specific reserves on those assets. Any loan past due 90 days or more and any loan on nonaccrual is considered to be a nonperforming asset. Any loan 90 days or more past due that is not both adequately collateralized and in a positive cash-flow position and any loan to a borrower experiencing serious financial deterioration may be placed on nonaccrual by the Senior Credit Officer with the concurrence of senior management. Interest received on nonaccrual loans – also referred to as nonperforming loans – is recorded as a reduction of principal. The table to follow summarizes nonperforming loans and other nonperforming assets by category.

				Problem assets at December 31,
	2011			2010			2009			2008			2007
				(Dollar amounts in thousands)
Nonaccrual loans	$	3,836		$	4,373		$	4,716		$	1,752		$	2,645
Past due 90 days or more and still accruing		177			487			458			261			158
Restructured loans and leases(1)		—			—			—			—			—
Total nonperforming loans		4,013			4,860			5,174			2,013			2,803
Other real estate owned		18			58			104			354			194
Total nonperforming assets	$	4,031		$	4,918		$	5,278		$	2,367		$	2,997
Loans outstanding, net	$	213,952		$	190,685		$	194,071		$	179,831		$	191,488
Nonperforming loans to total net loans		1.88	%		2.55	%		2.67	%		1.12	%		1.46	%
Nonperforming assets to total assets		0.99	%		1.31	%		1.43	%		0.70	%		0.98	%
Allowance for loan losses to total loans		1.46	%		1.34	%		1.48	%		0.95	%		1.05	%
Allowance for loan losses to nonperforming loans		78.82	%		53.19	%		56.17	%		85.35	%		72.35	%

(1) All restructured loans and leases as of the dates shown were on nonaccrual status and are included as nonaccrual loans and leases in this table.

16

Securities

Total securities increased $12.1 million or 8.8% at December 31, 2011 when compared to December 31, 2010. Securities are primarily comprised of mortgage-backed securities, municipal securities and securities issued by corporations. The Bank actively purchases bonds issued by local municipalities, school systems and other public entities when opportunities arise. 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, the security is classified as held to maturity and it is reflected on the balance sheet at amortized 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 fair value. Management generally believes that all securities should be classified as available for sale but makes that determination at the time of purchase. In order to more effectively manage securities and to be in a better position to react to market conditions, at December 31, 2011, all securities were classified as available for sale. At year-end 2011 and 2010 there was no single issuer of securities where the total book value of such securities exceeded 10% of shareholders’ equity except for U.S. government and agency obligations.

The following table shows the amortized cost and estimated fair values of the corporation’s securities portfolio at the date indicated.

	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
	(Dollar amounts in thousands)
December 31, 2011
Available for sale:
U.S. Government and federal agency	$	2,430	$	16	$	—		$	2,446
State and municipal		53,841		3,592		(10	)		57,423
Mortgage-backed: residential		88,362		2,060		(136	)		90,286
Equity securities		23		—		(3	)		20
Total securities	$	144,656	$	5,668	$	(149	)	$	150,175
December 31, 2010
Available for sale:
U.S. Government and federal agency	$	2,954	$	21	$	—		$	2,975
State and municipal		44,656		833		(484	)		45,005
Corporate bonds and notes		1,487		29		—			1,516
Mortgage-backed: residential		86,001		2,766		(240	)		88,527
Equity securities		23		—		(13	)		10
Total securities	$	135,121	$	3,649	$	(737	)	$	138,033
December 31, 2009
Available for sale:
U.S. Government and federal agency	$	819	$	—	$	—		$	819
State and municipal		28,019		763		(99	)		28,683
Corporate bonds and notes		7,640		137		—			7,777
Mortgage-backed: residential		89,972		3,058		(87	)		92,943
Equity securities		23		—		(4	)		19
Total securities	$	126,473	$	3,958	$	(190	)	$	130,241

17

The contractual maturity of securities available for sale at December 31, 2011 is shown below.

	One year or less			More than one to five years			More than five to ten years			More than ten years			Total securities
	Amortized Cost Average yield			Amortized Cost Average yield			Amortized Cost Average yield			Amortized Cost Average yield			Amortized Cost Average yield			Fair value
	(Dollar amounts in thousands)
U.S. Government and	$	—		$	1,743		$	687		$	—		$	2,430		$	2,446
federal agency		—			1.22	%		4.49	%		—			2.15	%
State and municipal		2,748			3,787			19,639			27,667			53,841			57,423
		1.36	%		3.25	%		3.41	%		3.69	%		3.44	%
Mortgage-backed:
residential		—			697			73,532			14,133			88,362			90,286
		—			1.66	%		2.57	%		3.55	%		2.72	%
Total	$	2,748		$	6,227		$	93,858		$	41,800		$	144,633		$	150,155
		1.36	%		2.51	%		2.76	%		3.64	%		2.98	%

Restricted Equity Securities

As of December 31, 2011, the Bank held 24,855 shares of $100 par value Federal Home Loan Bank of Cincinnati stock, which are restricted-equity securities. FHLB stock represents an equity interest in the FHLB, but it does not have a readily determinable fair 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.

As of December 31, 2011, the Bank held 14,960 shares of Federal Reserve Bank stock, with a carrying value of $734 thousand, which are restricted equity securities. The capital stock represents an equity interest in the Federal Reserve Bank, but does not have a readily determinable fair value. Member institutions are required to hold 6% of capital and surplus in Federal Reserve Bank stock at all times.

Total Liabilities

Total liabilities increased by $28.2 million or 8.4% from 2010 to 2011. This increase is primarily a result of a $31.5 million increase in deposits, partially offset by a decrease of $7.0 million in Federal Home Loan Bank advances.

Deposits

Deposits increased during 2011 by $31.5 million or 10.2%. The increase is primarily attributed to a growth in interest-bearing demand deposits of $20.4 million or 15.2%. Much of the increase in this category is attributed to the Bank’s success in marketing our “Platinum Checking” and “Bonus Checking” accounts. The increase in interest-bearing demand deposits was partially offset by a decrease in time deposits. Savings accounts increased by $6.0 million or 12.0% from the end of 2010 to the end of 2011. Time deposits decreased by $8.2 million or 12.1%. This decrease is a result of the success of our premium money market and interest-bearing checking accounts, and management’s decision to maintain a reasonable time deposit rate structure.

Maturity of time deposits of $100,000 or more at December 31, 2011

(Dollar amounts in thousands)

	Amount		Percent of Total
Time remaining to maturity:
Three months or less	$	2,209		14.4	%
Over three through 12 months		7,328		47.9	%
Over one year through 3 years		4,790		31.3	%
Over 3 years		978		6.4	%
	$	15,305		100.0	%

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. Both short- and long-term liquidity needs are addressed by maturities and sales of unpledged 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 purchased. The use of these resources, combined with access to credit, provide funds for satisfying depositor and borrower 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, which can be caused by higher interest rates paid by competitors. Management continually 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.

18

The most liquid assets are cash and cash equivalents, which at year-end 2011 consisted of $15.2 million in cash and due from banks. At year-end 2010 cash and cash equivalents consisted of $12.8 million in cash and due from banks. Federal funds sold are overnight investments with correspondent banks, an investment and liquidity tool used to maximize earning assets. Securities classified as available for sale that are not pledged are another source of liquidity. We 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 2011 was 63.7%. At the end of 2011 the fair value of securities available for sale was approximately $150.2 million, while the fair value of securities pledged was approximately $63.9 million, representing securities pledged to secure public deposits and repurchase agreements.

The Corporation’s operating activities, as described in the Consolidated Statements of Cash Flows in the attached consolidated financial statements, include net cash provided of $6.8 million in 2011, $5.1 million in 2010 and $1.4 million in 2009, generated principally from net income in those years. The Bank reported $11.3 and $11.4 million in originations and proceeds from sales of mortgage loans held for sale as operating activities in 2011.

The Corporation’s investing activities, as described in the Consolidated Statements of Cash Flows in the attached consolidated financial statements, consist primarily of loan originations and repayments, along with securities purchases, sales and maturities. In 2011, net cash used in investing activities was $29.4 million. The purchases of securities, offset by maturities, repayments and sales accounted for the use of $10.6 million. Proceeds from the maturities and repayments of time deposits with other financial institutions provided $5.5 million. The increase in loans over the year utilized $26.1 million of cash.

In 2010, net cash used in investing activities was $4.2 million. The purchase of securities, offset by maturities, repayments and sales accounted for the use of $9.0 million. Proceeds from the maturities and repayments of time deposits with other financial institutions provided $8.9 million. Purchases of property and equipment, primarily related to our office rebranding project, were $4.2 million.

The Corporation’s financing activities, as described in the Consolidated Statements of Cash Flows in the attached consolidated financial statements, include the solicitation and repayment of customer deposits, borrowings and repayments, treasury stock activity, and the payment of dividends. In 2011, net cash provided by financing activities was $25.5 million. The increase in deposits over the year provided $31.5 million of cash. At December 31, 2011, the Bank had $8.0 million of borrowings outstanding with FHLB, maturing in the years 2012 and 2014. This amount represents a $7.0 million decrease from the $15.0 million that was owed at the end of 2010.

Net cash provided by financing activities was $3.8 million in 2010. The increase in deposits during 2010 provided $17.8 million of cash. The maturity of FHLB borrowings used $12.0 million of cash during the year.

First National Bank has approximately $14.0 million available in short-term funding arrangements with its correspondent banks and the FHLB as of December 31, 2011. Additional information concerning FHLB borrowings and bank obligations under repurchase agreements is contained in Notes 8 and 9 of the consolidated financial statements of National Bancshares Corporation. 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:

	Year ended December 31,
	2011			2010			2009
	(Dollar amounts in thousands)
Balance at year-end	$	10,168		$	7,747		$	6,105
Average balance outstanding		9,071			8,032			7,442
Maximum month-end balance		11,114			12,083			8,965
Weighted-average rate at year-end		0.15	%		0.15	%		0.25	%
Average rate during the year		0.15	%		0.15	%		0.26	%

The Bank is subject to federal regulations imposing minimum capital requirements. Total risk-based capital, tier I risk-based capital, and tier I leverage capital ratios are monitored to assure compliance with regulatory capital requirements. At December 31, 2011, the Bank exceeded minimum risk-based and leverage capital ratio requirements. The Bank’s ratio of total capital to risk-based assets was 13.85% on December 31, 2011. The minimum required ratio to be considered adequately capitalized is 8%. Additional information concerning capital ratios at year-end 2011 and 2010 is contained in Note 14 of the consolidated financial statements.

19

Contractual Obligations

As discussed in the notes to National Bancshares Corporation’s consolidated financial statements, obligations exist to make payments under contracts, including borrowings. At December 31, 2011, the aggregate contractual obligations are outlined below:

	Payment due by period
	(Dollar amounts in thousands)
	Total		One year or less		More than one to three years		More than three to five years		More than five years
Time deposits	$	59,663	$	30,812	$	24,056	$	4,795	$	—
Deposits without a stated maturity		281,001		281,001		—		—		—
Long-term obligations		8,000		3,000		5,000		—		—
Information system contract obligations		3,030		1,099		1,733		198		—
Operating lease obligations		194		51		98		45		—
	$	351,888	$	315,963	$	30,887	$	5,038	$	—

Off-Balance Sheet and Contingent Liabilities

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 commitments are agreements to provide credit or to support the credit of others, as long as conditions established in the contracts 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 losses. Since these commitments are viewed as loans, the same credit policies used for loans are used to evaluate making the commitments. These funding commitments by expiration period were as follows at year-end 2011:

	Expiration of funding commitments
	One year or less		More than one year		Total
	(Dollar amounts in thousands)
Unused loan commitments	$	20,457	$	26,405	$	46,862
Commitment to make loans		3,376		—		3,376
Overdraft protection		11,664		—		11,664
Letters of credit		266		—		266
	$	35,763	$	26,405	$	62,168

Of the unused loan commitments, $2,256 are fixed-rate commitments, $48,248 are variable-rate commitments and $11,664 are related to automatic overdraft protection for checking accounts. Rates on unused fixed-rate loan commitments range from 5.00% to 6.75%. The funding commitments shown in the table above do not necessarily represent future cash requirements since experience demonstrates that a large percentage of funding commitments expire unused or partially used.

The Bank is required by regulations of the Federal Reserve Board to maintain cash reserves 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. First National Bank was required to maintain cash reserve balances with the Federal Reserve Bank of $100 thousand at year-end 2011 and $100 thousand at year-end 2010.

The Bank sells some of the loans it originates, particularly conventional fixed-rate residential mortgage loans. The loans are sold without recourse. The Bank has retained mortgage-servicing rights on approximately $16.4 million of residential mortgage loans sold.

Shareholders’ Equity

The $3.8 million or 9.7% increase in shareholders’ equity from year-end 2010 to year-end 2011 was caused by an increase in retained earnings of $1.9 million, and a $1.7 million increase in accumulated other comprehensive income, which resulted from an increase in the fair value of securities available for sale. Accumulated other comprehensive income represents the unrealized appreciation or depreciation (net of taxes) in the fair value of securities available for sale. Interest rate volatility, economic and interest rate conditions could cause material fluctuations in accumulated other comprehensive income. The dividend payout ratio for 2011 was 27.03% versus 53.28% in 2010.

National Bancshares Corporation is dependent on the Bank for earnings and funds necessary to pay dividends, and the payment of dividends, by the Bank to National Bancshares Corporation, 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). The Bank could, without prior approval, pay dividends to the holding company of approximately $5.7 million as of December 31, 2011.

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Interest Rate Sensitivity

Asset-liability management is the active management of a bank’s balance sheet to maintain a mix of loans and deposits consistent with its goals for long-term growth and risk management. Banks, in the normal course of business, assume financial risk by making loans at interest rates that differ from rates paid on deposits. Deposits often have shorter maturities than loans and adjust to current market rates faster than loans. The result is a balance sheet mismatch between assets (loans) and liabilities (deposits).

The function of asset-liability management is to measure and control three levels of financial risk: interest rate risk (the pricing difference between loans and deposits), credit risk (the probability of default), and liquidity risk (occurring when loans and deposits have different maturities).

A primary objective in asset-liability management is managing net interest margin, that is, the net difference between interest earning assets (loans) and interest paying liabilities (deposits) to produce consistent growth in the loan portfolio and shareholder earnings, regardless of short-term movement in interest rates. The dollar difference between assets (loans) maturing or repricing and liabilities (deposits) is known as the rate sensitivity gap (or maturity gap). Banks attempt to manage this asset-liability gap by pricing some of their loans at variable interest rates.

A more precise measure of interest rate risk is duration, which measures the impact of changes in interest rates on the expected maturities of both assets and liabilities. In essence, duration takes the gap report data and converts that information into present-value worth of deposits and loans, which is more meaningful in estimating maturities and the probability that either assets or liabilities will reprice during the period under review.

Interest rate risk is the result of such risks as repricing risk, option risk and basis risk. Repricing risk is caused by the differences in the maturity, or repricing, of assets and liabilities. Most residential mortgage and consumer loans give consumers the right to prepay with little or no prepayment penalty, and because of competitive pressures, it may not be advisable to enforce prepayment penalties on commercial loans. Fixed-rate conventional mortgage loans are originated with loan documentation that permits such loans to be sold in the secondary market. The Bank’s policy is to classify these loans as “Held for Sale” or “Held in Portfolio” at the time the loans are originated based on such factors as the Bank’s liquidity position, interest rate environment and general economic conditions.

Option risk is the risk that a change in prevailing interest rates will lead to an adverse impact on earnings or capital caused by changes in the timing of cash flows from investments, loans and deposits. Cash flows may be received earlier than expected as a result of the exercise of the option to prepay or withdraw early embedded in the financial contracts. The option a borrower has to prepay a loan is similar to the option a depositor has to make an early withdrawal from a deposit account. This form of embedded option gives the customer the opportunity to benefit when interest rates change in their favor and ordinarily occurs at the Bank’s expense in the form of higher interest expense or lower interest income. Residential mortgage loans tend to have higher option risk because of the borrower’s option to prepay the loan, primarily through refinancing when rates decline, and higher interest rate risk because of the longer term associated with residential mortgage loans. Option risk in the form of prepayments also affects the value of mortgage-backed securities.

Basis risk is the risk that changes in interest rates will cause interest-bearing deposit liabilities to reprice at a different rate than interest-bearing assets, creating an asset-liability mismatch. If for example, a bank lends at a rate which changes as the prime rate changes and finances the loan with deposits not tied to the prime rate as an index; it faces basis risk due to the possibility that the prime rate-deposit rate spread might change.

Economic Value of Equity

The economic value of equity, (EVE), is the difference between the net present value of the assets and the net present value of liabilities. EVE can be thought of as the liquidation value of the Bank on the date the calculation is made. Calculating EVE involves using a discount rate to calculate the net present value of assets and liabilities after making assumptions about the duration of assets and liabilities. As interest rates change, the discount rate changes and the change in interest rates effects the duration of assets and liabilities. If interest rates fall, for example, the duration of loans shortens since borrowers tend to prepay. Conversely the duration of loans increases if interest rates rise since borrowers are inclined to hold on to the favorable rate they were able to obtain in the lower interest rate environment.

The Board of Directors has established revised limits on a decline in the economic value of equity (EVE) and earnings at risk (EAR) given changes in interest rates. These limits are that EVE shall not decline by more than 10%, 20% and 30% given a 1%, 2% and 3% increase or decrease in interest rates respectively and that EAR shall not be greater than 8%, 16% or 24% given a 1%, 2% or 3% increase or decrease in interest rates respectively. The following illustrates our equity at risk in the economic value of equity model.

December 31, 2011
Basis Point Change in Rates	+300 bp		+200 bp		+100 bp		-100 bp		-200 bp	-300 bp
Increase (decrease) in EVE	(13.3	)%	(6.3	)%	(1.1	)%	(8.2	)%	nm	nm

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December 31, 2010
Basis Point Change in Rates	+300 bp		+200 bp		+100 bp		-100 bp		-200 bp	-300 bp
Increase (decrease) in EVE	(12.9	)%	(6.8	)%	(1.9	)%	(4.3	)%	nm	nm

nm – not meaningful

The Bank is in compliance with the interest rate risk policy limits related to EVE as of December 31, 2011 and 2010.

Earnings at Risk

Earnings at risk, is the amount by which net interest income will be affected given a change in interest rates. The interest income and interest expense for each category of earning assets and interest bearing liabilities is recalculated after making up and down assumptions about the change in interest rates. Changes in prepayment speeds and repricing speeds are also taken into account when computing earnings at risk given a change in interest rates.

The following illustrates the effect on earnings or EAR given rate increases of 100 to 300 basis points and decreases in interest rates of 100 to 300 basis points.

December 31, 2011
Basis Point Change in Rates	+300 bp		+200 bp		+100 bp		-100 bp		-200 bp	-300 bp
Increase (decrease) in Earnings	(1.0	)%	(0.4	)%	(0.1	)%	(0.4	)%	nm	nm

December 31, 2010
Basis Point Change in Rates	+300 bp		+200 bp		+100 bp		-100 bp		-200 bp	-300 bp
Increase (decrease) in Earnings	(0.7	)%	(0.4	)%	(0.3	)%	(1.4	)%	nm	nm

nm – not meaningful

The Bank is in compliance with the interest rate risk policy limits related to EAR as of December 31, 2011 and 2010.

One way to minimize interest rate risk is to maintain a balanced or matched interest-rate sensitivity position. However, matched funding does not generally maximize profits. To increase net interest income, the Bank mismatches asset and liability repricing to take advantage of interest rate conditions. The magnitude of the mismatch depends on management’s assessment of the risks presented by the interest rate environment.

Interest rate risk can significantly affect income and expense on interest sensitive assets and liabilities, and can also affect the underlying value of the Bank’s assets. The goal in managing interest rate sensitivity is to maintain an appropriate balance between interest sensitive assets and liabilities in order to minimize the impact of volatility in market interest rates.

Management of maturity distributions of assets and liabilities between the most and least sensitive extremes is as important as the balances on hand. 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, and insulating net interest income from changes in market and interest rate conditions is one of the objectives of the Bank’s asset/liability management strategy.

Management attempts to maintain consistent 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 Bank management which reports directly to the Board of Directors. Bank management 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. Bank management also monitors the Bank’s liquidity levels. Interest rate risk exposure is reviewed quarterly with the Board of Directors. Risk is mitigated by matching maturities or repricing opportunities.

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 consists primarily of gathering deposits and making loans, principally in Wayne, Stark, Summit, Medina and Holmes counties, Ohio.

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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 following table. 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.

	Year ended December 31,
	2011							2010							2009
	Average Balance		Interest		Yield/ Cost			Average Balance		Interest		Yield/ Cost			Average Balance		Interest		Yield/ Cost
	(Dollars amounts in thousands)
Assets
Interest earning assets:
Securities:
Taxable	$	91,834	$	3,019		3.38	%	$	99,508	$	3,541		3.70	%	$	113,608	$	5,397		4.88	%
Nontaxable(1)		48,973		2,462		5.19	%		35,072		1,839		5.43	%		20,557		1,226		6.09	%
Federal funds sold		—		—		—			—		—		—			6,063		12		0.20	%
Interest bearing deposits		25,847		93		0.36	%		25,704		210		0.82	%		1,906		25		1.31	%
Net loans (including nonaccrual loans)		200,802		10,676		5.32	%		192,836		10,536		5.46	%		183,001		10,222		5.59	%
Total interest-earning assets		367,456		16,250		4.42	%		353,120		16,126		4.57	%		325,135		16,882		5.19	%
All other assets		30,815							27,689							27,502
Total assets	$	398,271						$	380,809						$	352,637
Liabilities and Shareholder’s Equity
Interest-bearing liabilities:
Deposits:
Interest-bearing checking	$	148,611		766		0.52	%	$	123,993		683		0.55	%	$	109,400		1,026		0.94	%
Savings		53,688		81		0.15	%		48,721		62		0.13	%		48,198		123		0.26	%
Time, $100,000 and over		16,748		212		1.27	%		18,962		357		1.88	%		13,901		340		2.45	%
Time, other		47,471		691		1.46	%		55,742		1,086		1.95	%		58,822		1,627		2.77	%
Federal Home Loan Bank advances		9,915		256		2.58	%		24,652		984		3.99	%		25,389		1,076		4.24	%
Other funds purchased		9,661		44		0.46	%		9,115		47		0.52	%		8,777		45		0.51	%
Total interest-bearing liabilities		286,094		2,050		0.72	%		281,185		3,219		1.14	%		264,487		4,237		1.60	%
Demand deposits		67,968							56,657							46,265
Other liabilities		3,336							3,345							3,662
Shareholders’ equity		40,873							39,622							38,223
Total liabilities and shareholders’ equity	$	398,271						$	380,809						$	352,637
Net interest income(1)			$	14,200						$	12,907						$	12,645
Interest rate spread(2)						3.70	%						3.43	%						3.59	%
Net yield on interest-earning assets(3)						3.86	%						3.66	%						3.89	%
Ratio of average interest-earning assets to average interest-bearing liabilities				128.44%									125.58	%				122.93%

(1) Tax-equivalent basis

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

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

23

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 have been allocated proportionally to the change due to volume and the change due to rate.

	2011 over 2010									2010 over 2009
(Dollar amounts in thousands)	Volume			Rate			Net change			Volume			Rate			Net change
Interest income
Securities:
Taxable	$	(346	)	$	(176	)	$	(522	)	$	(658	)	$	(1,198	)	$	(1,856	)
Nontaxable (tax-equivalent basis)		643			(20	)		623			722			(109	)		613
Federal funds sold		—			—			—			(12	)		—			(12	)
Interest bearing deposits		1			(118	)		(117	)		194			(9	)		185
Loans (including nonaccrual loans)		424			(284	)		140			537			(223	)		314
Total interest income (tax-equivalent basis)	$	722		$	(598	)	$	124		$	783		$	(1,539	)	$	(756	)
Interest expense
Deposits
Interest bearing checking	$	127		$	(44	)	$	83		$	80		$	(423	)	$	(343	)
Savings		7			12			19			1			(62	)		(61	)
Time, $100,000 and over		(28	)		(117	)		(145	)		95			(78	)		17
Time, other		(120	)		(275	)		(395	)		(60	)		(481	)		(541	)
Federal Home Loan Bank Advances		(381	)		(347	)		(728	)		(29	)		(63	)		(92	)
Other funds purchased		2			(5	)		(3	)		2			—			2
Total interest expense	$	(393	)	$	(776	)	$	(1,169	)	$	89		$	(1,107	)	$	(1,018	)
Change in net interest income (tax-equivalent basis)*	$	1,115		$	178		$	1,293		$	695		$	(433	)	$	262

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

2011 versus 2010

During 2011, net income increased $1.3 million or 97.1% to $2.6 million. Accordingly, basic and diluted earnings per share increased from $0.60 per share in 2010 to $1.18 per share in 2011. Earnings for 2011 were positively impacted by an increase in net interest income and a decrease in the provision for loan losses partially offset by an increase in noninterest expense and an increase in income tax expense. Returns on average equity and average assets for the year ending December 31, 2011, were 6.39% and 0.66%, respectively, compared to 3.34% and 0.35% for the year ending December 31, 2010.

Interest and fees on loans increased $140 thousand or 1.3%, due to an increase in the average balance of loans in 2011, offset by a decrease in the yield on loans. Securities interest and dividend income decreased $111 thousand or 2.3% over 2010. Much of this decrease is attributable to a lower yield on securities.

Interest expense decreased $1.2 million or 36.3% during 2011, as the Bank’s deposits and short-term borrowings were affected by the falling interest rate environment. The cost of interest-bearing liabilities fell from 1.14% in 2010 to 0.72% in 2011. Most of the growth in interest-bearing liabilities occurred in interest-bearing demand deposit accounts. The cost of interest-bearing demand deposits is relatively low compared to other interest-bearing liabilities. Interest expense on deposits decreased $438 thousand or 20.0% in 2011. Federal Home Loan Bank advances interest expense decreased $728 thousand or 74.0% as the amount of advances decreased from $15 million to $8 million during 2011.

The provision for loan losses was $600 thousand in 2011, compared to $2.2 million in 2010. The allowance for loan losses and the related provision for loan losses is based on management’s judgment and evaluation of the loan portfolio. The 2011 provision for loan losses was primarily related to the growth in the loan portfolio. Net charge-offs were $22 thousand for 2011, compared to $2.6 million for 2010. The charge-offs in 2010 relate primarily to two commercial loans totaling $1.7 million. One of the aforementioned loans was graded substandard and considered impaired as of December 31, 2009. Management allocated $500 thousand for the loan as of December 31, 2009. The allowance as a percentage of loans increased from 1.34% at December 31, 2010 to 1.46% at December 31, 2011. Classified loans have decreased from $12.5 million as of December 31, 2010 to $12.1 million as of December 31, 2011. Total nonperforming loans have decreased from $4.9 million as of December 31, 2010 to $4.0 million as of December 31, 2011. Management believes the current allowance for loan losses is adequate, however changing economic and other conditions may require future adjustments to the allowance for loan losses.

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Noninterest income decreased $158 thousand or 5.0% during 2011. The change is primarily related to the decrease in securities gains (losses), net partially offset by gains on sale of SBA loans and the death benefit of a life insurance policy.

Noninterest expense was $12.7 million for the year ended December 31, 2011 compared to $11.8 million for 2010, an increase of 7.5%. Salaries and employee benefits, data processing and occupancy expense were higher in 2011, compared to 2010 levels. The increase in salaries and employee benefits is primarily related to an expansion of branch hours in late 2010. The increase in data processing is related to the increased customer usage of online banking, including bill-pay. The increase in net occupancy expense is primarily related to depreciation expense from property and equipment purchased in 2009 and 2010 during our office rebranding project.

Income tax expense was $444 thousand for the year ended December 31, 2011, representing an increase of $373 thousand compared to 2010. The change is primarily related to an increase in income before income taxes, partially offset by an increase in interest income derived from nontaxable securities.

2010 versus 2009

During 2010, net income decreased $284 thousand or 17.6% to $1.3 million. Accordingly, basic and diluted earnings per share decreased from $0.73 per share in 2009 to $0.60 per share in 2010. Earnings for 2010 were negatively impacted by an increase in the provision for loan loss and noninterest expense, partially offset by an increase in noninterest income and a decrease in income tax expense. Returns on average equity and average assets for the year ending December 31, 2010, were 3.34% and 0.35%, respectively, compared to 4.21% and 0.46% for the year ending December 31, 2009.

Total interest and dividend income decreased $964 thousand or 5.9% in 2010. Interest and fees on loans increased $314 thousand or 3.1%, due to an increase in the average balance of loans in 2010, offset by a decrease in the yield on loans. Securities interest and dividend income decreased $1.5 million or 23.4% over 2009. Much of this decrease is attributable to a lower yield on securities.

Interest expense decreased $1.0 million or 24.0% during 2010, as the Bank’s deposits and short-term borrowings were affected by the falling interest rate environment. The cost of interest-bearing liabilities fell from 1.60% in 2009 to 1.14% in 2010. Most of the growth in interest-bearing liabilities occurred in interest-bearing demand deposit accounts. The cost of interest-bearing demand deposits is relatively low compared to other interest-bearing liabilities. Interest expense on deposits decreased $928 thousand or 29.8% in 2010. Federal Home Loan Bank advances interest expense decreased $92 thousand or 8.6% as the amount of advances decreased from $27 million to $15 million during 2010.

The provision for loan losses was $2.2 million in 2010, compared to $1.8 million in 2009. The allowance for loan losses and the related provision for loan losses is based on management’s judgment and evaluation of the loan portfolio. Net charge-offs were $2.6 million for 2010, compared to $641 thousand for 2009. The increase in charge-offs in 2010 relate primarily to two commercial loans totaling $1.7 million. One of the aforementioned loans was graded substandard and considered impaired as of December 31, 2009. Management allocated $500 thousand for the loan as of December 31, 2009. The allowance as a percentage of loans decreased from 1.48% at December 31, 2009 to 1.34% at December 31, 2010. Classified loans have decreased from $14.6 million as of December 31, 2009 to $12.5 million as of December 31, 2010. Total nonperforming loans have decreased from $5.2 million as of December 31, 2009 to $4.9 million as of December 31, 2010. Management believes the current allowance for loan losses is adequate, however changing economic and other conditions may require future adjustments to the allowance for loan losses.

Noninterest income increased $218 thousand or 7.3% during 2010. The change is primarily related to an increase in Visa check card interchange fees and a reduction in the loss on sales of other real estate owned, partially offset by a decline in net gains recorded on the sale of investments.

Noninterest expense was $11.8 million for the year ended December 31, 2010 compared to $11.4 million for 2009, an increase of 4.2%. Salaries and employee benefits, data processing, occupancy expense and professional and consulting fees were slightly higher in 2010, compared to 2009 levels. Professional and consulting fees, which includes legal fees, increased $103 thousand in 2010, compared to 2009. Legal fees were higher in 2010 due to the cost of managing and resolving problem assets. The amortization of intangibles decreased $135 thousand in 2010, compared to 2009, due to the branch acquisition and customer relationship intangibles becoming fully amortized in 2009.

Income tax expense was $71 thousand for the year ended December 31, 2010, representing a decrease of $327 thousand or 82.2% compared to 2009. The change is primarily related to a decrease in income before income taxes and an increase in interest income from nontaxable securities.

Critical Accounting Policies

National Bancshares Corporation’s 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

25

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 Corporation’s most significant accounting policies are presented in Note 1 of the consolidated financial statements. Management considers the allowance for loan losses, valuation of securities and goodwill and other intangible assets 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 generally accepted accounting principles is a valuation allowance for probable incurred credit losses, based on current information and events, increased by the provision for loan losses and decreased by charge-offs less recoveries. 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 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, 2011, 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 non-performing 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 and related to a deterioration of the credit worthiness of the issuer would be recorded as a loss within noninterest income in the consolidated statements of income.

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 intangible assets. Goodwill 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 a straight line or accelerated method over their estimated useful lives, which is 7 to 10 years.

The Corporation performed a goodwill impairment analysis as of September 30, 2011. The fair value of the single reporting unit was determined to be greater than the carrying value. The fair value was determined by using estimated sales price multiples based on recent observable market transactions.

New Accounting Pronouncements

See Note 1 of the consolidated financial statements for details on new accounting pronouncements.

26

CONSOLIDATED BALANCE SHEETS

December 31, 2011 and 2010

(Dollar amounts in thousands, except per share data)

	2011			2010
ASSETS
Cash and due from banks	$	15,213		$	12,837
Time deposits with other financial institutions		246			5,697
Securities available for sale		150,175			138,033
Restricted equity securities		3,220			3,219
Loans held for sale		207			—
Loans, net of allowance for loan losses:
2011 – $3,163
2010 – $2,585		213,952			190,685
Premises and equipment, net		12,173			12,526
Goodwill		4,723			4,723
Identified intangible assets		—			107
Accrued interest receivable		1,404			1,270
Bank owned life insurance		2,649			2,862
Other assets		2,124			2,137
	$	406,086		$	374,096
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Non-interest bearing	$	70,810		$	57,435
Interest bearing		269,854			251,699
Total deposits		340,664			309,134
Repurchase agreements		10,168			7,747
Federal Reserve note account		—			724
Federal Home Loan Bank advances		8,000			15,000
Accrued interest payable		219			312
Accrued expenses and other liabilities		4,290			2,198
Total liabilities		363,341			335,115
Commitments and contingent liabilities
Shareholders’ equity
Common stock, no par value; 6,000,000 shares authorized;
2,289,528 shares issued		11,447			11,447
Additional paid-in capital		4,815			4,775
Retained earnings		24,335			22,475
Treasury stock, at cost (76,259 and 83,555 shares)		(1,495	)		(1,639	)
Accumulated other comprehensive income		3,643			1,923
Total shareholders’ equity		42,745			38,981
	$	406,086		$	374,096

See accompanying notes.

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CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

	2011			2010			2009
Interest and dividend income
Loans, including fees	$	10,676		$	10,536		$	10,222
Securities:
Taxable		3,019			3,541			5,397
Nontaxable		1,625			1,214			809
Federal funds sold and other		93			210			37
Total interest and dividend income		15,413			15,501			16,465
Interest expense
Deposits		1,750			2,188			3,116
Short-term borrowings		44			47			45
Federal Home Loan Bank advances		256			984			1,076
Total interest expense		2,050			3,219			4,237
Net interest income		13,363			12,282			12,228
Provision for loan losses		600			2,229			1,829
Net interest income after provision for loan losses		12,763			10,053			10,399
Noninterest income
Checking account fees		1,085			1,125			1,070
Visa check card interchange fees		549			442			353
Deposit and miscellaneous service fees		321			338			280
Mortgage banking activities		256			285			310
Loss on sales of other real estate owned		(38	)		(24	)		(112	)
Securities gains, net		214			661			770
Gain on sale of SBA loans		171			—			—
Death benefit from life insurance policy		121			—			—
Other		353			363			301
Total noninterest income		3,032			3,190			2,972
Noninterest expense
Salaries and employee benefits		6,025			5,550			5,279
Data processing		1,160			1,033			909
Net occupancy		1,480			1,231			1,056
FDIC assessment		362			520			605
Professional and consulting fees		637			685			582
Franchise tax		360			348			327
Maintenance and repairs		237			203			187
Amortization of intangibles		107			90			225
Telephone		242			237			216
Marketing		240			240			233
Director fees		188			193			199
Directors pension expense		181			98			25
Software license and maintenance fees		245			202			189
Postage and supplies		283			295			304
Other		992			922			1,028
Total noninterest expense		12,739			11,847			11,364
Income before income taxes		3,056			1,396			2,007
Income tax expense		444			71			398
Net income	$	2,612		$	1,325		$	1,609
Weighted average common shares outstanding		2,211,508			2,205,973			2,202,457
Basic and diluted earnings per common share	$	1.18		$	0.60		$	0.73

See accompanying notes.

28

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

	Common Stock			Additional Paid-In Capital		Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income			Total Shareholders’ Equity
Balance at January 1, 2009	$	11,447		$	4,718	$	20,972		$	(1,709	)	$	1,453		$	36,881
Comprehensive income:
Net income							1,609									1,609
Other comprehensive income (loss), net of tax													1,034			1,034
Total comprehensive income																2,643
Cash dividends declared ($.32 per share)							(705	)								(705	)
Stock awards issued from Treasury Shares (3,605 shares)							(20	)		70						50
Compensation expense under stock-based compensation plans					34											34
Balance at December 31, 2009		11,447			4,752		21,856			(1,639	)		2,487			38,903
Comprehensive income:
Net income							1,325									1,325
Other comprehensive income (loss), net of tax													(564	)		(564	)
Total comprehensive income																761
Cash dividends declared ($.32 per share)							(706	)								(706	)
Compensation expense under stock-based compensation plans					23											23
			��
Balance at December 31, 2010		11,447			4,775		22,475			(1,639	)		1,923			38,981
Comprehensive income:
Net income							2,612									2,612
Other comprehensive income (loss), net of tax													1,720			1,720
Total comprehensive income																4,332
Cash dividends declared ($.32 per share)							(706	)								(706	)
Stock awards issued from Treasury Shares (7,296 shares)							(46	)		144						98
Compensation expense under stock-based compensation plans					40											40
Balance at December 31, 2011	$	11,447		$	4,815	$	24,335		$	(1,495	)	$	3,643		$	42,745

See accompanying notes.

29

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

	2011			2010			2009
Cash flows from operating activities
Net income	$	2,612		$	1,325		$	1,609
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses		600			2,229			1,829
Deferred income taxes		25			95			(382	)
Depreciation, amortization and accretion		2,338			1,876			877
Earnings on Bank owned life insurance		(87	)		(91	)		(94	)
Death benefit from life insurance policy		(121	)		—			—
Restricted equity securities dividends		(1	)		(1	)		(1	)
Origination of mortgage loans held for sale		(11,313	)		(11,889	)		(16,751	)
Proceeds from sales of mortgage loans held for sale		11,362			12,490			16,745
Gain on sale of loans		(256	)		(285	)		(310	)
Net security gains		(214	)		(661	)		(770	)
Loss on sale/write-down of other real estate owned		38			24			112
Gain from the sale of loans guaranteed by SBA		(171	)		—			—
Compensation expense under stock-based compensation plans		138			23			84
Change in other assets and liabilities		1,331			(68	)		(1,503	)
Net cash from operating activities		6,281			5,067			1,445
Cash flows from investing activities
Purchases of time deposits with other financial institutions		—			(984	)		(13,580	)
Proceeds from time deposits with other financial institutions		5,451			8,867			—
Available for sale securities:
Maturities, repayments and calls		37,781			38,526			36,757
Sales		14,980			18,775			23,084
Purchases		(63,364	)		(66,312	)		(60,353	)
Purchases of premises and equipment		(580	)		(4,241	)		(3,437	)
Proceeds from the sale of loans guaranteed by SBA		2,360			—			—
Proceeds from sale of other real estate owned		56			113			191
Proceeds from the sale of an impaired loan		—			930			—
Purchase of loans		—			(1,184	)		(1,151	)
Net change in loans to customers		(26,110	)		1,350			(15,118	)
Net cash from investing activities		(29,426	)		(4,160	)		(33,607	)
Cash flows from financing activities
Net change in deposits		31,530			17,761			27,731
Net change in short-term borrowings		1,697			(1,249	)		(3,565	)
Proceeds from Federal Home Loan Bank advances		—			—			10,000
Repayments Federal Home Loan Bank advances		(7,000	)		(12,000	)		(4,000	)
Dividends paid		(706	)		(706	)		(881	)
Net cash from financing activities		25,521			3,806			29,285
Net change in cash and cash equivalents		2,376			4,713			(2,877	)
Beginning cash and cash equivalents		12,837			8,124			11,001
Ending cash and cash equivalents	$	15,213		$	12,837		$	8,124
Supplemental cash flow information:
Interest paid	$	2,143		$	3,315		$	4,519
Income taxes paid		420			537			400
Supplemental noncash disclosures:
Transfer from loans to other real estate owned		54			91			54

See accompanying notes.

30

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

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 subsidiaries, First National Bank, Orrville, Ohio (Bank) and NBOH Properties, LLC, together referred to as “the Corporation.” NBOH Properties, LLC owns a multi-tenant commercial building in Fairlawn, Ohio. A portion of this building is utilized as our Fairlawn banking office. This activity is not considered material for segment reporting purposes. The Bank has a minority interest in First Kropf Title, LLC, which is immaterial to the consolidated financial statements. Intercompany transactions and balances are eliminated in consolidation.

The Corporation provides financial services through its main and branch offices in Orrville, Ohio, and branch offices in surrounding communities in Wayne, Medina, Stark and Summit counties. 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 investment securities and deposit accounts in other financial institutions. There are no significant concentrations of loans to any one industry or customer. However, the customer’s ability to repay their loans is dependent on the real estate and general economic conditions of the Corporation’s market area.

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 financial service operations are considered by management to be aggregated in one reportable operating segment.

Use of Estimates: To prepare financial statements in conformity with U. S. generally accepted accounting principles, 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, fair values of financial instruments and carrying value of intangible assets are particularly subject to change.

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

Time Deposits with Other Financial Institutions:Interest-bearing deposits in other financial institutions mature within eight months and are carried at cost.

Securities: Debt 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. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.

Management evaluates securities for other than temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be

31

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

recognized in the income statement and 2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of other-than-temporary impairment is recognized through earnings.

Loans Held for Sale:Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.

Mortgage loans held for sale may be sold with servicing rights retained or released. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right for loans sold with servicing retained. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

Loans: Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned and deferred income and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

Interest income on real estate, real estate construction and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 or more days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. A loan is moved to non-accrual status in accordance with the Corporation’s policy, typically after 90 days of non-payment.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is recorded as a reduction in principal, 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.

Concentration of Credit Risk: Most of the Corporation’s business activity is with customers located within Wayne, Stark, Summit, Holmes and Medina Counties. Therefore, the Corporation’s exposure to credit risk is significantly affected by changes in the economy in these counties.

Purchased Loans: The Corporation purchases individual loans and groups of loans. Purchased loans that show evidence of credit deterioration at the time of purchase are recorded at the amount paid, such that there is no carryover of the seller’s allowance for loan losses. After acquisition, incurred losses are recognized by an increase in the allowance for loan losses.

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. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. 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.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors.

A loan is impaired when, based on current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans, for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.

32

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

Commercial and commercial real estate loans over $250 thousand or to borrowers whose aggregate total borrowing exceeds $250 thousand, except for first and second mortgage loans on a borrower’s personal residence are individually evaluated for impairment. 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. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Corporation determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Corporation utilizing weighted amounts applied to the twelve quarter moving average to a blended rate of the twelve quarter moving average and the twenty quarter moving average. This approach enhances the time frame over which we evaluate loss experience and emphasizes the most recent loss experience. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: commercial loans, commercial real estate loans, residential real estate loans, home equity loans and consumer loans.

The majority of the Corporation’s loan portfolio is residential real estate, home equity and consumer loans made to individuals in the Corporation’s market area. These loans are largely secured by underlying real estate or consumer collateral. Repayment of these loans is dependent on general economic conditions and unemployment levels in the Corporation’s market area.

Commercial and commercial real estate loans primarily consist of income producing real estate and related business assets. Repayment of these loans depends, to a large degree, on the results of operations, cash flow and management of the related businesses. These loans may be affected to a greater extent by adverse commerce conditions or the economy in general, including today’s economic recession. Accordingly, the nature of these loans makes them more difficult for management to monitor and evaluate.

Servicing Rights: When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. The Corporation compares the valuation model inputs and results to published industry data in order to validate the model results and assumptions. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

33

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES(Continued)

At December 31, 2011 and 2010, the servicing assets of the Corporation totaled $47 and $76, respectively, and are included with other assets on the consolidated balance sheets. When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage servicing contracts, when available or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Servicing assets are evaluated for impairment based upon the fair value of the assets compared to carrying amount. Any impairment is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping.

Servicing fee income is recorded when earned for servicing loans based on a contractual percentage of the outstanding principal or a fixed amount per loan. The amortization of mortgage servicing rights is netted against loan servicing fee income. Servicing fees totaled $92, $76 and $75 for the years ended December 31, 2011, 2010 and 2009, respectively. Late fees and ancillary fees related to loan servicing are not material.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.

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.

Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) Stock: The Bank is a member of the FHLB and FRB systems. FHLB members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. The stocks are carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

Bank Owned Life Insurance: The Corporation has purchased life insurance policies on its directors. Life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other amounts due that are probable at settlement.

Goodwill and Other Intangible Assets: Goodwill resulting from business combinations prior to January 1, 2009 represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill resulting from business combinations after January 1, 2009, is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually. The Corporation has selected September 30^th as the date to perform the annual impairment test. Intangible assets with definite useful lives are amortized over their estimated useful lives to their estimated residual values. Goodwill is the only intangible asset on the Corporation’s balance sheet with an indefinite life.

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 range from 7 to 10 years.

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 discretionary contributions to the Corporation’s 401(k) plan as determined by Board decision. Director retirement plan expense allocates the benefits over the estimated years of service.

34

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock-Based Compensation: Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period, on an accelerated basis.

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.

A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.

The Corporation recognizes interest and/or penalties related to income tax matters in income tax expense.

Transfers of Financial Assets:Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Corporation, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Loan Commitments and Related Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial 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. Such financial instruments are recorded when they are funded.

Earnings Per Common Share: Earnings per common share is net income divided by the weighted average number of shares outstanding during the period. Diluted earnings per share includes the dilutive effect of additional potential common shares issuable under stock options. 84,500, 89,000 and 53,000 stock options were not considered in computing diluted earnings per common share for 2011, 2010 and 2009 because they were antidilutive.

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.

Restrictions on Cash: Cash on hand or on deposit with the Federal Reserve Bank of $100 was required to meet regulatory reserve and clearing requirements at year-end 2011 and 2010. These balances do not earn interest.

Dividend Restriction:Banking regulations require maintaining certain capital levels and limit the dividends paid by the Bank to the Corporation or by the Corporation to shareholders. Dividends paid by the Bank to the Corporation are the primary source of funds for dividends by the Corporation 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 these estimates.

Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation. Reclassification had no affect on prior year net income or shareholder’s equity.

35

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Adoption of New Accounting Standards:In April 2011, the FASB amended existing guidance for assisting a creditor in determining whether a restructuring is a troubled debt restructuring. The amendments clarify the guidance for a creditor’s evaluation of whether it has granted a concession and whether a debtor is experiencing financial difficulties. With regard to determining whether a concession has been granted, the ASU clarifies that creditors are precluded from using the effective interest method to determine whether a concession has been granted. In the absence of using the effective interest method, a creditor must now focus on other considerations such as the value of the underlying collateral, evaluation of other collateral or guarantees, the debtor’s ability to access other funds at market rates, interest rate increases and whether the restructuring results in a delay in payment that is insignificant. This guidance is effective for interim and annual reporting periods beginning after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. For purposes of measuring impairment on newly identified troubled debt restructurings, the amendments should be applied prospectively for the first interim or annual period beginning on or after June 15, 2011. The adoption of this guidance has resulted in added disclosure in the consolidated financial statements. See Note 3 – Loans.

In June 2011, the FASB amended existing guidance and eliminated the option to present the components of other comprehensive income as part of the statement of changes in shareholder’s equity. The amendment requires that comprehensive income be presented in either a single continuous statement or in two separate consecutive statements. The amendments in this guidance are effective as of the beginning of a fiscal reporting year, and interim periods within that year, that begins after December 15, 2011. The adoption of this amendment will change the presentation of the components of comprehensive income for the Corporation.

In September 2011, the FASB amended existing guidance relating to goodwill impairment testing. The amendment permits an assessment of qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing these events or circumstances, it is concluded that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. The amendments in this guidance are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, financial statements for the most recent annual or interim period have not yet been issued. The Corporation is currently evaluating the impact of this amendment.

NOTE 2 – SECURITIES

The amortized cost, fair value and the related gross unrealized gains and losses of available for sale securities recognized in accumulated other comprehensive income (loss) were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
2011
U.S. Treasury and federal agency	$	2,430	$	16	$	—		$	2,446
State and municipal		53,841		3,592		(10	)		57,423
Mortgage-backed: residential		88,362		2,060		(136	)		90,286
Equity securities		23		—		(3	)		20
Total debt securities	$	144,656	$	5,668	$	(149	)	$	150,175

36

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 2 – SECURITIES(continued)

	Amortized Cost		Gross Unrealized Gains			Gross Unrealized Losses			Fair Value
2010
U.S. Treasury and federal agency	$	2,954	$	21		$	—		$	2,975
State and municipal		44,656		833			(484	)		45,005
Corporate bond and notes		1,487		29			—			1,516
Mortgage-backed: residential		86,001		2,766			(240	)		88,527
Equity securities		23		—			(13	)		10
Total debt securities	$	135,121	$	3,649		$	(737	)	$	138,033
			2011			2010			2009
Sales of available for sale securities were as follows:
Proceeds			$	14,980		$	18,775		$	23,084
Gross gains				216			679			949
Gross losses				(2	)		(26	)		(179	)
Gross gains from calls				—			8			—

The tax provision (benefit) related to these net realized gains and losses was $73, $225 and $262, respectively.

The amortized cost and fair value of securities at year-end 2011 by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities and equity securities, are shown separately.

	Amortized Cost		Fair Value
Due in one year or less	$	2,748	$	2,750
Due from one to five years		6,091		6,312
Due from five to ten years		19,765		21,346
Due after ten years		27,667		29,461
Mortgage-backed: residential		88,362		90,286
Equity securities		23		20
	$	144,656	$	150,175

Securities pledged at year-end 2011 and 2010 had a fair value of $63,941 and $58,827 and were pledged to secure public deposits and repurchase agreements.

At year-end 2011 and 2010, there were no holdings of securities of any one issuer, other than the U.S. Government, and its agencies and corporations, in an amount greater than 10% of shareholders’ equity.

All mortgage-backed securities are issued by the United States government or any agency or corporation thereof as of December 31, 2011.

Securities with unrealized losses at year-end 2011 and 2010, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
2011
State and municipal	$	366	$	(3	)	$	891	$	(7	)	$	1,257	$	(10	)
Mortgage-backed: residential		22,639		(136	)		—		—			22,639		(136	)
Equity		20		(3	)		—		—			20		(3	)
Total temporarily impaired	$	23,025	$	(142	)	$	891	$	(7	)	$	23,916	$	(149	)

37

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 2 – SECURITIES(continued)

	Less Than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
2010
State and municipal	$	18,125	$	(484	)	$	—	$	—		$	18,125	$	(484	)
Mortgage-backed: residential		17,067		(240	)		—		—			17,067		(240	)
Equity securities		—		—			10		(13	)		10		(13	)
Total temporarily impaired	$	35,192	$	(724	)	$	10	$	(13	)	$	35,202	$	(737	)

Unrealized losses have not been recognized into income because the securities are of high credit quality, management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in market interest rates or normally expected market pricing fluctuations. The fair value of debt securities is expected to recover as the securities approach their maturity date.

National Bancshares Corporation equity securities are comprised of FHLMC preferred stock. An other than temporary impairment charge was taken on this investment in 2008, reducing the cost basis to $23. The fair value of these securities at December 31, 2011 and 2010 was $20 and $10, respectively.

NOTE 3 – LOANS

Loans at year end were as follows:

	2011			2010
Real estate:
Commercial and land development	$	66,886		$	58,047
One-to-four family		56,917			47,204
Home equity		30,086			27,766
Multifamily		17,041			14,397
Real estate construction:
Commercial and land development		4,822			9,942
One-to-four family		683			301
Commercial		33,473			26,158
Consumer:
Auto:
Direct		2,065			2,474
Indirect		4,541			6,401
Other		980			989
		217,494			193,679
Unearned and deferred income		(379	)		(409	)
Allowance for loan losses		(3,163	)		(2,585	)
	$	213,952		$	190,685

38

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 3 – LOANS (Continued)

The following table presents the activity in the allowance for loan losses by portfolio segment for the year ending December 31, 2011:

	Commercial		Commercial Real Estate		Residential Real Estate			Home Equity			Consumer			Unallocated			Total
Allowance for loan losses:
Beginning Balance	$	460	$	1,267	$	675		$	100		$	53		$	30		$	2,585
Provision for loan losses		303		140		214			(9	)		(18	)		(30	)		600
Loans charged-off		—		—		(28	)		(26	)		(17	)		—			(71	)
Recoveries		25		1		—			1			22			—			49
Total ending allowance balance	$	788	$	1,408	$	861		$	66		$	40		$	—		$	3,163

Activity in the allowance for loan losses was as follows:

	2011			2010			2009
Beginning balance	$	2,585		$	2,906		$	1,718
Provision for loan losses		600			2,229			1,829
Loans charged-off		(71	)		(2,576	)		(659	)
Recoveries		49			26			18
Ending balance	$	3,163		$	2,585		$	2,906

39

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 3 – LOANS (Continued)

The recorded investment in loans includes the principal balance outstanding, net of unearned and deferred income and including accrued interest receivable. The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2011 and 2010:

December 31, 2011	Commercial		Commercial Real Estate		Residential Real Estate		Home Equity		Consumer		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	151	$	183	$	182	$	—	$	—	$	—	$	516
Collectively evaluated for impairment		637		1,225		679		66		40		—		2,647
Total ending allowance balance	$	788	$	1,408	$	861	$	66	$	40	$	—	$	3,163
Recorded investment in loans:
Loans individually evaluated for impairment	$	597	$	2,420	$	320	$	—	$	—	$	—	$	3,337
Loans collectively evaluated for impairment		32,984		69,290		74,230		30,288		7,698		—		214,490
Total ending loans balance	$	33,581	$	71,710	$	74,550	$	30,288	$	7,698	$	—	$	217,827
December 31, 2010	Commercial		Commercial Real Estate		Residential Real Estate		Home Equity		Consumer		Unallocated		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	—	$	30	$	239	$	—	$	—	$	—	$	269
Collectively evaluated for impairment		460		1,237		436		100		53		30		2,316
Total ending allowance balance	$	460	$	1,267	$	675	$	100	$	53	$	30	$	2,585
Recorded investment in loans:
Loans individually evaluated for impairment	$	662	$	2,881	$	1,149	$	—	$	—	$	—	$	4,692
Loans collectively evaluated for impairment		25,539		65,035		60,609		27,914		10,049		—		189,146
Total ending loans balance	$	26,201	$	67,916	$	61,758	$	27,914	$	10,049	$	—	$	193,838

40

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 3 – LOANS (Continued)

Individually impaired loans were as follows:

	2010
Year-end loans with no allocated allowance for loan losses	$	3,298
Year-end loans with allocated allowance for loan losses		1,394
Amount of the allowance for loan losses allocated		269

	2010		2009
Average of individually impaired loans during year	$	3,888	$	2,897

The impact of interest income of impaired loans was not significant to the consolidated statements of income.

The following table presents loans individually evaluated for impairment by class of loans as of, and for the year ended December 31, 2011:

	Unpaid				Allowance for		Average
	Principal		Recorded		Loan Losses		Recorded
December 31, 2011	Balance		Investment		Allocated		Investment
With no related allowance recorded:
Real estate:
Commercial and land development	$	406	$	406	$	—	$	426
One-to-four family		46		46		—		49
Real estate construction:
Commercial and land development		1,252		1,252		—		1,923
Commercial		29		29		—		31
With an allowance recorded:
Real estate:
Commercial and land development		762		762		183		902
One-to-four family		274		274		182		283
Multifamily		—		—		—		—
Commercial		568		568		151		509
	$	3,337	$	3,337	$	516	$	4,123

For purposes of this disclosure, the unpaid principal balance is not recorded for net charge-offs.

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2010:

	Unpaid				Allowance for
	Principal		Recorded		Loan Losses
December 31, 2010	Balance		Investment		Allocated
With no related allowance recorded:
Real estate:
Commercial and land development	$	1,258	$	1,256	$	—
One-to-four family		52		52		—
Real estate construction:
One-to-four family		1,326		1,325		—
Commercial		662		662		—
With an allowance recorded:
Real estate:
Commercial and land development		99		99		10
One-to-four family		1,097		1,097		239
Multifamily		—		—		—
Real estate construction:
Commercial and land development		198		198		20
	$	4,692	$	4,689	$	269

41

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 3 – LOANS (Continued)

Nonaccrual loans and loans past due 90 or more days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

The following table presents the recorded investment in nonaccrual and loans past due 90 or more days still on accrual by class of loans as of December 31, 2011 and 2010:

					Loans Past Due 90 or
	Nonaccrual				More Days Still Accruing
	2011		2010		2011		2010
Real estate:
Commercial and land development	$	1,168	$	1,358	$	—	$	—
One-to-four family		438		448		181		360
Home equity		382		382		—		116
Real estate construction:
Commercial and land development		1,252		1,524		—		—
Commercial		596		661		—		—
Consumer:
Auto:
Indirect		—		—		—		11
	$	3,836	$	4,373	$	181	$	487

The following table presents the aging of the recorded investment in past due loans as of December 31, 2011 by class of loans:

	30 - 59		60 - 89		90 or More
	Days		Days		Days		Total		Loans Not
	Past Due (1)		Past Due		Past Due (2)		Past Due		Past Due (3)		Total
Real estate:
Commercial and land development	$	—	$	30	$	922	$	952	$	65,940	$	66,892
One-to-four family		245		297		572		1,114		55,754		56,868
Home equity		—		—		382		382		29,906		30,288
Multifamily		—		—		—		—		17,001		17,001
Real estate construction:
Commercial and land development		856		—		396		1,252		3,566		4,818
One-to-four family		—		—		—		—		681		681
Commercial		37		—		597		634		32,947		33,581
Consumer:
Auto:
Direct		1		—		—		1		2,071		2,072
Indirect		17		—		—		17		4,629		4,646
Other		14		—		—		14		966		980
	$	1,170	$	327	$	2,869	$	4,366	$	213,461	$	217,827

(1) Includes $856 thousand of loans on nonaccrual status.

(2) All loans are nonaccrual status except for $181 thousand of loans past due 90 or more days still on accrual.

(3) Includes $292 thousand of loans on nonaccrual status.

42

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 3 – LOANS (Continued)

The following table presents the aging of the recorded investment in past due loans as of December 31, 2010 by class of loans:

	30 - 59		60 - 89		90 or More
	Days		Days		Days		Total		Loans Not
	Past Due (1)		Past Due (2)		Past Due (3)		Past Due		Past Due (4)		Total
Real estate:
Commercial and land development	$	—	$	165	$	1,076	$	1,241	$	56,806	$	58,047
One-to-four family		769		167		784		1,720		45,484		47,204
Home equity		2		45		498		545		27,221		27,766
Multifamily		—		—		—		—		14,397		14,397
Real estate construction:
Commercial and land development		930		396		198		1,524		8,418		9,942
One-to-four family		—		—		—		—		301		301
Commercial		—		22		661		683		25,475		26,158
Consumer:
Auto:
Direct		22		—		—		22		2,452		2,474
Indirect		52		—		11		63		6,338		6,401
Other		9		—		—		9		980		989
	$	1,784	$	795	$	3,228	$	5,807	$	187,872	$	193,679

(1) Includes $854 thousand of loans on nonaccrual status.

(2) Includes $399 thousand of loans on nonaccrual status.

(3) All loans are nonaccrual status except for $487 thousand of loans past due 90 or more days still on accrual.

(4) Includes $379 thousand of loans on nonaccrual status.

Troubled Debt Restructuring

As of period ending December 31, 2011, certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

The Corporation has two commercial loans with balances of $1,661 that were individually evaluated for impairment whose loan terms have been modified in troubled debt restructurings as of December 31, 2011. $300 of specific reserve has been allocated for these loans. The nature of the modifications did not impact the stated interest rate or the final maturities. The Corporation has not committed to lend any additional amounts as of December 31, 2011 to customers with outstanding loans that are classified as troubled debt restructurings. There have been no new loans classified as troubled debt restructurings as of December 31, 2011. There were $1,876 of loans whose terms have been modified in troubled debt restructurings as of December 31, 2010. No specific reserve has been allocated for these loans.

Both commercial loans that were modified as troubled debt restructurings experienced payment default within twelve months after modification. A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. The troubled debt restructuring that subsequently defaulted increased the allowance for loan losses by $300 thousand and resulted in charge offs of $0 during the period ending December 31, 2011.

The terms of certain other loans were modified during the year ending December 31, 2011 that did not meet the definition of a troubled debt restructuring. These loans have a total recorded investment as of December 31, 2011 of $888. The modification of these loans involved either a modification of the terms of a loan or a delay in a payment that was considered to be insignificant.

43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 3 – LOANS (Continued)

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Corporation’s internal underwriting policy.

Credit Quality Indicators:The Corporation categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends and other information specific to each borrower. The Corporation analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial, commercial real estate loans, and loans to commercial enterprises secured by one-to-four family residential properties. This analysis is performed on an annual basis or more frequently if management becomes aware of information affecting a borrower’s ability to fulfill its obligation. The Corporation uses the following definitions for risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current financial condition and paying capacity of the obligor or of the collateral securing the loan. Substandard loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt with a distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. As of December 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

			Special
	Pass		Mention		Substandard		Doubtful		Total
Real estate:
Commercial and land development	$	61,706	$	1,986	$	3,200	$	—	$	66,892
One-to-four family		—		263		1,129		—		1,392
Real estate construction:
Commercial and land development		3,104		196		1,518		—		4,818
Commercial		29,744		2,442		1,395		—		33,581
	$	94,554	$	4,887	$	7,242	$	—	$	106,683

As of December 31, 2010, the risk category of loans by class of loans is as follows:

			Special
	Pass		Mention		Substandard		Doubtful		Total
Real estate:
Commercial and land development	$	53,794	$	350	$	3,903	$	—	$	58,047
Real estate construction:
Commercial and land development		6,352		1,788		1,802		—		9,942
Commercial		23,627		507		2,024		—		26,158
	$	83,773	$	2,645	$	7,729	$	—	$	94,147

44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 3 – LOANS (Continued)

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses. For residential and consumer loan classes, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in residential and consumer loans based on payment activity as of December 31, 2011:

	Consumer						Residential Real Estate
											One-to-four		Home
	Direct		Indirect		Other		Construction		Multifamily		Family		Equity
Performing	$	2,072	$	4,646	$	980	$	681	$	17,001	$	54,904	$	29,906
Nonperforming		—		—		—		—		—		572		382
	$	2,072	$	4,646	$	980	$	681	$	17,001	$	55,476	$	30,288

The following table presents the recorded investment in residential and consumer loans based on payment activity as of December 31, 2010:

	Consumer						Residential Real Estate
											One-to-four		Home
	Direct		Indirect		Other		Construction		Multifamily		Family		Equity
Performing	$	2,474	$	6,390	$	989	$	301	$	14,397	$	46,420	$	27,268
Nonperforming		—		11		—		—		—		784		498
	$	2,474	$	6,401	$	989	$	301	$	14,397	$	47,204	$	27,766

NOTE 4 – LOAN SERVICING

Mortgage loans serviced for others are not reported as assets. The principal balances of these loans at year-end are as follows:

	2011		2010
Mortgage loan portfolios serviced for:
FHLMC	$	16,373	$	22,100

There were no custodial escrow balances maintained in connection with serviced loans at year-end 2011 and 2010.

Activity for mortgage servicing rights and the related valuation allowance follows:

	2011			2010			2009
Servicing rights:
Beginning of year	$	76		$	115		$	173
Additions		4			5			2
Amortized to expense		(33	)		(44	)		(60	)
End of year	$	47		$	76		$	115

45

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 5 – PREMISES AND EQUIPMENT

Year-end premises and equipment were as follows:

	2011			2010
Land	$	1,758		$	1,758
Buildings		11,893			11,503
Furniture, fixtures and equipment		5,242			5,332
Construction in progress		—			—
		18,893			18,593
Less: Accumulated depreciation		(6,720	)		(6,067	)��
	$	12,173			12,526

Depreciation expense was $932, $748 and $588 in 2011, 2010 and 2009.

Rent expense under operating leases included in occupancy was $21, $37 and $39 for the years ended December 31, 2011, 2010 and 2009. Future lease payments are not material.

NOTE 6 – INTANGIBLE ASSETS

During 2002, the Corporation acquired Peoples Financial Corporation and merged the Corporation’s banking operations into the Bank. Identified intangible assets totaling $1,791 were recognized and have useful lives of 7 to 10 years. Goodwill of $4,723 was realized from this transaction. Identified intangible assets at year-end were as follows:

	2011				2010
	Gross				Gross
	Carrying		Accumulated		Carrying		Accumulated
	Amount		Amortization		Amount		Amortization
Amortized intangible assets:
Core deposit intangibles	$	1,063	$	1,063	$	1,063	$	956
Branch acquisition intangible		760		760		760		760
Customer relationship intangibles		728		728		728		728
	$	2,551	$	2,551	$	2,551	$	2,444

Aggregate amortization expense was $107, $90 and $225 for 2011, 2010 and 2009.

Goodwill impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value, which is determined through a two-step impairment test. Step 1 includes the determination of the carrying value of our single reporting unit, including the existing goodwill and intangible assets, and estimating the fair value of the reporting unit. We determined the fair value of our reporting unit and compared it to its carrying amount. If the carrying amount of a reporting unit exceeds its fair value, we are required to perform a second step to the impairment test.

Our annual impairment analysis as of September 30, 2011, indicated that the Step 2 analysis was not necessary. Step 2 of the goodwill impairment test is performed to measure the impairment loss. Step 2 requires that the implied fair value of the reporting unit goodwill be compared to the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss shall be recognized in an amount equal to that excess.

NOTE 7 – DEPOSITS

	2011		2010
Demand, noninterest-bearing	$	70,810	$	57,435
Demand, interest-bearing		154,410		133,987
Savings		55,781		49,804
Time, $100,000 and over		15,305		16,089
Time, other		44,358		51,819
	$	340,664	$	309,134

46

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 7 – DEPOSITS(Continued)

A summary of time deposits at year-end 2011 by maturity follows:

2012	$	30,812
2013		11,230
2014		12,826
2015		4,705
2016		90
	$	59,663

NOTE 8 – FEDERAL HOME LOAN BANK ADVANCES

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

	2011		2010
Maturities in 2011, fixed rate at 4.93% to 5.79% at December 31, 2010, convertible to variable if 1-month LIBOR is at or above fixed rate	$	—	$	3,000
Maturities in 2011, fixed rate at 2.31% to 2.88%		—		4,000
Maturities in 2012, fixed rate at 2.00%		3,000		3,000
Maturities in 2014, fixed rate at 2.86% to 2.88%		5,000		5,000
	$	8,000	$	15,000

Each advance is payable at its maturity date; advances may be paid prior to maturity subject to a prepayment penalty. As collateral for the advances, the Bank has approximately $52,779 and $41,660 of first mortgage loans available under a blanket lien arrangement at year-end 2011 and 2010.

Required payments over the next four years are:

2012	2.00%	$	3,000
2014	2.86% to 2.88%		5,000

NOTE 9 – REPURCHASE AGREEMENTS

Repurchase agreements generally mature within 30 days from the transaction date. Information concerning repurchase agreements is summarized as follows:

	2011			2010			2009
Average balance during the year	$	9,071		$	8,032		$	7,442
Average interest rate during the year		0.15	%		0.15	%		0.26	%
Maximum month-end balance during the year	$	11,114		$	12,083		$	8,965
Weighted average rate at year-end		0.15	%		0.15	%		0.25	%

NOTE 10 – 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. Matching contributions may be made in amounts and at times determined by the Corporation. Total matching discretionary contributions made by the Corporation during 2011, 2010 and 2009 amounted to $54, $57 and $73.

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. Expenses recognized in 2011, 2010 and 2009 amounted to $1, $2 and $2.

47

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 10 – BENEFIT PLANS(Continued)

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 for each year of service on the Board from and after August 24, 1994 until August 2007, when the Board voted to cease further benefits. In addition, each director has the option of deferring any portion of directors’ fees to a maximum of $5 per month until retirement.

Interest credited to participant accounts associated with the deferrals was $8, $8 and $9 in 2011, 2010 and 2009. The deferred directors’ fee liability was $164 at December 31, 2011 and $193 at December 31, 2010. Expense recognized in 2011, 2010 and 2009 for the director retirement and death benefit plan was $172, $79 and $25. The liability related to the plan was $849 at December 31, 2011 and $713 at December 31, 2010.

NOTE 11 – INCOME TAXES

The components of deferred taxes were as follows:

	2011			2010
Deferred tax assets:
Bad debts	$	915		$	719
Deferred compensation		348			308
Deferred loan fees		165			195
FHLMC preferred stock impairment loss		151			151
Nonaccrual loan interest income		112			43
Stock-based compensation		43			26
Real estate owned write-down		38			26
Deferred income		33			37
Accrued bonus		23			14
Charitable contribution carryforward		—			21
AMT credit carryforward		—			17
Other		3			—
Total	$	1,831		$	1,557
Deferred tax liabilities:
Unrealized security gains, net	$	1,876		$	991
Depreciation		911			524
Federal Home Loan Bank stock dividends		542			542
Purchase accounting adjustments		66			105
Mortgage servicing rights		26			33
Prepaid expenses		9			24
Partnership income		3			3
Securities accretion		—			27
Total		3,433			2,249
Net deferred tax liability	$	(1,602	)	$	(692	)

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 at December 31, 2011. If the Bank were liquidated or otherwise ceases to be a bank or if tax laws were to change, this amount would be expensed.

The components of income tax expense are as follows:

	2011		2010			2009
Current	$	419	$	(24	)	$	780
Deferred		25		95			(382	)
	$	444	$	71		$	398

48

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 11 – INCOME TAXES(Continued)

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

	2011						2010						2009
	Rate			Amount			Rate			Amount			Rate			Amount
Tax at federal statutory rate		34	%	$	1,039			34	%	$	475			34	%	$	682
Tax-exempt income		(17	)		(513	)		(29	)		(399	)		(13	)		(270	)
Other		(2	)		(82	)		—			(5	)		(1	)		(14	)
Income tax expense		15	%	$	444			5	%	$	71			20	%	$	398

As of December 31, 2011 and December 31, 2010, the Corporation had no unrecognized tax benefits or accrued interest and penalties recorded. The Corporation does not expect the amount of unrecognized tax benefits to significantly increase within the next twelve months. The Corporation records interest and penalties as a component of income tax expense.

The Corporation and its subsidiaries are subject to U.S. federal income tax as well as income tax in the state of Ohio for National Bancshares. The Bank is subject to tax in Ohio based upon its net worth. The Corporation is no longer subject to examination by state taxing authorities for years prior to 2008.

NOTE 12 – RELATED-PARTY TRANSACTIONS

Loans to principal officers, directors, and their affiliates during 2011 were as follows:

Beginning balance	$	2,421
Effect of changes in composition of related parties		200
New loans		2
Repayments		(475	)
Ending balance	$	2,148

Unused commitments to these related parties totaled $1,729 and $1,798 at year-end 2011 and 2010. Related party deposits totaled $3,697 and $3,955 at year-end 2011 and 2010.

The Corporation has minority ownership in a title agency affiliated with a Director resulting in fee income to the Corporation of $4, $35 and $32 for 2011, 2010 and 2009, respectively.

NOTE 13 – STOCK-BASED COMPENSATION

The Corporation’s 2008 Equity Incentive Plan (“the Plan”), which is shareholder-approved, permits the grant of stock options or restricted stock awards, to its officers, employees, consultants and non-employee directors for up to 223,448 shares of common stock.

Stock Option Awards

Option awards are granted with an exercise price equal to the market price of the Corporation’s common stock at the date of grant; those option awards have vesting periods determined by the Corporation’s compensation committee and have terms that shall not exceed 10 years.

On May 20, 2008, the Corporation granted options to purchase 58,000 shares of stock to directors and certain key officers, 43,000 of which remained outstanding at December 31, 2011. The exercise price of the options is $18.03 per share. The options vest in five equal installments over a five-year period and have a term of 10 years. None of these options have been exercised as of December 31, 2011.

On October 19, 2010, the Corporation granted options to purchase 43,000 shares of stock to directors and certain key officers, of which 41,500 remained outstanding at December 31, 2011. The exercise price of the options is $13.22 per share. The options vest in five equal installments over a five-year period and have a term of 10 years. None of these options have been exercised as of December 31, 2011.

The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. Expected volatilities are based on historical

49

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 13 – STOCK-BASED COMPENSATION (Continued)

volatilities of the Corporation’s common stock. The Corporation has estimated the option exercise and post-vesting termination behavior and expected term of options granted due to the lack of historical data. The expected term of options granted represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferrable. The risk-free interest rate for the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

The fair value of options granted and the assumptions used for grants in 2011, 2010 and 2009 were as follows:

	2011		2010			2009
Fair value of options granted	$	—	$	2.53		$	—
Risk-free interest rate		—		1.49	%		—
Expected term (years)		—		6.5			—
Expected stock price volatility		—		24.67	%		—
Dividend yield		—		2.42	%		—

A summary of the activity in the stock option plan for 2011 follows:

	Shares			Weighted Average Exercise Price		Weighted Average Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at beginning of year		89,000		$	15.71
Granted		—			—
Exercised		—			—
Forfeited or expired		(4,500	)		16.43
Outstanding at end of year		84,500		$	15.70		7.6	$	—
Fully expected to vest		50,400		$	14.86		8.0	$	—
Exercisable at end of year		34,100		$	16.86		7.0	$	—

The total compensation cost that has been charged against income for the plan was $40, $23 and $34 for 2011, 2010 and 2009. The total income tax benefit was $14, $8 and $12 for 2011, 2010 and 2009. There was $60, $117 and $38 of total unrecognized compensation cost related to nonvested stock options granted under the Plan as of December 31, 2011, 2010 and 2009. The cost is expected to be recognized over a weighted-average period of 3.5 years.

Restricted Stock Awards

On December 23, 2009, the Corporation issued restricted stock awards for 3,605 shares of the Corporation’s common stock to certain officers. The awards vested immediately and the compensation expense related to the awards of $50 was recorded in 2009. The fair value of the stock was determined using closing market price of the Corporation’s common stock on the date of the grant.

On January 3, 2011, the Corporation granted restricted stock awards for 3,744 shares of the Corporation’s common stock to certain directors in lieu of cash payment of fees. The awards vested immediately and the compensation expense related to the awards of $50 was recorded in 2010. The fair value of the stock was determined using closing market price of the Corporation’s common stock on the date of the grant.

On July 1, 2011, the Corporation granted restricted stock awards for 3,552 shares of the Corporation’s common stock to certain directors in lieu of cash payment of fees. The awards vested immediately and the compensation expense related to the awards of $48 was recorded in 2011. The fair value of the stock was determined using closing market price of the Corporation’s common stock on the date of the grant.

50

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 14 – REGULATORY CAPITAL MATTERS

Banks 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. Management believes as of December 31, 2011, the Bank meets all capital adequacy requirements to which it is subject.

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 are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2011 and 2010, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.

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

	Actual					Required For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
2011
Total capital to risk weighted assets	$	34,367		13.85	%	$	19,847		8.00	%	$	24,809		10.00	%
Tier 1 capital to risk weighted assets		31,256		12.60	%		9,923		4.00	%		14,885		6.00	%
Tier 1 capital to average assets		31,256		7.78	%		16,069		4.00	%		20,086		5.00	%
2010
Total capital to risk weighted assets	$	31,032		13.59	%	$	18,267		8.00	%	$	22,834		10.00	%
Tier 1 capital to risk weighted assets		28,447		12.46	%		9,134		4.00	%		13,701		6.00	%
Tier 1 capital to average assets		28,447		7.46	%		15,261		4.00	%		19,077		5.00	%

Dividend Restrictions—The Corporation’s principal source of funds for dividend payments is dividends received from the Bank. Banking regulations limit the amount of dividends that may be paid without prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. The Bank could, without prior approval, pay dividends to the holding Corporation of approximately $5,685 as of December 31, 2011.

NOTE 15 – LOAN COMMITMENTS AND OTHER RELATED ACTIVITIES

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, and usually have 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.

51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 15 – LOAN COMMITMENTS AND OTHER RELATED ACTIVITIES(Continued)

The contractual amounts of financial instruments with off-balance-sheet risk at year-end were as follows:

	2011		2010
Commitments to make loans	$	3,376	$	1,658
Unused lines of credit		46,862		56,448
Overdraft protection		11,664		10,837
Letters of credit		266		398

Of the above unused instruments at December 31, 2011, approximately $2,256 pertains to fixed-rate commitments, variable-rate commitments account for approximately $48,248 and $11,664 are related to automatic overdraft protection for checking accounts. At year-end 2010, approximately $602 of total commitments were fixed-rate, approximately $57,902 were variable rate and $10,837 were related to automatic overdraft protection for checking accounts. Rates on fixed-rate unused lines of credit ranged from 5.00% to 6.75% at December 31, 2011 and 3.38% to 21.90% at December 31, 2010.

NOTE 16 – FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Corporation used the following methods and significant assumptions to estimate fair value:

Investment Securities: The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3). Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Interest Rate Swaps: The fair values of interest rate swaps are based on valuation models using observable market data as of the measurement date (Level 2).

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned: Certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at fair value, less costs to sell. Fair values are based on recent real estate appraisals. These appraisals may use a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Loans Held for Sale: Loans held for sale are carried at the lower of cost or fair value, as determined by outstanding commitments, from third party investors.

52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 16 – FAIR VALUE(Continued)

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:

	Fair Value Measurements At December 31, 2011 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Available for sale securities:
U.S. Government and federal agency	$	—	$	2,446	$	—
State and municipal		—		53,937		3,486
Corporate bonds and notes		—		—		—
Mortgage-backed securities—residential		—		90,270		16
Equity securities		20		—		—
Interest rate swaps		—		46		—

	Fair Value Measurements At December 31, 2011 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Liabilities:
Interest rate swaps	$	—	$	46	$	—

	Fair Value Measurements At December 31, 2010 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Available for sale securities:
U.S. Government and federal agency	$	—	$	2,975	$	—
State and municipal		—		44,705		300
Corporate bonds and notes		—		1,516		—
Mortgage-backed securities—residential		—		88,507		20
Equity securities		10		—		—
Interest rate swaps		—		47		—

	Fair Value Measurements At December 31, 2010 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Liabilities:
Interest rate swaps	$	—	$	47	$	—

53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 16 – FAIR VALUE(Continued)

The following table presents the activity in security pricing using significant unobservable inputs (Level 3) during 2011:

	2011
Beginning Balance	$	320
State and Municipal:
Purchases		2,588
Transfers from Level 2 to Level 3		898
Transfers from Level 3 to Level 2		(300	)
Mortgage-backed securities:
Principal repayments		(4	)
Ending balance	$	3,502

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

	Fair Value Measurements At December 31, 2011 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans:
Commercial	$	—	$	—	$	417
Commercial and land development		—		—		974
One-to-four family		—		—		92
Other real estate owned		—		—		18
Loan servicing rights		—		—		47

	Fair Value Measurements At December 31, 2010 Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans
Commercial	$	—	$	—	$	1,769
Commercial and land development		—		—		1,202
One-to-four family		—		—		145
Other real estate owned		—		—		58
Loan servicing rights		—		—		76

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal amount of $1,999, with a valuation allowance of $516 at December 31, 2011, resulting in an additional provision for loan loss of $247 for the year ended December 31, 2011.

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal amount of $3,385, with a valuation allowance of $269 at December 31, 2010, resulting in an additional provision for loan loss of $1,790 for the year ended December 31, 2010.

Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $18, which is made up of the outstanding balance of $131, net of a valuation allowance of $113 at December 31, 2011. The property was written-down $38 in 2011 and $75 in 2009.

54

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 16 – FAIR VALUE(Continued)

Other real estate owned measured at fair value less costs to sell, had a net carrying amount of $58, which is made up of the outstanding balance of $133, net of a valuation allowance of $75 at December 31, 2010. The write-down of $75 occurred during the year end December 31, 2009. There were no write-downs of other real estate owned for the year ended December 31, 2010.

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

	2011				2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets
Cash and cash equivalents	$	15,634	$	15,634	$	12,837	$	12,837
Time deposits with other financial Institutions		246		246		5,697		5,697
Securities available for sale		150,175		150,175		138,033		138,033
Restricted equity securities		3,220		na		3,219		na
Loans, net		213,952		215,490		190,685		192,372
Accrued interest receivable		1,404		1,404		1,270		1,270
Interest rate swaps		46		46		47		47
Financial liabilities
Deposits		340,664		341,356		309,134		309,908
Short-term borrowings		10,168		10,168		8,471		8,471
Federal Home Loan Bank advances		8,000		8,299		15,000		15,337
Accrued interest payable		219		219		312		312
Interest rate swaps		46		46		47		47

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, time deposits with other financial institutions, interest bearing deposits, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. 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 value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of restricted equity securities due to restrictions placed on its transferability. The fair value of off-balance-sheet items is not considered material.

NOTE 17 – DERIVATIVES

The Corporation utilizes interest-rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position, not for speculation. The notional amount of the interest-rate swaps does not represent amounts exchanged by the parties. The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest-rate swap agreements.

The Corporation implemented a program in 2009 whereby it lends to its borrowers at a fixed rate with the loan agreement containing a two-way yield maintenance provision. The program has one participant as of December 31, 2011. If the borrower prepays the loan, the yield maintenance provision will result in a prepayment penalty or benefit depending on the interest rate environment at the time of the prepayment. This provision represents an embedded derivative which is required to be bifurcated from the host loan contract. As a result of bifurcating the embedded derivative, the Corporation records the transaction with the borrower as a floating rate loan and a pay floating / receive fixed interest-rate swap. To offset the risk of the interest-rate swap with the borrower, the Corporation enters into an interest-rate swap with an outside counterparty that mirrors the terms of the interest-rate swap between the Corporation and the borrower. Both interest-rate swaps are carried as freestanding derivatives with their changes in fair value reported in current earnings. The interest-rate swaps are not designated as hedges. The change in the fair value of the interest-rate swap between the Corporation and its borrower was a decrease of $1 for the year ended December 31, 2011, which was offset by an equal increase in value during the year ended December 31, 2011 on the interest-rate swap with an outside counterparty, with the result that there was no net impact on income in 2011.

55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 17 – DERIVATIVES(Continued)

Summary information about the interest-rate swaps not designated as hedges between the Corporation and its borrower is as follows:

	2011			2010
Notional amount	$	1,423		$	1,485
Weighted average receive rate		5.33	%		5.33	%
Weighted average pay rate		3.31	%		3.34	%
Weighted average maturity (years)		2.0			3.0
Fair value of interest-rate swap	$	46		$	47

Summary information about the interest-rate swaps between the Corporation and outside parties is as follows:

	2011			2010
Notional amount	$	1,423		$	1,485
Weighted average pay rate		5.33	%		5.33	%
Weighted average receive rate		3.31	%		3.34	%
Weighted average maturity (years)		2.0			3.0
Fair value of interest-rate swap	$	(46	)	$	(47	)

The fair value of the interest-rate swaps at year-end is reflected in other assets and other liabilities with a corresponding offset to noninterest income.

NOTE 18 – OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income components and related tax effects were as follows:

	2011			2010			2009
Unrealized holding gains (losses) on available for sale securities	$	2,821		$	(195	)	$	2,337
Reclassification adjustment for losses (gains) later recognized in income		(214	)		(661	)		(770	)
Net unrealized gains (losses)		2,607			(856	)		1,567
Tax effect		(887	)		292			(533	)
Other comprehensive income (loss)	$	1,720		$	(564	)	$	1,034

56

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 19 – PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION

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

CONDENSED BALANCE SHEETS

	December 31,
	2011		2010
ASSETS
Cash and cash equivalents	$	520	$	1,314
Investment in Bank subsidiary		39,645		35,239
Investment in real estate subsidiary		2,466		2,342
Securities available for sale		20		10
Other assets		271		253
Total assets	$	42,922	$	39,158
LIABILITIES AND SHAREHOLDERS’ EQUITY
Dividends payable	$	177	$	177
Shareholders’ equity		42,745		38,981
Total liabilities and shareholders’ equity	$	42,922	$	39,158

CONDENSED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

	Years ended December 31,
	2011			2010			2009
INCOME
Dividends from Bank subsidiary	$	—		$	—		$	—
Total Income		—			—			—
EXPENSES
Miscellaneous expense		(60	)		(48	)		(59	)
Income (loss) before income tax benefit and undistributed subsidiary income		(60	)		(48	)		(59	)
Income tax benefit		21			16			20
Undistributed equity in net income of Bank subsidiary		2,652			1,385			1,648
Undistributed equity in net loss of real estate subsidiary		(1	)		(28	)		—
Net income	$	2,612		$	1,325		$	1,609
Comprehensive income	$	4,332		$	761		$	2,643

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2011, 2010 and 2009

(Dollar amounts in thousands, except per share data)

NOTE 19 – PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION(Continued)

CONDENSED STATEMENTS OF CASH FLOWS

	Years ended December 31,
	2011			2010			2009
Cash flows from operating activities
Net income	$	2,612		$	1,325		$	1,609
Adjustments to reconcile net income to net cash from operating activities:
Equity in undistributed net income of Bank subsidiary		(2,652	)		(1,385	)		(1,648	)
Equity in undistributed net loss of real estate subsidiary		1			28			—
Change in other assets and liabilities		76			(16	)		31
Net cash from operating activities		37			(48	)		(8	)
Cash flows from investing activities
Investment in real estate subsidiary		(125	)		(2,370	)		—
Net cash from investing activities		(125	)		(2,370	)		—
Cash flows from financing activities
Dividends paid		(706	)		(706	)		(881	)
Net cash from financing activities		(706	)		(706	)		(881	)
Net change in cash		(794	)		(3,124	)		(889	)
Beginning cash and cash equivalents		1,314			4,438			5,327
Ending cash and cash equivalents	$	520		$	1,314		$	4,438

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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, 2011 and 2010, 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, 2011. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion. 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, 2011 and 2010, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2011 in conformity with U.S. generally accepted accounting principles.

                                                 Crowe Horwath LLP

Cleveland, Ohio

March 16, 2012

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REPORT OF MANAGEMENT ON THE CORPORATION’S

INTERNAL CONTROL OVER FINANCIAL REPORTING

March 16, 2012

Management of National Bancshares Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are made only in accordance with authorizations of management and directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.

Management of National Bancshares Corporation, including the Chief Executive Officer and the Chief Financial Officer, has assessed the Corporation’s internal control over financial reporting as of December 31, 2011, based on criteria for effective internal control over financial reporting described in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Corporation’s internal control over financial reporting was effective as of December 31, 2011, based on the specified criteria.

This annual report does not include an audit report of the Corporation’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to audit by the Corporation’s independent registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Corporation to provide only management’s report in this annual report.

David C. Vernon	James R. VanSickle
Chief Executive Officer	Chief Financial Officer
(Through December 31, 2011)

Mark R. Witmer

Chief Executive Officer

(Effective January 1, 2012)

61

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COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN OF NATIONAL BANCSHARES CORPORATION, S&P 500 STOCK INDEX, AND S&P 500 BANK INDEX

Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on National Bancshares’ Common Stock against the cumulative return of the S&P 500 Stock Index and the S&P 500 Bank Index for the period of five fiscal years commencing December 31, 2006 and ended December 31, 2011. The graph assumes that the value of the investment in National Bancshares Common Stock and each index was $100 of December 31, 2006 and that all dividends were reinvested.

	2006		2007		2008		2009		2010		2011
National Bancshares Corp	$	100.00		71.66		58.57		67.72		61.91		70.91
S&P 500 Stock Index*	$	100.00		105.49		66.46		84.05		96.71		98.76
S&P 500 Banks Index*	$	100.00		70.22		36.87		34.44		41.27		36.85

* National Bancshares Corporation is not included in the S&P 500 Bank Index or S&P 500 Stock Index

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PRICE RANGE OF COMMON STOCK

National Bancshares Corporation 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 Corporation common stock in 2011 and 2010 follows. This information does not reflect retail mark-up, markdown or commissions, and does not necessarily represent actual transactions.

	High		Low		Dividends per share
2011
First Quarter	$	15.65	$	12.52	$	.08
Second Quarter		14.65		13.39		.08
Third Quarter		14.92		13.35		.08
Fourth Quarter		14.92		13.49		.08
2010
First Quarter	$	13.91	$	12.20	$	.08
Second Quarter		14.47		12.77		.08
Third Quarter		13.98		12.56		.08
Fourth Quarter		13.66		12.62		.08

SHAREHOLDER INFORMATION

Corporate Office

National Bancshares Corporation

112 West Market Street, PO Box 57

Orrville, OH 44667

www.discoverfirstnational.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 829 shareholders of Record as of December 31, 2011.

Form 10-K

A copy of the Corporation’s 2011 Annual Report on Form 10-K as filed with the SEC will be furnished free of charge to shareholders upon written request to the Corporation.

Shareholder Assistance

National Bancshares Corporation

Shareholder Services Department

Ellen Gerber, Shareholder Relations

330-765-0609

ellengerber@discoverfirstnational.com

Transfer Agent

Registrar and Transfer Company

10 Commerce Drive

Cranford, NJ 07016

1-800-368-5948

info@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.

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CURRENT OFFICERS

NATIONAL BANCSHARES CORPORATION

Mark R. Witmer,President and Chief Executive Officer

James R. VanSickle,Senior Vice President and Chief Financial Officer

FIRST NATIONAL BANK

Mark R. Witmer,President and Chief Executive Officer

Business Banking

Thomas R. Poe,Executive Vice President, Senior Loan Officer

John L. Falatok, Senior Vice President, Market Manager

John R. Macks, Vice President

Robert C. McConnell, Vice President

John D. Shultz, Jr., Vice President

Darrell L. Smucker, Vice President

Laura R. Yoder,Vice President

Credit Administration and Managed Assets

Richard A. White,Vice President, Senior Credit Officer

Kathryn J. Barnes, Assistant Vice President, Credit Officer

Dallas W. Falb,Credit Officer

Agribusiness and Community Banking

Thomas R. Stocksdale,Senior Vice President

Harold D. Berkey, Vice President

John P. Hall, Vice President

Dean M. Karhan, Assistant Vice President

Retail Banking, Mortgage and Consumer Lending and Loan Operations

Myron Filarski,Executive Vice President, Chief Operating Officer

Cynthia A. Wagner,Vice President

Lisa M. Bryant, Consumer Credit Officer

Mindy L. Henderson,Assistant Vice President, Loan Operations Officer

Heather L. Kiner, Assistant Vice President, Relationship Manager

Patricia Massaro,Consumer Credit Officer

Jill R. Wachtel, Assistant Vice President, Relationship Manager

Amberly M. Wolf, Assistant Vice President, Retail Banking

Corporate

James R. VanSickle,Senior Vice President, Chief Financial Officer

James T. Griffith, Vice President, Information Technology

Pamela S. Null, Vice President, Compliance, BSA, CRA and Security

Michael G. Oberhaus,Vice President, Financial Analyst, Risk Manager

Maria A. Roush,Vice President, Auditor

Angela L. Smith,Controller

Jodi R. Blair, Deposit Operations Officer

Ellen L. Gerber, Administrative Officer, Assistant Secretary, Human Resource Manager

65

CURRENT BOARD OF DIRECTORS NATIONAL BANCSHARES CORPORATION & FIRST NATIONAL BANK	FIRST NATIONAL BANK OFFICES
John P. Cook, CPA, Ph.D	Orrville
Partner/Shareholder,	112 West Market Street
Long, Cook & Samsa, Inc.	330-682-1010
Bobbi E. Douglas	1320 West High Street
Executive Director,	330-682-2881
STEPS at Liberty Center
Every Woman’s House	1720 North Main Street CASH ATM ONLY
John W. Kropf
Chairman of the Board,	Apple Creek
National Bancshares Corporation	7227 East Lincoln Way
First National Bank	330-264-8070
Attorney,	Dalton
Kropf, Wagner & VanSickle, L.L.P.	12 West Main Street 330-828-2227
John L. Muhlbach, Jr.
Vice President,	Fairlawn
A.A. Hammersmith, Inc.	3085 West Market Street
	330-475-1363
Victor B. Schantz
President,	Kidron
Schantz Organ Company	4950 Kidron Road
	330-857-3101
Steve Schmid
President,	Lodi
Dairy Enterprises, Inc.	106 Ainsworth Street
	330-948-1414
James R. Smail
Chairman/Director	Massillon
J.R. Smail, Inc.	211 Lincoln Way East
Poulson Drilling, Inc.	330-832-7441
Monitor Ranch, Inc.
Monitor Bancorp, Inc.	2312 Lincoln Way N.W.
	330-833-1622
David C. Vernon
President & CEO, Retired	Mt. Eaton
National Bancshares Corporation	15974 East Main Street
First National Bank	330-359-3105 or 330-857-4301
Mark R. Witmer	Seville
President & CEO,	4885 Atlantic Drive
National Bancshares Corporation	330-769-3105
First National Bank
	Smithville
Howard J. Wenger	153 East Main Street
President,	330-669-2611
Wenger Excavating, Inc.
Lake Region Oil, Inc.	Wooster
Northstar Asphalt, Inc.	4192 Burbank Road
Massillon Materials, Inc.	330-263-5303
Stark Materials, Inc.
	1725 Cleveland Road 330-263-1725
Albert W. Yeagley
Vice President, Industry & Government Affairs
The J. M. Smucker Company

66