TABLE OF CONTENTS
3 Message to Shareholders
4 Financial Highlights
5 Selected Financial Data
7 Management`s Discussion and Analysis of Financial Condition and
Results of Operations
25 Consolidated Balance Sheets
26 Consolidated Statements of Income
27 Consolidated Statements of Changes in Shareholders` Equity
28 Consolidated Statements of Cash Flows
29 Notes to Consolidated Financial Statements December 31, 2008, 2007 and 2006
47 Report of Management on the Company`s Internal Control Over Financial
Reporting
48 Report of Independent Registered Public Accounting Firm
49 Comparison of Five-Year Cumulative Total Return of National Bancshares
Corporation, S&P 500 Stock Index, and S&P 500 Bank Index
50 Price Range of Common Stock
50 Shareholder Information
51 Officers
52 Directors
52 First National Bank Offices
MESSAGE TO SHAREHOLDERS
Dear Shareholders:
We made significant progress in 2008 as we continued our efforts to move
National Bancshares Corporation to a higher level of profitability. Net
income this past year increased 28% to $2.194 million from $1.711 million
for 2007.Net interest income before the provision for loan losses increased
$422 thousand or 4%. Noninterest income increased $343 thousand or 17%.
Noninterest expense decreased $327 thousand or 3%. Over the past two years
since we began our efforts to achieve improved results, noninterest income
has increased $680 thousand and noninterest expense has decreased
$1.181 million. Earnings per basic and diluted common share have improved
from $.52 in 2006 to $.77 or 48% in 2007 and $1.00 or 30% in 2008. For more
details on our 2008 financial results, please review the financial statements
and footnotes contained in this Annual Report.
In addition to the improvement in our financial results, positive change has
taken place in other areas. All of the work required to comply with the
Sarbanes Oxley act was completed in 2008. Our Business Continuity Plan was
completely rewritten and implemented. All policies have been reviewed,
rewritten and updated. Credit quality has been maintained and problem loan
administration has been improved. Loans past due over 90 days still on accrual
and nonaccrual loans declined from $2.8 million at year-end 2007 to $2 million
at year-end 2008. Compliance and Audit has been significantly improved. Twenty
members of the Bank`s staff have completed a one year sales training course.
We added the following Bank services: Business Internet Banking and remote
capture, all bank clients can now apply for a loan 24 hours each day 7 days
each week. We introduced Platinum Checking, a high interest checking account
for clients with balances above $10,000. We introduced Bonus Checking, an
account that pays bonus interest to clients that use our Visa debit card, use
bill pay, receive their statement electronically and make at least one
electronic direct deposit. All of the bank`s ATMs have been replaced and
updated. The bank`s website www.fnborrville.com has been completely
redesigned. We installed a new Cisco internet based VOIP telephone system
which has made it possible for us to hold company wide meetings and conference
calls. We implemented branch capture which transforms checks to electronic
media and eliminates the need to move checks by messenger for central
processing. Our Burbank Road office in Wooster became the first office to be
remodeled to incorporate all of the design elements of our office rebranding
project.
The results for 2008 represent great progress and we continue to take
advantage of opportunities for improvement. We are a strong Bank because
we are blessed with loyal clients and friends. We are not burdened with any
sub-prime loans our asset quality is strong and our allowance for loan losses
is adequate. We are well-positioned.
Despite our positioning however, 2009 will not be an easy year. We have already
been notified that our 2009 cost for FDIC insurance is going to increase by
nearly $1 million. However painful, that`s how the system works. The healthy
banks like First National Bank are required to pay for the cost of working
out the issues that have been caused by the problem banks.
There will likely be more surprises in 2009 which we cannot predict since
we are currently in a horrific economic malaise. There are several reasons,
however, for believing that we will successfully navigate our way through
this turbulence. First, we are well-capitalized and our asset quality is
strong. Second, we have an outstanding Board of Directors. Third, we have
a dedicated staff of banking professionals. Fourth, we have loyal clients
and friends. Fifth, we have the support of you, our shareholders.
Even though we are faced with a challenging economic environment we intend to
distinguish ourselves by making progress as we work to improve our community
financial services business. We are determined to make every effort to improve
this wonderful company. Thank you for your interest in National Bancshares
Corporation and First National Bank. We appreciate your support.
David C. Vernon
President and CEO
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 Financial Review and the consolidated financial statements and notes
to the consolidated financial statements.
Financial Position
(Dollar amounts in thousands, except per share data)
Percentage
At December 31, 2008 2007 Change
Total assets $338,002 $306,651 10.2 %
Deposits 263,642 242,523 8.7 %
Loans - net 179,831 191,488 (6.1)%
Securities 127,248 84,514 50.6 %
Shareholders` equity 36,881 34,991 5.4 %
Book value per share 16.75 15.85 5.7 %
Year ended December 31,
Net interest income $ 11,286 $ 10,864 3.9 %
Income before income taxes 2,964 2,207 34.3 %
Net income 2,194 1,711 28.2 %
Cash dividends declared 1,404 1,430 (1.8)%
Net income per share 1.00 0.77 29.9 %
Cash dividends per share 0.64 0.64 --
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 thirteen offices in Orrville, Wooster, Massillon,
Apple Creek, Dalton, Kidron, Lodi, Mt. Eaton, Seville and Smithville.
Additional information is available at www.fnborrville.com.
SELECTED FINANCIAL DATA
(Dollar amounts in thousands, except per share data)
As of or for the years ended December 31,
2008 2007 2006 2005 2004
Income statement data:
Interest income $17,071 $17,832 $17,157 $16,075 $15,312
Interest expense 5,785 6,968 5,995 4,128 3,346
Net interest income 11,286 10,864 11,162 11,947 11,966
Provision for loan losses 482 147 160 159 178
Net interest income after
provision for loan losses 10,804 10,717 11,002 11,788 11,788
Noninterest income 2,333 1,990 1,653 1,801 1,895
Noninterest expense 10,173 10,500 11,354 10,986 9,897
Income before income taxes 2,964 2,207 1,301 2,603 3,786
Income taxes 770 496 137 503 875
Net income 2,194 1,711 1,164 2,100 2,911
Balance sheet data:
Cash and due from banks $11,001 $11,842 $ 8,955 $10,985 $11,756
Federal funds sold -- 443 9,820 8,780 6,070
Securities 127,248 84,514 86,000 77,009 76,327
Loans, net 179,831 191,488 184,481 191,538 196,725
Deposits 263,642 242,523 247,681 249,488 248,522
Borrowings 34,285 26,374 22,744 19,952 21,679
Shareholders` equity 36,881 34,991 34,680 34,653 35,319
Total assets 338,002 306,651 308,358 306,881 308,425
Share and per share data:
Net income $ 1.00 $ 0.77 $ 0.52 $ 0.94 $ 1.30
Cash dividends 0.64 0.64 0.64 0.64 0.61
Book value at period end 16.75 15.85 15.52 15.51 15.81
Weighted average number
of shares outstanding 2,203,218 2,231,369 2,234,488 2,234,488 2,234,488
Performance ratios:
Return on average equity 6.20% 4.94% 3.29% 5.90% 8.29%
Return on average assets 0.70% 0.56% 0.38% 0.70% 0.97%
Dividend payout percentage 64.00% 83.58% 122.87% 68.10% 46.83%
Efficiency ratio (1) 74.70% 81.69% 88.60% 79.91% 71.41%
Full time equivalent staff 108 105 132 135 136
Average total assets to
full time equivalent staff $2,916 $2,903 $2,296 $2,234 $2,214
Asset quality ratios:
Allowance for loan losses
to ending total loans 0.95% 1.05% 1.07% 0.98% 0.89%
Net loan charge-offs
to average loans 0.41% 0.06% 0.03% 0.01% 0.01%
Capital ratios:
Average equity to average
assets 11.24% 11.35% 11.66% 11.81% 11.65%
Leverage ratio (2) 7.78% 8.26% 8.57% 9.76% 9.41%
Total risk-based capital
ratio (2) 12.60% 12.78% 13.26% 14.45% 13.73%
(1) The efficiency ratio is calculated by dividing noninterest expenses by
the sum of net interest income and noninterest income.
(2) Computed in accordance with Comptroller of the Currency and FDIC guidelines.
SELECTED FINANCIAL DATA
The following table shows quarterly results of operations for 2008 and 2007.
Basic and
Interest Net interest Provision for Income before diluted earnings
income income loan losses income taxes Net income per share
(Dollar amounts in thousands)
2008
First quarter $4,270 $2,744 $187 $660 $491 $0.22
Second quarter 4,196 2,763 71 685 514 0.23
Third quarter 4,294 2,843 126 778 574 0.26
Fourth quarter 4,311 2,936 98 841 615 0.28
2007
First quarter $4,352 $2,642 $27 $354 $287 $0.13
Second quarter 4,542 2,758 -- 361 314 0.14
Third quarter 4,497 2,741 -- 674 507 0.23
Fourth quarter 4,441 2,723 120 818 603 0.27
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, 2008, 2007 and 2006. 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 2009 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 Company is a community-oriented financial institution offering a variety
of financial services to meet the needs of the communities it serves. The
Company 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 2008, the Company continued to execute a plan, which was implemented
in December 2006. The plan focuses on four critical areas. These areas are
first; enhancing services for depositor clients, second; strengthening
regulatory compliance, third; enhancing the Company`s ability to originate
loan assets and fourth; reducing costs and increasing noninterest income.
In the first half of 2008, the company introduced `Platinum Checking`,
a high-interest checking account for clients with balances above $10 thousand.
The Platinum Checking account product accounted for $25.4 million or 9.6% of
total deposits at December 31, 2008. In November 2008, the Company introduced
`Bonus Checking`, an account that pays bonus interest to clients that use our
Visa debit card, bill pay services, receive their account statement online,
and make at least one electronic direct deposit.
In the first quarter of 2008, the Company hired a new Compliance Officer and
Internal Auditor. Each of these new officers has at least twenty years of
banking industry experience. In 2008, these officers conducted a comprehensive
review of our Compliance and Internal Audit risk assessments and programs to
ensure an effective risk-based approach is utilized.
Loans, net of allowance for loan losses decreased $11.7 million or 6.1% from
2007 to 2008. The change in loans was significantly impacted by a $20.9 million
mortgage loan securitization transaction in December 2008. Most of the loan
growth, net of the securitization, has occurred through loan participations
purchased from other Ohio financial institutions. The Bank announced a new
senior loan officer in January 2009. The new senior loan officer has 27 years
of banking experience and is responsible for business development and
management of all Bank lending activities.
Checking account fees, Visa check card interchange fees and income from
mortgage banking activities have significantly increased since the
implementation of this plan. In July 2008, the Bank sold its $1.5 million
credit card portfolio and generated a $435 thousand gain on the transaction.
Cost reductions have been realized in 2008 through reduced salaries and wages
and marketing expenses. Salaries and employee benefits were $5.1 million for
the year ended December 31, 2008, a decrease of $0.7 million compared to the
year ended December 31, 2006. Nearly thirty full-time equivalent positions
have been eliminated since 2006 almost entirely through attrition. Marketing
expenses were $144 thousand for the year ended December 31, 2008, a decrease
of $272 thousand compared to the same period in 2006.
Office of the Comptroller of the Currency (`OCC`) regulations requires 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%. The Bank had capital ratios above the
well-capitalized levels at December 31, 2008 and December 31, 2007.
The Company 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 or any current recommendations by its
regulators which would have a material effect if implemented. The Company
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 10.2% to $338.0 million as of December 31, 2008,
from $306.7 million at December 31, 2007. Securities available for sale
totaled $127.2 million as of December 31, 2008, compared to $84.5 million
at December 31, 2007. Loans, net of allowance for loan losses decreased
$11.7 million to $179.8 million as of December 31, 2008, compared to
$191.5 million at December 31, 2007. The increase in securities available
for sale and the decrease in the loan portfolio were significantly impacted
by a $20.9 million mortgage loan securitization transaction with the Federal
Home Loan Mortgage Corporation in December 2008. The Bank has recorded the
securities as available for sale and continues to service the loans. Deposits
increased 8.7% to $263.6 million as of December 31, 2008, compared to
$242.5 million at December 31, 2007. Shareholders` equity increased 5.4% to
$36.9 million at the end of 2008, from $35.0 million at the end of 2007.
Accumulated other comprehensive income increased to $1.5 million as of
December 31, 2008, compared to $295,000 as of Dec. 31, 2007. The change
in accumulated other comprehensive income was a result of an increase in
unrealized gains on securities.
Loans:
Net loans decreased by $11.7 million or 6.1% from 2007 to 2008. The change
in net loans was significantly impacted by the aforementioned securitization
transaction. The loan demand in the Bank`s primary market remains soft.
However, the Bank is focusing its efforts on aggressively attracting
commercial loan business and continuing to buy loan participations from
other Ohio banks (commercial and commercial real estate and consumer loans.)
Real estate loans decreased by $20.6 million or 12.8%. Home equity loans
increased $3.6 million or 17.2% from 2007 to 2008 as a result of increased
marketing efforts by the Bank`s mortgage banking department. The Bank`s loan
portfolio consists of $140.2 million loans secured by real estate, which
represents 77.1% of total loans as of December 31, 2008.
First National Bank`s loan policy provides for a loan mix 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%.
Consumer loans increased $2.4 million as of December 31, 2008 compared to
December 31, 2007. Consumer loans increased due to the purchase of automobile
loans from another Ohio bank. The purchased loans are subject to the same
underwriting standards as loans generated in our offices.
Loan portfolio composition at December 31,
2008 2007 2006 2005 2004
$ % $ % $ % $ % $ %
(Dollar amounts in thousands)
Real estate:
Commercial $48,034 27% $51,463 27% $45,737 25% $47,638 25% $47,081 24%
Residential 54,924 30% 80,113 41% 86,652 46% 91,592 47% 97,694 49%
Home equity 24,442 13% 20,857 11% 19,383 10% 19,045 10% 18,272 9%
Construction 12,846 7% 8,367 4% 6,079 3% 6,440 3% 6,327 3%
140,246 77% 160,800 83% 157,851 84% 164,715 85% 169,374 85%
Consumer 14,354 8% 11,988 6% 7,522 4% 6,205 3% 5,386 3%
Commercial 25,583 14% 17,552 9% 18,519 10% 20,046 10% 21,197 10%
Credit cards -- 0% 1,614 1% 1,521 1% 1,406 1% 1,362 1%
Other 1,658 1% 1,987 1% 1,609 1% 1,566 1% 1,675 1%
Total Loans 181,841 100% 193,941 100% 187,022 100% 193,938 100% 198,994 100%
Less:
Unearned and
deferred income (292) (425) (548) (496) (505)
Allowance for
loan losses (1,718) (2,028) (1,993) (1,903) (1,763)
Net loans $179,831 $191,488 $184,481 $191,539 $196,726
Net loans as
a percent of
total assets 53.20% 62.45% 59.83% 62.41% 63.78%
In 2008, total agricultural loans decreased by $1.4 million to $2.9 million.
$2.4 million of the principal outstanding consists of loans collateralized
by farmland, which is included in the $48.0 million commercial loans secured
by real estate. The remainder, $500 thousand, consists of loans for
agricultural production and other loans to farmers, and that figure
is included in the $25.6 million figure for commercial loans (not
collateralized by real estate). Ranked by North American Industry
Classification System ~ or NAICS ~ codes, the industries most represented
by First National Bank`s commercial borrowers includes lessors of residential
buildings and dwellings and lessors of non-residential buildings, in that
order, accounting for 3.8% and 1.3% of the total loans at year-end 2008,
respectively.
Approximately 46% of the conventional mortgage loans secured by 1-4 family
real estate are long term fixed interest rate loans. The majority of loans
added to First National Bank`s portfolio, by the 2002 acquisition of Peoples
Federal, were fixed- rate residential mortgage loans, but the number of such
loans has declined since the merger as the fixed-rate mortgages have been
refinanced or paid off. Approximately 54% of the portfolio of conventional
mortgage loans secured by 1-4 family and multifamily real estate at year-end
2008 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 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` liquidity position, the interest rate environment and general economic
conditions.
First National Bank has not engaged in the practice of originating sub-prime
loans. As of December 31, 2008, the Bank does not have a single variable-rate
loan on which the interest is scheduled to increase.
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 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 Statement of Financial
Accounting Standards (SFAS) 5, `Accounting for Contingencies,` for pools of
homogenous loans, or (2) according to SFAS 114, `Accounting by Creditors for
Impairment of a Loan,` for loans the Bank considers impaired based upon
individual loan review. Management determines the necessary allowance balance
using the Bank`s loan loss experience, the nature and volume of the portfolio,
information about specific borrower situations and estimated collateral
values, economic conditions, and other factors. Loan losses are charged
against the allowance when management believes the uncollectibility of a loan
balance is confirmed.
Loans Analyzed Individually.
Determining the loan loss allowance begins with the Bank`s assessment of
credit risk for loans analyzed individually. Individual loans are assigned
credit-risk grades based on the Bank`s assessment of conditions affecting
a borrower`s ability to satisfy its contractual obligation under the loan
agreement. The assessment process includes reviewing a borrower`s current
financial information, historical payment experience, credit documentation,
public information, and other information specific to each borrower. Loans
reviewed individually are reviewed at least annually or more frequently if
management becomes aware of information affecting a borrower`s ability to
fulfill its obligation. All loans over $250 thousand or to customers whose
aggregate total borrowing exceeds $250 thousand are reviewed individually,
except for first mortgage loans on a borrower`s personal residence. Loans
or customers with balances under $250 thousand may also be reviewed
individually if considered necessary by the board and management. All
commercial lending relationships over $100 thousand are ranked according
to risk at least annually. Risk rankings also change at any point during
the year if the creditworthiness of a borrower changes. In addition, risk
ratings are reviewed annually by a qualified independent third party. The
independent third party reviews all aggregate loan relationships of $250
thousand or greater along with a sampling of loan relationships between
$100 thousand and $250 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 could result in
deterioration of repayment prospects. In the case of a commercial
borrower, for example, potential weaknesses could include adverse trends in
the borrower`s operations or adverse economic or market conditions that could
affect the borrower in the future.
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 existing
facts, conditions and values make collection or liquidation in full highly
questionable and improbable. The possibility of loss is extremely high, but
because of factors that could work to the borrower`s advantage classification
of the `doubtful` loan as `loss` is deferred.
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-loan then that loan is considered
impaired. Management measures the amount of impairment using the loan`s
expected future cash flows (discounted at the loan`s effective interest rate),
or the fair value of the underlying collateral if loan repayment is expected
to come from the sale or operation of the collateral. First National Bank
considers commercial or non-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 SFAS 5. Loans classified `special mention` or `substandard`,
and smaller-balance loans classified `doubtful` are assigned a provision
based upon a historical migration analysis performed on classified loans.
The migration analysis identifies the percentage of classified loans by
category that has historically been ultimately charged-off. The migration
percentages are reviewed and adjusted by management to reflect various
factors such as the growth and change in mix of the loan portfolio and
the regulator`s guidelines. Loans ranked `loss` are 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.
As of December 31, 2008, 2007 and 2006 classified assets were as follows:
Classified assets at December 31,
2008 2007 2006
Percent of Percent of Percent of
Amount total loans Amount total loans Amount total loans
(Dollar amounts in thousands)
Classified Loans:
Special mention $3,294 1.8% $ 401 0.2% $6,476 3.5%
Substandard 3,874 2.1% 4,839 2.5% 5,350 2.9%
Doubtful -- 0.0% 79 0.0% 161 0.0%
Loss -- 0.0% -- 0.0% 152 0.0%
Total classified loans 7,168 3.9% 5,319 2.7% 12,139 6.5%
Other classified assets -- 0.0% -- 0.0% -- 0.0%
Total classified assets 7,168 3.9% 5,319 2.7% 12,139 6.5%
Pools of Loans Analyzed under SFAS 5
The total loan loss allowance is derived both from analysis of individual
impaired loans under SFAS 114 and analysis of aggregated pools of loans under
SFAS 5. Smaller balance loans (such as automobile or home equity loans, for
example), groups of loans (such as residential mortgage loans), and less
severely classified loans reviewed individually may be analyzed on an
aggregated or pooled basis under SFAS 5.
Under SFAS 5, loans are segmented into groups of loans having similar risk
characteristics based on purpose, loan type, and collateral, for example
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
A proper loan review function is vital to establishment of an appropriate
loan loss allowance. Loan officers and the Bank`s credit analysts are
responsible for the assignment of risk ratings for loans reviewed
individually. 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. The Bank adjusts its loan loss allowance methodologies retrospectively
as well, making adjustments in its estimates and assumptions as necessary
to account for variances of estimated loan losses from actual loan loss
experience. The Bank`s determination about classification of its assets
and the amount of its allowances is subject to review by the Office of the
Comptroller of the Currency (OCC), which may order the establishment of
additional loss allowances.
First National Bank`s allowance for loan losses to total loans was 0.95% for
2008. This is a decrease of 0.10% when compared to 2007. In 2007, the
percentage of the allowance for loan losses to total loans was 1.05%.
This represents a 0.02% decrease over 2006. Total nonperforming loans
have decreased from $2.8 million as of December 31, 2007 to $2.0 million
at December 31, 2008. In 2008, total classified loans increased from $5,319
to $7,168 or 34.8%. A stagnant local economy and marginal deterioration of
the financial position of some of the Bank`s commercial borrowers led to
more loans being classified.
Loan review and monitoring is vital to establishment of an appropriate loan
loss allowance and to proper credit administration and risk management. In
order to minimize the credit risk inherent in the lending process, management
and the Board has adopted a more formal and systematic approach with credit
administration and loan review. As part of this systematic approach, in both
2007 and 2008, a qualified independent third party was engaged to perform
loan reviews. Management intends to continue this practice on an annual basis.
Loans deemed uncollectible are charged against the allowance for loan
losses. After a loan is charged off, the Bank continues to recover the
loss. Recoveries of previously charged-off amounts are credited to the
allowance for loan losses. The Bank recorded a $676 thousand partial
charge-off of a $1.7 million Summit County commercial real estate loan
in 2008. Transactions in the allowance for loan losses are summarized
in following table:
Year ended December 31,
2008 2007 2006 2005 2004
(Dollar amounts in thousands)
Balance, beginning of period $2,028 $1,993 $1,903 $1,763 $1,604
Loans charged off:
Collateralized by real estate:
Commercial 688 -- 39 -- --
Residential 16 12 42 -- 24
Home equity 9 -- -- -- --
Construction -- -- -- -- --
Consumer 69 72 43 8 25
Commercial 32 67 17 33 --
Credit cards 21 -- 21 16 20
Other 10 -- -- -- --
Total loans charged off 845 151 162 57 69
Recoveries of loans
previously charged off:
Collateralized by real estate:
Commercial 5 -- -- -- --
Residential 14 1 14 -- --
Home equity 2 -- -- -- --
Construction -- -- 55 32 --
Consumer 11 37 16 5 1
Commercial -- -- 1 1 41
Credit cards 1 1 6 -- 8
Other 20 -- -- -- --
Total recoveries 53 39 92 38 50
Net loans charged off (792) (112) (70) (19) (19)
Provision charged to operations 482 147 160 159 178
Balance, end of period $1,718 $2,028 $1,993 $1,903 $1,763
Loans outstanding:
Average $192,472 $187,888 $186,146 $197,064 $194,032
End of period 181,549 193,941 187,022 193,937 198,993
Ratio of allowance for loan
losses to total loans
outstanding at end of period 0.95% 1.05% 1.07% 0.98% 0.89%
Net charge offs to average loans 0.41% 0.06% 0.04% 0.01% 0.01%
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,
2008 2007 2006 2005 2004
Amount Percent(1) Amount Percent(1) Amount Percent(1) Amount Percent(1) Amount Percent(1)
(Dollar amounts in thousands)
Real estate:
Commercial $ 501 27% $ 779 27% $ 654 25% $ 720 25% $ 373 24%
Residential 169 30% 321 41% 88 46% 186 47% 114 49%
Home equity 121 13% 115 11% 9 10% 8 10% 13 9%
Construction 26 7% -- 4% -- 3% -- 3% -- 3%
Consumer 280 8% 116 6% 89 4% 40 3% 16 3%
Commercial 579 14% 552 9% 1,064 10% 826 10% 1,226 10%
Credit cards -- 0% 48 1% 31 1% 47 1% 21 1%
Other 10 1% -- 1% 58 1% 76 1% -- 1%
Unallocated 32 n/a 97 n/a -- n/a -- n/a -- n/a
Total $1,718 100% $2,028 100% $1,993 100% $1,903 100% $1,763 100%
(1) - Percent of loans in each category to total loans.
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 non-accrual 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 non-accrual by the Senior
Credit Officer with the concurrence of senior management. Interest received
on non-accrual loans ~ also referred to as nonperforming loans ~ is recorded
as a reduction of principal. The table to follow summarizes nonperforming
assets and other nonperforming assets by category.
Problem assets at December 31,
2008 2007 2006 2005 2004
(Dollar amounts in thousands)
Real estate:
Commercial:
Non-accrual $ 1,306 $ 2,106 $ 454 $ -- $ --
Past due 90 days or more -- -- -- -- --
Residential:
Non-accrual 60 209 223 599 395
Past due 90 days or more 173 142 217 198 52
Home equity:
Non-accrual 386 -- 8 5 --
Past due 90 days or more 34 9 -- -- --
Construction:
Non-accrual -- -- 276 -- 125
Past due 90 days or more -- -- -- -- --
Not collateralized by real estate:
Consumer:
Non-accrual -- -- -- 4 8
Past due 90 days or more 24 1 8 5 4
Commercial:
Non-accrual -- 330 1,100 1,472 899
Past due 90 days or more 30 -- 22 36 --
Credit cards:
Non-accrual -- -- -- -- --
Past due 90 days or more -- 6 -- 6 --
Total nonperforming loans 2,013 2,803 2,308 2,325 1,483
Other real estate owned 354 194 103 103 46
Total nonperforming assets $ 2,367 $ 2,997 $ 2,411 $ 2,428 $ 1,529
Loans outstanding, net $179,831 $191,488 $184,481 $191,538 $196,725
Nonperforming loans
to total net loans 1.12% 1.46% 1.25% 1.21% 0.75%
Nonperforming assets
to total assets 0.70% 0.98% 0.78% 0.79% 0.50%
Allowance for loan losses
to total loans 0.95% 1.05% 1.07% 0.98% 0.89%
Allowance for loan losses
to nonperforming loans 85.35% 72.35% 86.38% 81.86% 118.88%
Securities
Total securities increased $42.7 million or 50.6% at December 31, 2008 when
compared to December 31, 2007. The Bank actively purchases bonds issued
by local municipalities, school systems and other public entities when
opportunities arise. Other securities are primarily comprised of
mortgage-backed securities, municipal securities and securities issued
by corporations. 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
market 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, 2008,
all securities were classified as available for sale. At year-end 2008 and
2007 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.
Gross Gross
Amortized unrealized unrealized Fair
cost gains losses value
(Dollar amounts in thousands)
December 31, 2008
Available for sale:
State and municipal $ 16,173 $ 234 $ (193) $ 16,214
Corporate bonds and notes 7,630 5 (453) 7,182
Mortgage-backed 101,220 2,616 -- 103,836
Equity Securities 23 -- (7) 16
Total securities $125,046 $ 2,855 $ (653) $127,248
December 31, 2007
Available for sale:
U.S. Government and federal
agency $ 10,107 $ 161 $ -- $ 10,268
State and municipal 15,786 295 (13) 16,068
Corporate bonds and notes 17,864 26 (295) 17,595
Mortgage-backed 40,310 294 (21) 40,583
Total securities $ 84,067 $ 776 $ (329) $ 84,514
December 31, 2006
Available for sale:
U.S. Government and federal
agency $ 29,537 $ 69 $ (226) $ 29,380
State and municipal 17,110 330 (45) 17,395
Corporate bonds and notes 27,579 132 (441) 27,270
Mortgage-backed 12,030 4 (79) 11,955
Total securities $ 86,256 $ 535 $ (791) $ 86,000
The contractual maturity of securities available for sale at
December 31, 2008 is shown below.
One year More than one More than five More than
or less to five years to ten years ten years Total securities
Carrying value Carrying value Carrying value Carrying value Carrying value Market
Average yield Average yield Average yield Average yield Average yield value
(Dollar amounts in thousands)
State and municipal $ 297 $ 4,465 $ 6,593 $ 4,859 $ 16,214 $ 16,214
4.89% 3.91% 4.10% 4.03% 4.04%
Corporate bonds
and notes 3,884 3,298 -- -- 7,182 7,182
6.91% 5.68% -- -- 6.34%
Mortgage-backed 3 -- 30,315 73,518 103,836 103,836
9.57% -- 4.86% 5.26% 5.14%
Total securities $ 4,184 $ 7,763 $ 36,908 $ 78,377 $127,232 $127,232
6.77% 4.66% 4.72% 5.19% 5.07%
Restricted Equity Securities
As of December 31, 2008, 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 market value. The stock can be
sold at its par value only, and only to the FHLB or to another member
institution. Member institutions are required to maintain a minimum stock
investment in the FHLB, based on total assets, total mortgages, and total
mortgage-backed securities.
Total Liabilities
Total liabilities increased by $29.5 million or 10.8% from 2007 to 2008.
This increase is primarily a result of a $19.5 million increase in
interest-bearing deposits and an increase of $4.0 million in Federal
Home Loan Bank advances.
Deposits
Deposits increased during 2008 by $21.1 million or 8.7%. The increase
is primarily attributed to a growth in interest-bearing demand deposits
of $27.9 million. This increase was partially offset by decreases in
savings and time deposits. First National Bank`s savings accounts include
passbook and statement savings, as well as preferred savings accounts, which
are tiered to pay higher rates for higher balances. First National Bank has
not solicited brokered deposits. Savings accounts decreased by $3.9 million
or 7.3% from the end of 2007 to the end of 2008. This was primarily due to
customer fund movement to higher yielding money market type demand accounts.
Time deposits decreased by $4.6 million or 5.7%. This decrease is a result
of the success of our premium money market demand and checking accounts,
and management`s decision to maintain a reasonable time deposit rate
structure. Interest-bearing demand deposits, which include negotiable order
of withdrawal accounts and money market demand accounts, increased $27.9
million or 43.2% during 2008. Much of the increase in this category is
attributed to the Bank`s success in marketing our `Platinum Checking` account.
Maturity of time deposits of $100,000 or more at December 31, 2008
(Dollar amounts in thousands)
Time Remaining to Maturity Amount Percent of Total
Three months or less $ 4,303 33.3%
Over three through 12 months 5,601 43.3%
Over one year through 3 years 3,033 23.4%
Over 3 years -- --%
Total $12,937 100.0%
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.
The most liquid assets are cash and cash equivalents, which at year-end 2008
consisted of $11.0 million in cash and due from banks. At year-end 2007
cash and cash equivalents consisted of $11.8 million in cash and due from
banks and $0.4 million in federal funds sold. 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 100%. The ratio of total loans to deposits
at year-end 2008 was 68.9%. At the end of 2008 the fair value of securities
available for sale was approximately $127.2 million, while the total carrying
value of securities pledged was approximately $30.7 million, representing
securities pledged to secure public deposits and repurchase agreements.
Operating activities, as described in the Consolidated Statements of Cash
Flows in the attached consolidated financial statements, shows net cash
provided of $2.9 million in 2008, $1.8 million in 2007 and $2.4 million in
2006, generated principally from net income in those years. The Bank
reported $7.1 million in originations and proceeds from sales of mortgage
loans held for sale as operating activities in 2008.
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 2008, net cash used in investing activities was
$31.8 million. The increase in loans over the year and the purchase of
loans utilized $11.3 million of cash. Net cash used from activity in
securities available for sale totaled $21.0 million in 2008. Management
continued the reallocation of the investment portfolio started in 2007
by primarily purchasing seasoned 15 and 20 year discount agency
mortgage-backed securities in 2008. In 2007, net cash used in investing
activities was $4.9 million. The increase in loans over the year and
the purchase of loans generated a $7.2 million use of cash. Net proceeds
from activity in securities available for sale was $2.3 million in 2007.
During 2007, management sold $22.7 million of callable securities and
corporate bonds. The proceeds from those sales were used to purchase `bullet
substitute` discount agency mortgage-backed securities with shorter duration
than the securities sold and seasoned 15 and 20 year discount agency
mortgage-backed securities. A `bullet substitute` is a collateralized
mortgage obligation whose structure and price lends itself to perform
well in a declining rate environment like a bullet bond of a similar
duration. Three characteristics that contribute to a bullet like
performance are discount coupon, prepayment accretion and structure
(e.g. principal lock-out and prepayment protection.) Duration is a
weighted-average term-to-maturity of a security`s cash flows, the
weights being the present value of each cash flow as a percentage of
the security`s full price. In 2006, as interest rates continued to
increase we experienced a decline in loans. Overall, net cash used in
investing activities was $2.9 million, as net loan pay downs resulted
in a $6.7 million source of cash and net securities purchased resulted
in an $8.8 million use of cash. Additionally, capital expenditures resulted
in a use of cash, in the amount of $918 thousand, primarily for the cost
associated with replacing our Kidron, Ohio, office with a new office.
Financing activities, as described in the Consolidated Statements of Cash
Flows in the attached consolidated financial statements, includes the
solicitation and repayment of customer deposits, borrowings and repayments,
treasury stock activity, and the payment of dividends. In 2008, net cash
provided by financing activities was $27.5 million. The increase in deposits
and short-term borrowings over the year provided $25.0 million of cash. At
December 31, 2008, the Bank had $21 million of borrowings outstanding with
FHLB, maturing in the years 2009, 2010 and 2011. This amount represents
a $4.0 million increase from the $17.0 million that was owed at the end
of 2007.
First National Bank has approximately $45.6 million available in short-term
funding arrangements with its correspondent banks and the FHLB. Additional
information concerning FHLB borrowings and bank obligations under repurchase
agreements is contained in Notes 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,
2008 2007 2006
(Dollar amounts in thousands)
Balance at year-end $10,469 $ 8,831 $ 7,902
Average balance outstanding 10,134 8,642 6,008
Maximum month-end balance 11,136 10,956 7,902
Weighted-average rate at year-end 0.50% 2.85% 3.63%
Weighted-average rate during the year 1.43% 3.86% 3.48%
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, 2008, the Bank exceeded
minimum risk-based and leverage capital ratio requirements. The Bank`s ratio
of total capital to risk-based assets was 12.60% on December 31, 2008.
The minimum required ratio is 8%. Additional information concerning capital
ratios at year-end 2008 and 2007 is contained in Note 14 of the consolidated
financial statements.
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, 2008, the aggregate contractual
obligations are outlined below:
Payment due by period
(Dollar amounts in thousands)
One year More than one More than three More than
Contractual Obligations Total or less to three years to five years five years
Time deposits $75,326 $51,744 $21,813 $ 1,763 $ 6
Long-term obligations 21,000 3,000 18,000 -- --
Information system
contract obligations 3,409 632 1,147 1,073 557
Operating lease obligations 36 26 10 -- --
Total $99,771 $55,402 $40,970 $ 2,836 $ 563
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 2008:
Expiration of funding commitments
One year More than
or less one year Total
(Dollar amounts in thousands)
Unused loan commitments $26,454 $22,935 $49,389
Commitment to make loans 2,382 -- 2,382
Letters of credit 109 -- 109
Total $28,945 $22,935 $51,880
Of the unused loan commitments, $10,065 are fixed-rate commitments and
$39,324 are variable-rate commitments. Rates on unused fixed-rate loan
commitments range from 6.25% to 19.80%. 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. Reserve balances do not earn interest. First
National Bank was required to maintain cash reserve balances with the
Federal Reserve Bank of $100 thousand at year-end 2008 and
$3.5 million at year-end 2007.
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 $38.0 million
of residential mortgage loans sold.
Shareholders` Equity
The $1.9 million or 5.4% increase in shareholders` equity from year-end 2007
to year-end 2008 was caused by an increase in accumulated other comprehensive
income, which results from improvement in the market value of securities
available for sale and earnings greater than the dividend payout. These
increases were partially offset by the purchase of 5,017 shares of National
Bancshares Corporation common stock for $86 thousand in 2008. Accumulated
other comprehensive income represents the unrealized appreciation or
depreciation (net of taxes) in the market 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 2008 is 64.00% versus 83.58% in 2007.
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). In December 2008, the Bank
paid a dividend to National Bancshares Corporation in the amount of
$2.5 million. During 2009, the Bank must obtain regulatory approval to
pay dividends to the holding company until 2009 net income exceeds $1,210.
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. First National
Bank`s 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 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. Cash flows may be received earlier than expected
as a result of the exercise of options or of embedded options in 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, which gives the customer the opportunity to benefit
when interest rates change in their favor, ordinarily occurs at the Bank`s
expense in the form of higher interest expense or lower interest income.
Although residential mortgage loans tend to have lower credit risk than
other types of loans, they tend also to have higher option risk because of
the borrower`s option to prepay the loan and 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 a bank
lends at prime rate and finances itself at Libor rates, it faces basis risk
due to the possibility that the prime-to-Libor spread might narrow.
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 by refinancing their loan. 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.
In 2007, the Board of Directors adopted revised limits on a decline in EVE
and 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, 2008
Basis Point Change in Rates +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp
Increase (decrease) in EVE (11.0)% (4.3)% (0.5)% (1.8)% (15.5)% (28.6)%
The Bank is in compliance with the interest rate risk policy limits related
to EVE as of December 31, 2008.
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, 2008
Basis Point Change in Rates +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp
Increase (decrease) in Earnings (19.0)% (12.1)% (5.7)% 7.8% 1.4% (5.5)%
The Bank is in compliance with the interest rate risk policy limits related
to EAR as of December 31, 2008.
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.
MANAGEMENT`S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Results of Operations
First National Bank derives substantially all of its income from banking
and bank-related services, including interest earnings on residential
real estate, commercial real estate, commercial and consumer loans and
investment securities along with fee income from deposit services. National
Bancshares Corporation`s business consists almost exclusively of acting as
holding company for the Bank. First National Bank`s business is not complex:
the Bank gathers deposits and it makes loans, principally in Wayne, Stark,
Medina and Holmes counties, Ohio.
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,
(Dollars amounts in thousands)
2008 2007 2006
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
Assets
Interest earning assets:
Securities:
Taxable $ 79,522 4,095 5.14% $ 68,787 3,585 5.18% $ 65,044 3,299 5.07%
Nontaxable (1) 16,491 991 6.07% 16,757 1,059 6.39% 18,820 1,209 6.45%
Federal funds sold 3,353 63 1.88% 6,447 335 5.20% 8,816 440 4.99%
Interest bearing deposits 1,019 18 1.77% 1,319 69 5.23% -- -- --
Net loans (including
nonaccrual loans) 192,472 12,241 6.36% 187,888 13,144 7.00% 186,146 12,620 6.78%
Total interest-earning assets 292,857 17,408 5.94% 281,198 18,192 6.34% 278,826 17,568 6.30%
All other assets 22,059 23,645 24,215
Total assets $314,916 $304,843 $303,041
Liabilities and
Shareholder`s Equity
Interest-bearing liabilities:
Interest-bearing checking $ 73,243 1,342 1.83% $ 58,148 1,341 2.31% $ 42,342 908 2.14%
Savings 51,963 291 0.56% 56,690 615 1.08% 64,979 721 1.11%
Time, $100,000 and over 13,197 497 3.77% 14,087 641 4.55% 14,168 584 4.12%
Time, other 65,248 2,527 3.87% 72,584 3,231 4.45% 71,593 2,754 3.85%
Other funds purchased 31,138 1,128 3.62% 23,838 1,140 4.78% 21,319 1,028 4.82%
Total interest-bearing liabilities 234,789 5,785 2.46% 225,347 6,968 3.09% 214,401 5,995 2.80%
Demand deposits 42,004 42,225 51,078
Other liabilities 2,741 2,666 2,221
Shareholders` equity 35,382 34,605 35,341
Total liabilities and
shareholders` equity $314,916 $304,843 $303,041
Net interest income (1) $11,623 $11,224 $11,573
Interest rate spread (2) 3.48% 3.25% 3.50%
Net yield on interest-
earning assets (3) 3.97% 3.99% 4.15%
Ratio of average interest-
earning assets to average
interest-bearing liabilities 124.73% 124.78% 130.05%
(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.
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.
2008 over 2007 2007 over 2006
(Dollar amounts in thousands)
Volume Rate Net change Volume Rate Net change
Interest Income
Securities:
Taxable $ 557 $ (47) $ 510 $ 214 $ 72 $ 286
Nontaxable (27) (41) (68) (144) (6) (150)
(tax-equivalent basis)
Federal funds sold (58) (214) (272) (123) 18 (105)
Interest bearing deposits (5) (46) (51) 69 -- 69
Loans (including
nonaccrual loans) 292 (1,195) (903) 122 402 524
Total interest income
(tax-equivalent basis) $ 759 $(1,543) $ (784) $ 138 $ 486 $ 624
Interest Expense
Deposits
Interest bearing checking $ 277 $ (276) $ 1 $ 365 $ 68 $ 433
Savings (26) (298) (324) (90) (16) (106)
Time, $100,000 and over (34) (110) (144) (4) 61 57
Time, other (284) (420) (704) 44 433 477
Other funds purchased 264 (276) (12) 120 (8) 112
Total interest expense $ 197 $(1,380) $(1,183) $ 435 $ 538 $ 973
Change in net
interest income
(tax-equivalent basis)* $ 562 $ (163) $ 399 $ (297) $ (52) $ (349)
*Tax equivalence based on highest statutory tax rates of 34%.
2008 versus 2007
During 2008, net income increased $483 thousand or 28.2% to $2.2 million.
Accordingly, basic and diluted earnings per share increased from $0.77 per
share in 2007 to $1.00 per share in 2008. The increase in net income is the
result of a relatively stable net interest margin, an increase in noninterest
income and a decrease in noninterest expenses. Returns on average equity
(ROE) and average assets (ROAA) for the year ending December 31, 2008,
were 6.20% and 0.70%, respectively, compared to 4.94% and 0.56% for the
year ending December 31, 2007.
Total interest and dividend income decreased $761 thousand or 4.3% in 2008.
Interest and fees on loans decreased $903 thousand or 6.9%, due primarily to
the decrease in interest rates during the year, partially offset by the
$4.6 million increase in average loans. Management has focused on
aggressively attracting commercial loan business and purchasing loan
participations from other Ohio banks (commercial real estate and consumer
loans). Securities interest and dividend income increased $465 thousand
or 10.9% over 2007. Much of this increase is attributable to an increase
in the average balance of securities.
Interest expense decreased by $1.2 million or 17.0% during 2008, as the
Bank`s deposits and short-term borrowings were affected by the falling
interest rate environment. Interest expense on deposits decreased
$1.2 million or 20.1% in 2008. Deposit customers continued moving funds
from lower-rate deposit accounts to higher-yielding accounts, such as
premium money market accounts and high interest checking accounts during
2008. Interest expense for short-term borrowings decreased by $196 thousand
or 54.4%, primarily due to the significant decrease in short-term market
interest rates during 2008. Federal Home Loan Bank advances interest expense
increased $184 thousand or 23.6% as the amount of advances increased from
$17 million to $21 million during 2008.
The provision for loan losses was $482 thousand in 2008, compared to
$147 thousand in 2007. 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 $792 thousand
for 2008, compared to $112 thousand for 2007. The increase in 2008
charge-offs were primarily related to a $676 thousand partial charge-off
of a $1.7 million Summit County commercial real estate loan. The allowance
as a percentage of loans declined from 1.05% at December 31, 2007 to 0.95%
at December 31, 2008. Classified loans have increased from $5.3 million as
of December 31, 2007 to $7.2 million as of December 31, 2008. Total
nonperforming loans have decreased from $2.8 million as of December 31, 2007
to $2.0 million as of December 31, 2008, a decrease of 28.2%. 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 $343 thousand or 17.2% during 2008. The
increase is related to the Bank`s enhancement of the deposit and service
charge fee structure, improvements in mortgage banking operations and
marketing activities and an increase in customer utilization of Visa check
card transactions. The Bank sold its $1.5 million credit card portfolio in
July 2008. The transaction generated a $435 thousand gain on sale. During
2008, the Company recorded an other than temporary impairment of
$444 thousand for the FHLMC preferred stock owned by the holding company.
Noninterest expense was $10.2 million for the year ended December 31, 2008
compared to $10.5 million for 2007, a decrease of 3.1%. The decrease is
primarily due to lower data processing expenses, professional and consulting
fees and maintenance and repairs expense. Data processing expense decreased
$158 thousand during 2008 as a result of a new contract entered into in
January of 2008 with the provider of the Bank`s core processing solution.
The decrease in professional and consulting fees was the result of a higher
level of services utilized in 2007. The Company engaged a consulting firm
to review the key business processes and procedures of First National Bank
in 2007.
Income tax expense was $770 thousand for the year ended December 31, 2008,
representing an increase of $274 thousand or 55.2%.
2007 versus 2006
During 2007, net income increased $547 thousand or 47.0%. Accordingly,
basic and diluted earnings per share increased from $0.52 per share in
2006 to $0.77 per share in 2007. The increase in net income is the result
of a relatively stable net interest margin, an increase in noninterest income
and a decrease in noninterest expenses. Returns on average equity (ROE) and
average assets (ROAA) for the year ending December 31, 2007 were 4.94% and
0.56%, respectively, compared to 3.29% and 0.38% for the year ending
December 31, 2006.
Total interest and dividend income increased $675 thousand or 3.9% in 2007.
Interest and fees on loans increased $524 thousand or 4.2%, due primarily to
the $7.0 million increase in loans. Management has focused on aggressively
attracting commercial loan business and purchasing loan participations from
other Ohio banks (commercial real estate and consumer loans). Securities
interest and dividend income increased $187 thousand or 4.6% over 2006.
Much of this increase is attributable to an increase in the average balance
of securities.
Interest expense increased by $1.0 million or 16.2% during 2007, as the Bank
continued to experience a shift from lower interest rate deposits to higher
paying interest rate deposits. Interest expense on deposits increased
$861 thousand or 17.3% in 2007. Deposit customers continued moving funds
from lower rate deposit accounts to higher yielding certificates of deposit
and premium money market accounts during 2007. Short-term borrowings
increased by $135 thousand or 60.0%, primarily due to the increase in
repurchase agreements.
The provision for loan losses was $147 thousand in 2007, compared to
$160 thousand in 2006. The allowance for loan losses and the related
provision for loan losses is based on the management`s judgment and
evaluation of the loan portfolio. Net charge-offs have been relatively
low in recent years. Classified loans have decreased from $12.1 million
as of December 31, 2006 to $5.3 million as of December 31, 2007, a decrease
of 56.2%. The decrease in classified loans is the primary reason the
allowance as a percentage of loans declined from 1.07% at December 31, 2006,
to 1.05% at December 31, 2007. Total nonperforming loans have increased
from $2.3 million as of December 31, 2006, to $2.8 million as of
December 31, 2007, an increase of 21.7%. 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 $337 thousand or 20.4% during 2007. The
increase is related to the Bank`s enhancement of the deposit and
service charge fee structure effective July 1, 2007. The Bank hired two
mortgage-banking specialists and reorganized mortgage loan operations
in the fourth quarter of 2007. The Bank is in the process of enhancing its
residential mortgage product and service offerings in an effort to improve
noninterest income in 2008 and beyond.
Noninterest expense was $10.5 million for the year ended December 31, 2007,
compared to $11.4 million for 2006, a decrease of 7.9%. The decrease is
primarily due to lower salaries and employee benefits due to lower staff
levels and a reduction in marketing expenses. Salaries and employee benefits
decreased $678 thousand in 2007 as the Bank reduced the number of full-time
equivalent employees from 132 at December 31, 2006 to 105 at
December 31, 2007. Marketing expenses decreased $289 thousand to
$127 thousand in 2007, compared to $416 thousand in 2006. Management has
focused on efficient and effective marketing solutions in an effort to reduce
unnecessary marketing costs in 2007. Offsetting the decrease in noninterest
expense for 2007 were increases in professional and consulting fees of
$344 thousand and data processing of $102 thousand. In the first half of
2007, the Company engaged a consulting firm to review key business processes
and procedures for the Bank. The consulting firm identified opportunities to
improve operational efficiency and enhance the deposit and service charge fee
structure.
Income tax expense was $496 thousand for the year ended December 31, 2007,
representing an increase of $359 thousand or 262.0%.
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 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, 2008, 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 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.
New Accounting Pronouncements
See Note 1 of the consolidated financial statements for details on new
accounting pronouncements.
CONSOLIDATED BALANCE SHEETS
December 31, 2008 and 2007
(Dollar amounts in thousands, except per share data)
2008 2007
ASSETS
Cash and due from banks $ 11,001 $ 11,842
Federal funds sold -- 443
Total cash and cash equivalents 11,001 12,285
Securities available for sale 127,248 84,514
Restricted equity securities 3,217 3,121
Loans, net of allowance for loan losses:
2008 ~ $1,718
2007 ~ $2,028 179,831 191,488
Premises and equipment, net 6,197 5,206
Goodwill 4,723 4,723
Identified intangible assets 422 654
Accrued interest receivable 1,230 1,502
Cash surrender value of life insurance 2,677 2,587
Other assets 1,456 571
$338,002 $306,651
LIABILITIES AND SHAREHOLDERS` EQUITY
Liabilities
Deposits
Non interest bearing $ 46,159 $ 44,492
Interest bearing 217,483 198,031
Total deposits 263,642 242,523
Repurchase agreements 10,469 8,831
Federal funds purchased 1,830 --
Federal Reserve note account 986 543
Federal Home Loan Bank advances 21,000 17,000
Accrued interest payable 690 975
Accrued expenses and other liabilities 2,504 1,788
Total liabilities 301,121 271,660
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 4,718 4,690
Retained earnings 20,972 20,182
Treasury stock, at cost (87,160 and
82,143 shares) (1,709) (1,623)
Accumulated other comprehensive income (loss) 1,453 295
Total shareholders` equity 36,881 34,991
$338,002 $306,651
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
2008 2007 2006
Interest and dividend income
Loans, including fees $ 12,241 $ 13,144 $ 12,620
Securities:
Taxable 4,095 3,585 3,299
Nontaxable 654 699 798
Federal funds sold and other 81 404 440
Total interest and dividend income 17,071 17,832 17,157
Interest expense
Deposits 4,657 5,828 4,967
Short-term borrowings 164 360 225
Federal Home Loan Bank advances 964 780 803
Total interest expense 5,785 6,968 5,995
Net interest income 11,286 10,864 11,162
Provision for loan losses 482 147 160
Net interest income after provision for
loan losses 10,804 10,717 11,002
Noninterest income
Checking account fees 1,218 1,191 985
Visa check card interchange fees 326 269 205
Deposit and miscellaneous service fees 171 176 170
Mortgage banking activities 126 19 17
Gain on sale of credit card portfolio 435 -- --
Gain (loss) on sales or write-down of
other real estate owned (15) (33) (29)
Securities gains (losses), net (344) 14 44
Other 416 354 261
Total noninterest income 2,333 1,990 1,653
Noninterest expense
Salaries and employee benefits 5,118 5,182 5,860
Data processing 947 1,105 1,003
Net occupancy 915 859 826
Professional and consulting fees 412 593 249
Franchise tax 326 336 362
Maintenance and repairs 212 327 294
Amortization of intangibles 232 237 246
Telephone 194 243 263
Marketing 144 127 416
Director fees and pension 312 212 380
Other 1,361 1,279 1,455
Total noninterest expense 10,173 10,500 11,354
Income before income taxes 2,964 2,207 1,301
Income tax expense 770 496 137
Net income $ 2,194 $ 1,711 $ 1,164
Basic and diluted weighted average common
shares outstanding 2,203,218 2,231,369 2,234,488
Basic and diluted earnings per common share $ 1.00 $ 0.77 $ 0.52
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS` EQUITY
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
Accumulated
Additional Other Total
Common Paid In Retained Treasury Comprehensive Shareholders`
Stock Capital Earnings Stock Income (Loss) Equity
Balance at January 1, 2006 $11,447 $4,690 $20,167 $(1,189) $ (362) $34,753
Comprehensive income:
Net income 1,164 1,164
Other comprehensive income
(loss) 193 193
Total comprehensive
income 1,357
Cash dividends declared ($.64 per share) (1,430) (1,430)
Balance at December 31, 2006 11,447 4,690 19,901 (1,189) (169) 34,680
Comprehensive income:
Net income 1,711 1,711
Other comprehensive income (loss) 464 464
Total comprehensive income 2,175
Cash dividends declared ($.64 per share) (1,430) (1,430)
Purchase of 27,103 common stock (434) (434)
Balance at December 31, 2007 11,447 4,690 20,182 (1,623) 295 34,991
Comprehensive income
Net income 2,194 2,194
Other comprehensive income (loss) 1,158 1,158
Total comprehensive income 3,352
Cash dividends declared ($.64 per share) (1,404) (1,404)
Purchase of 5,017 common stock (86) (86)
Compensation expense under stock-based
compensation plans 28 28
Balance at December 31, 2008 $11,447 $4,718 $20,972 $(1,709) $1,453 $36,881
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands except per share data)
2008 2007 2006
Cash flows from operating activities
Net income $2,194 $ 1,711 $ 1,164
Adjustments to reconcile net income
to net cash from operating activities
Provision for loan losses 482 147 160
Deferred income taxes 40 (19) (310)
Depreciation, amortization and accretion 271 442 944
Earnings on Bank owned life insurance (90) (88) (83)
Federal Home Loan Bank stock dividend (96) -- (134)
Origination of mortgage loans held for sale (7,080) (1,826) (3,834)
Proceeds from sales of mortgage loans held
for sale 7,187 1,826 3,812
Gain on sale of loans (114) (19) (17)
Net security (gains) losses 344 (14) (43)
Gain on sale of credit card portfolio (435) -- --
Impairment charge for property -- -- 124
(Gain) loss on sales or write-down of other real estate owned
and property and equipment 24 33 29
Compensation expense under stock-based compensation plans 28 -- --
Change in other assets and liabilities (498) (353) 562
Net cash from operating activities 2,257 1,840 2,374
Cash flows from investing activities
Proceeds from maturities of securities held to maturity -- -- 50
Securities available for sale
Proceeds from maturities and repayments 28,426 15,753 8,795
Proceeds from sales 25,417 22,662 278
Purchases (74,179) (36,083) (17,906)
Purchases of property and equipment (1,462) (325) (918)
Proceeds from sale of credit card portfolio 1,871 -- --
Proceeds from sale of property and equipment 13 211 --
Proceeds from sale of other real estate owned 179 -- 105
Purchase of loans (6,130) (6,408) --
Net change in loans to customers (5,210) (747) 6,677
Net cash from investing activities (31,075) (4,937) (2,919)
Cash flows from financing activities
Net change in deposits 21,119 (5,158) (1,807)
Net change in short-term borrowings 3,911 629 5,792
Proceeds from Federal Home Loan Bank advances 4,000 3,000 --
Repayments Federal Home Loan Bank advances -- -- (3,000)
Dividends paid (1,410) (1,430) (1,430)
Purchase of common stock (86) (434) --
Net cash from financing activities 27,534 (3,393) (445)
Net change in cash and cash equivalents (1,284) (6,490) (990)
Beginning cash and cash equivalents 12,285 18,775 19,765
Ending cash and cash equivalents $11,001 $12,285 $18,775
Supplemental cash flow information:
Interest paid $ 6,070 $ 7,022 $ 5,671
Income taxes paid 970 662 375
Supplemental noncash disclosures:
Transfer from loans to securities available for sale $20,810 $ -- $ --
Transfer from loans to other real estate owned 354 124 134
Transfer securities from held to maturity
to available for sale -- -- 16,831
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(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 subsidiary, First National Bank, Orrville, Ohio (Bank),
together referred to as `the Corporation.` The Bank has a minority interest
in First Kropf Title, LLC. The Bank`s investment in First Kropf Title, LLC
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 and Stark 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 deposit accounts in other financial institutions and
federal funds sold. 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
this 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.
Securities: Securities are classified as held to maturity and carried at
amortized cost when management has the positive intent and ability to
hold them to maturity. Securities are classified as available for sale
when they might be sold before maturity. 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.
Declines in the fair value of securities below their cost that are
other than temporary are reflected as realized losses. In estimating
other than temporary losses, management considers the length of time and
extent that fair value has been less than cost, the financial condition
and near term prospects of the issuer, and the Company`s ability and intent
to hold the security for a period sufficient to allow for any anticipated
recovery in fair value.
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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 mortgage 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.
All interest accrued but not received for loans placed on nonaccrual is
reversed against interest income. Interest received on such loans is
accounted for on the cash-basis or cost recovery method, until qualifying
for return to accrual. Loans are returned to accrual status when all the
principal and interest amounts contractually due are brought current and
future payments are reasonably assured.
Concentration of Credit Risk: Most of the Company`s business activity is
with customers located within Wayne, Stark, Holmes and Medina Counties.
Therefore, the Company`s exposure to credit risk is significantly affected
by changes in the economy in the Wayne, Stark, Holmes and Medina County area.
Purchased Loans: The Company 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 full payment under the loan terms is not expected.
Commercial and commercial real estate loans 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 loans, such as consumer and residential real estate loans, are
collectively evaluated for impairment, and accordingly, they are not
separately identified for impairment disclosures.
Servicing Rights: Servicing rights are recognized separately when they are
acquired through sales of loans. For sales of mortgage loans prior to
January 1, 2007, a portion of the cost of the loan was allocated to the
servicing right based on relative fair values. The Company adopted
SFAS No. 156 on January 1, 2007, and for sales of mortgage loans beginning
in 2007, 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
Company 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.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
At December 31, 2008 and 2007, the servicing assets of the Corporation
totaled $173 and $67, respectively, and is included with other assets
on the consolidated balance sheets. Fair value is determined using
prices for similar assets with similar characteristics, when available,
or based upon discounted cash flows using market-based assumptions.
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.
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 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 an accelerated method over their estimated useful lives,
which range from 7 to 10 years.
The Corporation also has intangible assets associated with a prior branch
acquisition, including unidentified intangibles of approximately $27 and
$56 at year-end 2008 and 2007. Management does not believe that this
purchase constituted a business combination and therefore is continuing
to amortize the unidentified intangible asset.
Long-term Assets: These assets are reviewed for impairment when events
indicate their carrying amount may not be recoverable from future
undiscounted cash flows. If impaired, the assets are recorded at fair
value.
Repurchase Agreements: Substantially all repurchase agreement liabilities
represent amounts advanced by various customers. Securities are pledged
to cover these liabilities, which are not covered by federal deposit
insurance.
Benefit Plans: Retirement plan expense is the amount of required matching
contributions plus any discretionary contributions to the Corporation`s
401(k) plan as determined by Board decision. Director retirement plan
expense allocates the benefits over the estimated years of service.
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.
For awards with graded vesting, compensation cost is recognized on a
straight-line basis over the requisite service period for the entire
award.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes: Income tax expense is the total of the current year income
tax due or refundable and the change in deferred tax assets and liabilities.
Deferred tax assets and liabilities are the expected future tax amounts for
the temporary differences between carrying amounts and tax bases of assets
and liabilities, computed using enacted tax rates. A valuation allowance,
if needed, reduces deferred tax assets to the amount expected to be realized.
The Company adopted FASB Interpretation 48, Accounting for Uncertainty in
Income Taxes (`FIN 48`), as of January 1, 2007. 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 adoption had no affect on the Company`s
financial statements.
The Company 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 Company, 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 Company 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. 58,000 stock options
were not considered in computing diluted earnings per common share for 2008
because they were antidilutive. No options were outstanding prior to 2008.
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 and $3,527 was required to meet regulatory reserve and clearing
requirements at year-end 2008 and 2007. 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 holding
company or by the holding company to shareholders. Dividends paid by the
Bank to the holding company are the primary source of funds for dividends
by the holding company to its shareholders.
Fair Value of Financial Instruments: Fair values of financial instruments
are estimated using relevant market information and other assumptions, as
more fully disclosed in a separate note. Fair value estimates involve
uncertainties and matters of significant judgment regarding interest rates,
credit risk, prepayments, and other factors, especially in the absence of
broad markets for particular items. Changes in assumptions or in market
conditions could significantly affect the estimates.
Reclassifications: Certain items in the prior year financial statements
were reclassified to conform to the current presentation.
Adoption of New Accounting Standards: In September 2006, the FASB issued
Statement No. 157, Fair Value Measurements (FAS 157). This Statement
defines fair value, establishes a framework for measuring fair value and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
expands disclosures about fair value measurements. This Statement
establishes a fair value hierarchy about the assumptions used to
measure fair value and clarifies assumptions about risk and the effect
of a restriction on the sale or use of an asset. The standard was
effective for fiscal years beginning after November 15, 2007. In
February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date
of FASB Statement No. 157. This FSP delays the effective date of FAS 157
for all nonfinancial assets and nonfinancial liabilities, except those that
are recognized or disclosed at fair value on a recurring basis (at least
annually) to fiscal years beginning after November 15, 2008, and interim
periods within those fiscal years. The impact of adoption was not material.
In October 2008, the FASB issued FSP 157-3, Determining the Fair Value of
a Financial Asset when the Market for That Asset Is Not Active. This FSP
clarifies the application of FAS 157 in a market that is not active. The
impact of adoption was not material.
In February 2007, the FASB issued Statement No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities. The standard provides
companies with an option to report selected financial assets and liabilities
at fair value and establishes presentation and disclosure requirements
designed to facilitate comparisons between companies that choose different
measurement attributes for similar types of assets and liabilities. The new
standard was effective for the Company on January 1, 2008. The Company did
not elect the fair value option for any financial assets or financial
liabilities as of January 1, 2008.
Effect on Newly Issued But Not Yet Effective Accounting Standards: In
December 2007, the FASB issued FAS No. 141 (revised 2007), Business
Combinations (`FAS 141(R)`), which establishes principles and requirements
for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in an acquiree, including the recognition and
measurement of goodwill acquired in a business combination. FAS No. 141(R)
is effective for fiscal years beginning on or after December 15, 2008.
Earlier adoption is prohibited. The adoption of this standard will not have
a material effect on the Corporation`s results of operations or financial
position.
In December 2007, the FASB issued SFAS No. 160, `Noncontrolling Interest in
Consolidated Financial Statements, an amendment of ARB No. 51`
(`SFAS No. 160`), which will change the accounting and reporting for
minority interests, which will be recharacterized as noncontrolling
interests and classified as a component of equity within the consolidated
balance sheets. FAS No. 160 is effective as of the beginning of the first
fiscal year beginning on or after December 15, 2008. The adoption of this
standard will not have a material effect on the Corporation`s results of
operations or financial position
In March 2008, the FASB issued SFAS No. 161, `Disclosures about Derivative
Instruments and Hedging Activities, an amendment of SFAS No. 133`.
FAS No. 161 amends and expands the disclosure requirements of SFAS No. 133
for derivative instruments and hedging activities. FAS No. 161 requires
qualitative disclosure about objectives and strategies for using derivative
and hedging instruments, quantitative disclosures about fair value amounts
of the instruments and gains and losses on such instruments, as well as
disclosures about credit-risk features in derivative agreements. FAS No. 161
is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application
encouraged. The adoption of this standard will not have a material effect
on the Corporation`s results of operations or financial position.
NOTE 2 ~ SECURITIES
The fair value of available for sale securities and the related gross
unrealized gains and losses recognized in accumulated other comprehensive
income (loss) were as follows:
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
2008
State and municipal $ 16,214 $ 234 $(193)
Corporate bond and notes 7,182 5 (453)
Mortgage backed 103,836 2,616 --
Equity securities 16 -- (7)
Total debt securities $127,248 $2,855 $(653)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 2 ~ SECURITIES (Continued)
Gross Gross
Fair Unrealized Unrealized
Value Gains Losses
2007
U.S. Treasury and federal agency $10,268 $161 $ --
State and municipal 16,068 295 (13)
Corporate bond and notes 17,595 26 (295)
Mortgage-backed 40,583 294 (21)
Total debt securities $84,514 $776 $(329)
Sales of available for sale securities were as follows:
2008 2007 2006
Proceeds $25,471 $22,662 $278
Gross gains 330 132 38
Gross losses (230) (121) --
Gross gains from calls -- 3 6
Other than temporary impairment loss (444) -- --
The tax provision (benefit) related to these net realized gains and losses
was $(34), $5, and $15, respectively.
The fair value of debt securities at year-end 2008 by contractual maturity
were as follows. Securities not due at a single maturity date, primarily
mortgage backed securities, are shown separately.
Fair Value
Due in one year or less $ 4,181
Due from one to five years 7,763
Due from five to ten years 6,593
Due after ten years 4,859
Mortgage backed 103,836
Equity securities 16
Total $127,248
Securities pledged at year-end 2008 and 2007 had a carrying amount of
$30,679 and $24,668 and were pledged to secure public deposits
and repurchase agreements.
At year-end 2008 and 2007, there were no holdings of securities of
any one issuer, other than the U.S. Government and its agencies, in
an amount greater than 10% of shareholders` equity.
Securities with unrealized losses at year end 2008 and 2007, 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 Unrealized Fair Unrealized Fair Unrealized
2008 Value Loss Value Loss Value Loss
State and municipal $3,406 $(193) $ -- $ -- $3,406 $(193)
Corporate bonds and notes 5,166 (453) -- -- 5,166 (453)
Mortgage-backed -- -- -- -- -- --
Equity securities 23 (7) -- -- 23 (7)
Total temporarily impaired $8,595 $(653) $ -- $ -- $8,595 $(653)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 2 ~ SECURITIES (Continued)
Less Than 12 Months 12 Months or More Total
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
2007
U.S. Government
and federal agency $ -- $ -- $ -- $ -- $ -- $ --
State and municipal 486 (8) 1,969 (5) 2,455 (13)
Corporate bonds and notes 1,181 (17) 12,156 (278) 13,337 (295)
Mortgage-backed 6,246 (9) 1,269 (12) 7,515 (21)
Total temporarily impaired $7,913 $ (34) $15,394 $(295) $23,307 $(329)
Unrealized losses have not been recognized into income because the securities
are of high credit quality, management has the intent and ability to hold
for the foreseeable future, and the decline in fair value is largely due to
increases in market interest rates or normally expected market pricing
fluctuations. The fair value of debt securities is expected to recover as
the securities approach their maturity date and/or market rates decline.
National Bancshares Corporation purchased $467 of FHLMC preferred stock in
the first quarter of 2008. During 2008, management determined this preferred
stock was other than temporarily impaired. Management recorded $84 and $360
of other than temporary impairment write-downs in the second and third
quarter of 2008 related to this investment security. The loss has been
recorded in Securities gains (losses), net in the Consolidated Statements
of Income and Comprehensive Income. The market value of these securities
at December 31, 2008 was $16 compared to an adjusted cost basis of $23.
The Bank holds a senior corporate bond issued by American International
Group, Inc. (`AIG`) maturing May 2013, which was purchased in October, 2003.
At December 31, 2008, the bond had an amortized cost of $982 and a market
value of $701. Based on management`s evaluation of this AIG security bond,
it is believed the decline in market value is temporary due to current
market conditions and negative press primarily centering around capital
contributions in consideration of the financial support of AIG so far
from the U.S. Treasury Department. The Bank has the intent and ability
to hold this security until the fair value is recovered, which may be at
maturity. Management will continue to monitor this security for impairment.
NOTE 3 ~ LOANS
Loans at year-end were as follows:
2008 2007
Collateralized by real estate:
Commercial $ 48,034 $ 51,463
Residential 54,924 80,113
Home equity 24,442 20,857
Construction 12,846 8,367
140,246 160,800
Other:
Consumer 14,354 11,988
Commercial 25,583 17,552
Credit card -- 1,614
Other 1,658 1,987
181,841 193,941
Unearned and deferred income (292) (425)
Allowance for loan losses (1,718) (2,028)
Total $179,831 $191,488
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 3 ~ LOANS (Continued)
Activity in the allowance for loan losses was as follows:
2008 2007 2006
Beginning balance $2,028 $1,993 $1,903
Provision for loan losses 482 147 160
Loans charged-off (845) (151) (162)
Recoveries 53 39 92
Ending balance $1,718 $2,028 $1,993
Individually impaired loans were as follows:
2008 2007
Year end loans with no allocated allowance
for loan losses $ 396 $ --
Year end loans with allocated allowance
for loan losses 940 2,702
Amount of the allowance for loan losses
allocated 75 629
2008 2007 2006
Average of individually impaired
loans during year
$1,846 $2,500 $ 584
The impact on interest income of impaired loans was not significant to
the consolidated statements of income.
Nonaccrual loans and loans past due 90 days still on accrual were as follows:
2008 2007
Loans past due over 90 days still on accrual $ 261 $ 158
Nonaccrual loans 1,752 2,645
Nonaccrual loans and loans past due 90 days still on accrual include both
smaller balance loans that are collectively evaluated for impairment and
individually classified impaired loans.
The Bank sold its $1,486 credit card portfolio to Elan Financial Services
(Elan), a subsidiary of U.S. Bank National Association ND in July, 2008.
Under the agreement, Elan purchased the Bank`s existing credit card
portfolio, and subsequently will issue credit cards for the Bank utilizing
the First National Bank name and logo. First National Bank will continue
to earn certain fees from ongoing portfolio activity and new accounts.
The transaction generated a $435 gain recorded in the third quarter of 2008.
The Bank securitized $20,897 single-family residential mortgage loans
formerly held in its mortgage loan portfolio, with Freddie Mac in
December, 2008. The Bank has recorded the securities as available for sale
and continues to service the loans. The securitization increased the Bank`s
liquidity as the securities are readily marketable, eliminated credit risk
on the loans and increased the Bank`s risk-based capital ratio. Since the
Bank cannot de-securitize the securities to get back the loans, the
securitization is not considered a sale or transfer under SFAS No. 140,
Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, but an exchange of loans for securities
under SFAS No. 134, Accounting for Mortgage-Backed Securities Retained
after the Securitization of Mortgage Loans Held for Sale by a Mortgage
Banking Enterprise, and SFAS No. 115, Accounting for Certain Investments in
Debt and Equity Securities because the Bank received the beneficial interest
in the loans it transferred to Freddie Mac. As a result of the
securitization, single-family residential mortgage loan balances net of
unamortized loan origination fees declined $20,810, the loan servicing asset
increased $132 and securities available for sale increased $21,532. The
unrealized gain on the securities at December 31, 2008 was $840 which
increased the Bank`s capital by $554.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
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:
2008 2007
Mortgage loan portfolios serviced for:
FHLMC $38,011 $17,597
There were no custodial escrow balances maintained in connection with
serviced loans at year end 2008 and 2007.
Activity for mortgage servicing rights and the related valuation allowance follows:
2008 2007 2006
Servicing rights:
Beginning balance $ 67 $ 86 $ 84
Additions 139 19 40
Amortized to expense (33) (38) (38)
Ending balance $173 $ 67 $ 86
NOTE 5 ~ PREMISES AND EQUIPMENT
Year end premises and equipment were as follows:
2008 2007
Land $ 1,528 $ 1,378
Buildings 6,380 6,096
Furniture, fixtures and equipment 4,764 4,536
Construction in progress 275 --
12,947 12,010
Less: Accumulated depreciation (6,750) (6,804)
$ 6,197 $ 5,206
Depreciation expense was $442, $457 and $446 in 2008, 2007 and 2006.
Rent expense under operating leases included in occupancy was $39, $38
and $47 for the years ended December 31, 2008, 2007 and 2006. Future lease
payments are not material.
NOTE 6 ~ INTANGIBLE ASSETS
During 2002, the Corporation acquired Peoples Financial Corporation and
merged the Company`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:
2008 2007
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
Amortized intangible assets:
Core deposit intangibles $1,063 $ 772 $1,063 $ 673
Branch acquisition intangible 760 733 760 704
Customer relationship intangibles 728 624 728 520
Total $2,551 $2,129 $2,551 $1,897
Aggregate amortization expense was $232, $237 and $246 for 2008,
2007 and 2006.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 6 ~ INTANGIBLE ASSETS (Continued)
Estimated amortization expense for the next four years:
2009 $224
2010 90
2011 86
2012 22
NOTE 7 ~ DEPOSITS
2008 2007
Demand, noninterest-bearing $ 46,159 $ 44,492
Demand, interest-bearing 92,515 64,594
Savings 49,642 53,545
Time, $100,000 and over 12,937 12,725
Time, other 62,389 67,167
$263,642 $242,523
A summary of time deposits at year-end 2008 by maturity follows:
2009 $51,744
2010 17,941
2011 3,872
2012 1,181
2013 and thereafter 588
$75,326
NOTE 8 ~ FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows:
2008 2007
Maturity in 2010, fixed rate at 6.26%, $ 1,000 $ 1,000
onvertible to variable rate if 3-month LIBOR is
at or above predetermined conversion rate level
Maturities in 2010 and 2011, fixed rate at 4.93% 13,000 13,000
to 5.79% at December 31, 2008 and 2007,
convertible to variable if 1-month LIBOR is at
or above fixed rate
Maturities in 2009, fixed rate at 3.95% to 4.10% 3,000 3,000
Maturities in 2010, fixed rate at 3.19% 1,000 --
Maturities in 2011, fixed rate at 2.88% 3,000 --
Total $21,000 $17,000
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 8 ~ FEDERAL HOME LOAN BANK ADVANCES (Continued)
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 $49,769 and $76,395 of first mortgage loans
available under a blanket lien arrangement at year-end 2008 and 2007.
Required payments over the next three years are:
2009 3.95 to 4.10% $ 3,000
2010 3.19 to 6.26% 12,000
2011 2.88 to 5.12% 6,000
NOTE 9 - REPURCHASE AGREEMENTS
Repurchase agreements generally mature within 30 days from the transaction
date. Information concerning repurchase agreements is summarized as
follows:
2008 2007 2006
Average balance during the year $10,134 $ 8,642 $ 6,008
Average interest rate during the year 1.42% 3.86% 3.48%
Maximum month-end balance during the year $11,136 $10,956 $ 7,902
Weighted-average rate at year end 0.50% 2.85% 3.63%
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, with the Corporation matching 50%
of contributions up to 6% of the employee`s pay. Discretionary contributions
may also be made to the plan. Total matching and discretionary contributions
made by the Corporation during 2008, 2007 and 2006 amounted to $81, $83
and $142.
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 2008, 2007 and 2006
amounted to $1, $2, and $3.
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 $12, $29 and $45 in 2008, 2007 and 2006. The deferred directors` fee
liability was $374 at December 31, 2008 and $414 at December 31, 2007.
Expense recognized in 2008, 2007 and 2006 for the director retirement and
death benefit plan was $117, $59 and $167. The liability related to the
plan was $680 at December 31, 2008 and $599 at December 31, 2007.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 11 ~ INCOME TAXES
The components of deferred taxes were as follows:
2008 2007
Deferred tax assets:
Bad debts $ 424 $ 529
Deferred compensation 382 363
Deferred loan fees 192 190
FHLMC preferred stock impairment loss 151 --
Non-accrual loan interest income 45 78
Stock-based compensation 10 --
Core deposit intangibles 7 14
Other 5 --
Real estate owned write-down -- 11
Total $1,216 $1,185
2008 2007
Deferred tax liabilities:
Unrealized security gains, net $ 749 $ 152
Federal Home Loan Bank stock dividends 542 509
Depreciation 321 203
Purchase accounting adjustments 206 283
Mortgage servicing rights 59 23
Prepaid expenses 44 26
Securities accretion 31 87
Partnership income 1 2
Total 1,953 1,285
Net deferred tax asset (liability) $ (737) $ (100)
Federal income tax laws provided that the 2002 acquired entity could claim
additional bad debt deductions through 1987, totaling $1,864. Accounting
standards do not require a deferred tax liability to be recorded on this
amount, which liability otherwise would total $634 at December 31, 2008.
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:
2008 2007 2006
Currently payable $ 730 $ 515 $ 447
Deferred 40 (19) (310)
Total $ 770 $ 496 $ 137
The following is a reconciliation of income tax at the federal statutory
rate to the effective rate of tax on the financial statements:
2008 2007 2006
Rate Amount Rate Amount Rate Amount
Tax at federal statutory rate 34% $1,008 34% $ 750 34% $ 442
Tax-exempt income (7) (214) (10) (228) (20) (261)
Other (1) (24) (2) (26) (3) (44)
Income tax expense 26% $ 770 22% $ 496 11% $ 137
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 12 ~ RELATED-PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates during 2008
were as follows:
Beginning balance $3,324
Effect of changes in composition of related parties --
New loans 1,233
Repayments 781
Ending balance $3,776
Unused commitments to these related parties totaled $969 and $1,088 at
year-end 2008 and 2007. Related party deposits totaled $2,050 and $2,758
at year-end 2008 and 2007.
The Corporation has minority ownership in a title agency affiliated with a
Director resulting in fee income to the Corporation of $11, $16 and $20
for 2008, 2007 and 2006, respectively.
NOTE 13 ~ STOCK-BASED COMPENSATION
The Company`s 2008 Equity Incentive Plan (`the Plan`), which is
shareholder-approved, permits the grant of stock options to its
officers, employees, consultants and non-employee directors for up to
223,448 shares of common stock. Option awards are granted with an
exercise price equal to the market price of the Company`s common stock
at the date of grant; those option awards have vesting periods determined
by the Company`s compensation committee and have terms that shall not
exceed 10 years.
On May 20, 2008, the Company granted options to purchase 58,000 shares of
stock to directors and certain key officers, all of which remain outstanding
at December 31, 2008. 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. As of December 31, 2008 none of the options had been
forfeited. All options are expected to vest.
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 volatilities of the Company`s common stock. The Company uses
historical data to estimate option exercise and post-vesting termination
behavior. The expected term of options granted is based on historical data
and 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 of $1.83 per option was determined using
the following weighted-average assumptions as of grant date.
Risk-free interest rate 3.19%
Expected term (years) 6.5
Expected stock price volatility 13.76%
Dividend yield 3.60%
The total compensation cost that has been charged against income for
the plan was $28 for 2008. The total income tax benefit was $10 for 2008.
As of December 31, 2008, there was $78 of total unrecognized compensation
cost related to nonvested stock options granted under the Plan. The cost is
expected to be recognized over a weighted-average period of 4.4 years. At
December 31, 2008, no options are vested and the outstanding options have
no intrinsic value. The weighted average remaining contractual term is
9.4 years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(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, 2008,
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 2008
and 2007, 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 are presented below at year-end.
To Be Well
Required Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Regulations
Amount Ratio Amount Ratio Amount Ratio
2008
Total capital to risk
weighted assets $26,730 12.60% $16,971 8.00% $21,213 10.00%
Tier 1 capital to risk
weighted assets 25,012 11.79% 8,485 4.00% 12,728 6.00%
Tier 1 capital to
average assets 25,012 7.78% 12,853 4.00% 16,066 5.00%
2007
Total capital to risk
weighted assets $26,810 12.78% $16,785 8.00% $20,981 10.00%
Tier 1 capital to risk
weighted assets 24,782 11.81% 8,392 4.00% 12,588 6.00%
Tier 1 capital to
average assets 24,782 8.26% 12,001 4.00% 15,001 5.00%
Dividend Restrictions ~ The Company`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. During 2009, the Bank must obtain
regulatory approval to pay dividends to the holding company until 2009 net
income exceeds $1,210.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
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.
The contractual amounts of financial instruments with off balance sheet risk
at year-end were as follows:
2008 2007
Commitments to make loans $ 2,382 $ 6,723
Unused lines of credit 49,389 56,077
Letters of credit 109 157
Of the above unused instruments at December 31, 2008, approximately $10,065
pertains to fixed-rate commitments and variable-rate commitments account
for approximately $41,815. At year-end 2007, approximately $9,257 of
total commitments were fixed-rate and approximately $53,700 were variable
rate. Rates on fixed-rate unused lines of credit ranged from 6.25% to
19.80% at December 31, 2008 and 5.75% to 16.90% at December 31, 2007.
NOTE 16 - FAIR VALUE
Statement 157 establishes a fair value hierarchy which requires an entity
to maximize the use of observable inputs and minimize the use of unobservable
inputs when measuring fair value. The standard describes three levels of
inputs that may be used to measure fair value:
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 fair values of securities available for sale are determined by obtaining
quoted prices on nationally recognized securities exchanges (Level 1 inputs)
or matrix pricing, which is a mathematical technique widely used in the
industry to value debt securities without relying exclusively on quoted
prices for the specific securities but rather by relying on the relationship
to other benchmark quoted securities (Level 2 inputs).
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 typically significant and result in a Level 3
classification of the inputs for determining fair value.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(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, 2008 Using
Quoted Prices in Significant
Active Markets Other Significant
for Identical Observable Unobservable
Assets Inputs Inputs
(Level 1) (Level 2) (Level 3)
Assets:
Available for sale securities $16 $127,232 $--
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, 2008 Using
Quoted Prices in Significant
Active Markets Other Significant
for Identical Observable Unobservable
Assets Inputs Inputs
(Level 1) (Level 2) (Level 3)
Assets:
Impaired loans $-- $-- $865
Impaired loans, which are measured for impairment using the fair value of the
collateral for collateral dependent loans, had a principal amount of $940,
with a valuation allowance of $75, resulting in an additional provision for
loan loss of $75.
Carrying amount and estimated fair values of financial instruments at
year-end were as follows:
2008 2007
Carrying Fair Carrying Fair
Amount Value Amount Value
Financial assets
Cash and cash equivalents $ 11,001 $ 11,001 $ 12,285 $ 12,285
Securities available for sale 127,248 127,248 84,514 84,514
Loans, net 179,831 179,586 191,488 193,823
Accrued interest receivable 1,230 1,230 1,502 1,502
Financial liabilities
Deposits (263,642) (264,731) (242,523) (242,759)
Short-term borrowings (13,285) (13,285) (9,374) (9,374)
Federal Home Loan Bank advances (21,000) (21,239) (17,000) (17,060)
Accrued interest payable (690) (690) (975) (975)
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,
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. It was not praticable to determine the fair
value of restricted equity stock due to restrictions placed on its
transferability. Fair value of debt is based on current rates for similar
financing. The fair value of off balance sheet items is not considered
material.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 17 ~ OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related tax effects
were as follows:
2008 2007 2006
Unrealized holding gains (loss) on
available for sale securities $ 571 $ 717 $ 73
Reclassification adjustment for losses (gains)
later recognized in income 344 (14) (44)
Net unrealized gains (loss) 915 703 29
Initial unrealized gain on mortgage-backed
securities
received in securitization 840 -- --
Unrealized gains on securities
transferred from held to maturity
to available for sale -- -- 263
Tax effect (benefit) (597) (239) (99)
Other comprehensive income (loss) $1,158 $ 464 $ 193
NOTE 18 ~ PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial statements for National Bancshares Corporation
(parent only) are as follows:
BALANCE SHEETS December 31
2008 2007
ASSETS
Cash and cash equivalents $ 5,327 $ 4,846
Investment in Bank subsidiary 31,675 30,460
Securities available for sale 16 --
Other assets 215 43
Total assets $37,233 $35,349
LIABILITIES AND SHAREHOLDERS` EQUITY
Dividends payable $ 352 $ 358
Shareholders` equity 36,881 34,991
Total liabilities and shareholders` equity $37,233 $35,349
STATEMENTS OF INCOME Years ended December 31
2008 2007 2006
INCOME
Dividends from Bank subsidiary $2,500 $3,000 $3,000
Securities gains (losses), net (444) 1 29
Dividend income 16 -- --
Total Income 2,072 3,001 3,029
EXPENSES
Miscellaneous expense (72) (85) (47)
Income before income tax and undistributed
subsidiary income 2,000 2,916 2,982
Income tax benefit 170 29 9
Undistributed equity in (distributions in excess
of) net income of Bank subsidiary 24 (1,234) (1,827)
Net income $2,194 $1,711 $1,164
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2008, 2007 and 2006
(Dollar amounts in thousands, except per share data)
NOTE 18 PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (Continued)
STATEMENTS OF CASH FLOWS Years ended December 31
2008 2007 2006
Cash flows from operating activities
Net income $2,194 $1,711 $1,164
Adjustments to reconcile net income
to net cash from operating activities:
Distributions in excess of (equity
in undistributed net income)
of Bank subsidiary (24) 1,234 1,827
Net security (gains) loss 444 (1) (29)
Change in other assets and liabilities (170) (14) 76
Net cash from operating activities 2,444 2,930 3,038
Cash flows from investing activities
Proceeds from sale of securities -- 1 53
Purchase of security available for sale (467) -- --
Net cash from investing activities (467) 1 53
Cash flows from financing activities
Dividends paid (1,410) (1,430) (1,430)
Purchase of common stock (86) (434) --
Net cash from financing activities (1,496) (1,864) (1,430)
Net change in cash 481 1,067 1,661
Beginning cash and cash equivalents 4,846 3,779 2,118
Ending cash and cash equivalents $5,327 $4,846 $3,779
NOTE 19 ~ QUARTERLY FINANCIAL DATA (UNAUDITED)
Basic and
Interest Net interest Net diluted earnings
income income income per share
2008
First quarter $4,270 $2,744 $491 $0.22
Second quarter 4,196 2,763 514 0.23
Third quarter 4,294 2,843 574 0.26
Fourth quarter 4,311 2,936 615 0.28
2007
First quarter $4,352 $2,642 $287 $0.13
Second quarter 4,542 2,758 314 0.14
Third quarter 4,497 2,741 507 0.23
Fourth quarter 4,441 2,723 603 0.27
REPORT OF MANAGEMENT ON THE COMPANY`S INTERNAL CONTROL OVER
FINANCIAL REPORTING
March 27, 2009
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 Company`s internal
control over financial reporting as of December 31, 2008, 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 Company`s internal control
over financial reporting was effective as of December 31, 2008, based on
the specified criteria.
This annual report does not include an attestation report of the Company`s
registered public accounting firm regarding internal control over financial
reporting. Management`s report was not subject to attestation by the
Company`s registered public accounting firm pursuant to temporary rules of
the Securities and Exchange Commission that permit the Company to provide
only management`s report in this annual report.
</David C. Vernon>
David C. Vernon
Chief Executive Officer
</James R. VanSickle>
James R. VanSickle
Chief Financial Officer
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, 2008 and 2007, 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, 2008.
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, 2008 and 2007, and the results of
its operations and its cash flows for each of the three years in the period
ended December 31, 2008 in conformity with generally accepted accounting
principles in the United States of America.
</Crowe Horwath LLP>
Crowe Horwath LLP
Cleveland, Ohio
March 27, 2009
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN OF NATIONAL BANCSHARES
CORPORATION, S&P 500 STOCK INDEX, AND S&P 500 BANK INDEX
2003 2004 2005 2006 2007 2008
National Bancshares Corp $100.00 130.86 111.78 118.09 84.62 69.16
S&P 500 Stock Index~ $100.00 110.88 116.33 134.70 142.10 89.53
S&P 500 Banks Index~ $100.00 114.42 112.75 130.90 91.91 48.26
~ National Bancshares Corporation is not included in the S&P 500 Bank Index
or S&P 500 Stock Index.
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 2008 and 2007 follows. This information does not
reflect retail mark-up, markdown or commissions, and does not necessarily
represent actual transactions.
High Low Dividends per share
2008
First Quarter $18.10 $16.20 $.16
Second Quarter 18.50 14.50 .16
Third Quarter 16.69 14.30 .16
Fourth Quarter 16.00 11.60 .16
2007
First Quarter $25.57 $22.50 $.16
Second Quarter 22.80 18.40 .16
Third Quarter 18.50 15.07 .16
Fourth Quarter 17.50 15.11 .16
SHAREHOLDER INFORMATION
Corporate Office
National Bancshares Corporation
112 West Market Street, PO Box 57
Orrville, OH 44667
www.fnborrville.com
Stock Trading Information
The shares of common stock of National Bancshares Corporation are
traded on the OTC Bulletin Board. The ticker symbol for National
Bancshares Corporation is `NBOH.` The Corporation had 887 shareholders
of Record as of December 31, 2008.
Form 10-K
A copy of the Corporation`s 2008 Annual Report on Form 10-K as filed
with the SEC will be furnished free of charge to shareholders upon
written request to the Company.
Shareholder Assistance
National Bancshares Corporation
Shareholder Services Department
Ellen Gerber, Shareholder Relations
330-765-0609
egerber@fnborrville.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.
OFFICERS
NATIONAL BANCSHARES CORPORATION
David C. Vernon
President & Chief Executive Officer
James R. VanSickle
Senior Vice President & Chief Financial Officer
Paul G. Kubiak
Senior Vice President & Secretary
FIRST NATIONAL BANK
David C. Vernon
President & Chief Executive Officer
Business Banking
Thomas R. Poe
Senior Vice President, Senior Loan Officer
Thomas M. Fast
Senior Vice President, Business Banking
John D. Shultz, Jr.
Vice President, Business Banking
Darrell L. Smucker
Vice President, Business Banking
Laura R. Yoder
Assistant Vice President, Business Banking
Harold D. Berkey
Vice President, Relationship Manager
Earl G. Mullet
Vice President, Relationship Manager
Dean M. Karhan
Assistant Vice President, Relationship Manager
Steven J. Bodo
Vice President, Mortgage Banking
Matthew M. Miller
Assistant Vice President, Mortgage Banking
Credit Administration
Steven L. Riddick
Vice President, Senior Credit Officer
Kathryn J. Barnes
Assistant Vice President, Credit Analyst
Lisa M. Bryant
Loan Operations Officer
Mindy L. Henderson
Loan Officer
Patricia J. Massaro
Loan Officer
Retail Banking
Paul G. Kubiak
Senior Vice President, Retail Banking
Cindy A. Wagner
Assistant Vice President, Retail Banking
Amberly M. Wolf
Assistant Vice President, Retail Banking
Paul J. Bayus
Assistant Vice President, Relationship Manager
Karen K. Haueter
Assistant Vice President, Relationship Manager
Heather L. Kiner
Assistant Vice President, Relationship Manager
Darrell G. Ovak
Assistant Vice President, Relationship Manager
Jill R. Wachtel
Assistant Vice President, Relationship Manager
Corporate
James R. VanSickle
Senior Vice President, Chief Financial Officer
James T. Griffith
Vice President, Cashier, Information Technology
Pamela S. Null
Vice President, Compliance & Security
Michael G. Oberhaus
Vice President, Financial Analyst
Maria A. Roush
Vice President, Auditor & Risk Management
Angela L. Smith
Controller
Jodi R. Blair
Deposit Operations Officer
BOARD OF DIRECTORS FIRST NATIONAL BANK OFFICES
NATIONAL BANCSHARES CORPORATION &
FIRST NATIONAL BANK
Sara Steinbrenner Balzarini Orrville
Partner, 112 W. Market St.
Paramount Tennis, LLC. 330-682-1010
John P. Cook, CPA, Ph.D 1320 W. High St.
Shareholder, 330-682-2881
Long, Cook & Samsa, Inc.
1720 N. Main St.
Bobbi E. Douglas CASH ATM ONLY
Executive Director,
STEPS at Liberty Center Apple Creek
Every Woman`s House U.S. 30 at Co. Rd. 44
330-264-8070
John W. Kropf
Chairman of the Board, Dalton
National Bancshares Corporation 12 W. Main St.
First National Bank 330-828-2227
Attorney,
Kropf, Wagner, Lutz Kidron
& VanSickle, L.L.P. 4950 Kidron Rd.
330-857-3101
John L. Muhlbach, Jr.
Vice President, Lodi
A.A. Hammersmith, Inc. 106 Ainsworth St.
330-948-1414
Victor B. Schantz
President, Massillon
Schantz Organ Company 211 Lincoln Way E.
330-832-7441
Steve Schmid
President, 2312 Lincoln Way N.W.
Smith Dairy Products, Inc. 330-833-1622
Schmid Incorporated
51 Massillon Marketplace Dr. S.W.
David C. Vernon CASH ONLY ATM
President & CEO,
National Bancshares Corporation Mt. Eaton
First National Bank 15974 E. Main St.
330-857-4301
Howard J. Wenger 330-359-3105
President,
Wenger Excavating, Inc. Seville
Lake Region Oil, Inc. 4885 Atlantic Dr.
Northstar Asphalt, Inc. 330-769-3105
Massillon Materials, Inc.
Stark Materials, Inc. Smithville
153 E. Main St.
Albert W. Yeagley 330-669-2611
Vice President, Industry & Government Affairs
The J. M. Smucker Company Wooster
4192 Burbank Rd.
330-263-5303
1725 Cleveland Rd.
330-263-1725