TABLE OF CONTENTS
3 Message to Shareholders
6 Financial Highlights
7 Selected Financial Data
9 Management`s Discussion and Analysis of Financial Condition and
Results of Operations
28 Consolidated Balance Sheets
29 Consolidated Statements of Income
30 Consolidated Statements of Changes in Shareholders` Equity
31 Consolidated Statements of Cash Flows
32 Notes to Consolidated Financial Statements December 31, 2010, 2009
and 2008
57 Report of Independent Registered Public Accounting Firm
58 Report of Management on the Coorporation`s Internal Control Over
Financial Reporting
59 Comparison of Five-Year Cumulative Total Return of National
Bancshares Corporation, S&P 500 Stock Index, and S&P 500 Bank Index
60 Price Range of Common Stock
60 Shareholder Information
61 Officers
62 Directors
62 First National Bank Offices
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MESSAGE TO SHAREHOLDERS
Dear Shareholders;
2010 earnings of $1.325 million or $.60 per share were disappointing and
primarily caused by the need to add $2.2 million to the allowance for loan
losses. I warned in 2009, that because of continued poor economic
conditions, a higher provision for loan loss expense might be required in
2010. It was also pointed out that when our clients suffer financially, we
suffer. People without jobs cannot make loan payments. Retail merchants
who suffer a decline in business cannot make rent or mortgage payments.
Businesses which suffer a decline in sales cannot make loan payments. In
2010, the economy impacted all of our clients to some degree, but two
commercial loan borrowers went out of business resulting in losses above
our already pessimistic forecast. In addition, commercial real estate
values continued to drop and the decline in the value of collateral
securing loans required us to add even more to the allowance. By way
of example, a building in Massillon appraised for $2.8 million in 2005
when a loan was originated. The building is now valued at $1.1 million
and the business occupying the building when the loan was originated is
gone.
Even though we incurred the large provision expense in 2010, there is a
lot of good news in this Annual Report. Please take time to review the
financial statements and footnotes contained in this report for more
details about our financial results. Here are a few highlights.
In 2010, net interest income increased $54,000 and non interest income
increased $327,000 excluding securities gains of $661,000 in 2010 and
$770,000 in 2009. Loans declined slightly but the volume of new loans
in 2010 totaled $24,000,000 and loan fee income from commercial loans
was $247,000. A primary reason for the decline in loans is that a number
of large commercial loans paid off and borrowers with lines of credit
scaled back their usage of the lines. In this market, small businesses
are not taking on the risk of more debt and low interest rates alone
will not cause a small business to expand or take on additional risk.
Nor will low interest rates alone increase the value of houses.
Businesses need customers and people need jobs. Then and only then
will people buy homes and businesses borrow money to expand. Actually,
low interest rates are nothing more than a tax on savers and seniors.
Retirees need interest income and would spend it and savers who are
trying to accumulate funds for retirement, a rainy day or special
purpose should not be required to suffer nearly zero interest rates
while they watch the value of the dollar decline and purchasing power
erode even further.
Our Fairlawn office is now a full service office with a retail business
lobby and drive-in window.
Income from the sale of mortgage loans totaled $285,000 in 2010, down
slightly from 2009 because we started keeping 15 year residential loans
in the portfolio in October. A noteworthy change in our balance sheet is
the $13 million reduction in borrowing from the Federal Home Loan Bank.
This borrowing was originated by Peoples Savings prior
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to our acquisition of Peoples and there was no need to replace the
borrowing given the strength of our liquidity position.
In 2010, we continued to increase the sale of business cash management
services and remote deposit services which makes it possible for local
businesses to deposit checks electronically from their offices and
eliminate a trip to the bank. As a result in 2010, local businesses
made remote electronic deposits totaling $291,000,000. Hundreds of
our business customers are now using the many new services we have
introduced in the last two years.
In 2010, we redesigned Bonus Checking and renamed it Reward Checking.
We also introduced Reward Savings, a high-yield savings account available
to Reward Checking clients. Reward Checking is a service for customers who
use our debit card, make deposits electronically and receive their
statement electronically. The Reward Checking interest rate is 3.01% and
that rate is paid on the entire balance up to $25,000. In 2010 Reward
Checking grew $6,458,000 or 302%.
Several years ago, I was privileged to be in a group of approximately 60
individuals who spent a couple of hours with the legendary Warren Buffett
at Case Western Reserve University. Mr. Buffett handed out a sheet of paper
on which was listed the performance statistics of 10 companies. He asked
the group to explain why performance among the companies was so varied. Of
course one brave soul immediately responded `management.` Mr. Buffett
explained that management was not the answer since he owned all 10
companies. No, the answer was the business the company was in. One was
a textile company and Mr. Buffett wondered why he ever thought he could
make money in the textile business. Another was a candy company and he
observed that no matter who managed it, the candy company would make money
but the best managers in the world could not make money in textiles.
This is a tough environment. We are confronted with a bad economy, high
unemployment and a flood of new regulations. As a result, one wonders
if banking has not become one of those businesses where it is just
impossible to achieve an appropriate return on investment. We are
convinced however that banking, while under assault, is not one of
those textile type businesses and management does make a difference
and we are optimistic but at the same time realistic about our future.
Our Bank is strong. In 2010 deposits increased $17.8 million and our
capital base is well above regulatory requirements. We are blessed
with an outstanding and dedicated Board of Directors, the best staff
and management team any community bank could possibly assemble and
most importantly, we have the support of you, our shareholders.
Thank you for your interest in National Bancshares Corporation and
First National Bank. All of the directors, officers and staff
appreciate your support.
David C. Vernon
President and CEO
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In 2010, the Charitable Giving Committee of the Board of Directors
approved gifts to the following organizations.
Boy Scouts of America
Dalton Historical Society
Every Woman`s House
First National Bank Scholarship (Wayne County Community Foundation)
Goodwill Industries
Kidron Community Historical Society
Main Street Orrville
Main Street Wooster, Inc.
Massillon Boys and Girls Club
Massillon Chamber of Commerce
Orr Views
Orrville Area Boys and Girls Club
Orrville Chamber of Commerce
Orrville Community Chorus
Orrville-Dalton YMCA
Orrville Public Library
Orrville School Multi-Purpose Facility
Orrville United Way, Inc.
Paint Township Area Fireworks
Smithville Community Historical Society
STEPS (FKA Wayne County Alcoholism Services)
Tschantz Cabin
United Way of Wayne and Holmes Counties
United Way of Western Stark County
Village Network (FKA Boy`s Village)
Wayne College Capital Campaign
Wayne County Crippled Children`s Committee
Wayne County Fraternal Order of Police
Wayne Development Council
Wayne/Holmes Soap Box Derby
Wooster Chamber of Commerce
Wooster Jazz Arts Festival
Special thanks to the following local companies who have helped us with the
rebranding and remodeling of our offices.
Kidron Electric
RBS Construction
Northstar Asphalt
Orrville Plumbing and Heating
Benchmark Craftsmen
Adams Signs
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FINANCIAL HIGHLIGHTS
These financial highlights are excerpts of and are not a substitute for
National Bancshares Corporation`s consolidated financial statements,
including notes, and other detailed financial information we provide
elsewhere in this document. You should read the entire document,
including the consolidated financial statements and notes to the
consolidated financial statements.
Financial Position
(Dollar amounts in thousands, except per share data)
Percentage
At December 31, 2010 2009 Change
Total assets $374,096 $370,228 1.0 %
Deposits 309,134 291,373 6.1 %
Loans, net 190,685 194,071 (1.7)%
Securities 138,033 130,241 6.0 %
Shareholders` equity 38,981 38,903 0.2 %
Book value per share 17.67 17.64 0.2 %
Year ended December 31,
Net interest income $ 12,282 $ 12,228 0.4 %
Income before income taxes 1,396 2,007 (30.4)%
Net income 1,325 1,609 (17.6)%
Cash dividends declared 706 705 0.1 %
Net income per share 0.60 0.73 (17.8)%
Cash dividends per share 0.32 0.32 0.0 %
National Bancshares Corporation is the holding company for First
National Bank, a federally chartered national bank formed in Ohio
in 1881. First National Bank has fourteen offices in Orrville,
Massillon, Wooster, Apple Creek, Dalton, Fairlawn, Kidron, Lodi,
Mt. Eaton, Seville and Smithville. Additional information is available
at www.discoverfirstnational.com.
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SELECTED FINANCIAL DATA
(Dollar amounts in thousands, except per share data)
As of or for the years ended December 31,
2010 2009 2008 2007 2006
Income statement data:
Interest income $15,501 $16,465 $17,071 $17,832 $17,157
Interest expense 3,219 4,237 5,785 6,968 5,995
Net interest income 12,282 12,228 11,286 10,864 11,162
Provision for loan losses 2,229 1,829 482 147 160
Net interest income after
provision for loan losses 10,053 10,399 10,804 10,717 11,002
Noninterest income 3,190 2,972 2,333 1,990 1,653
Noninterest expense 11,847 11,364 10,173 10,500 11,354
Income before income taxes 1,396 2,007 2,964 2,207 1,301
Income taxes 71 398 770 496 137
Net income 1,325 1,609 2,194 1,711 1,164
Balance sheet data:
Cash and due from banks $12,837 $ 8,124 $11,001 $11,842 $ 8,955
Federal funds sold - - - 443 9,820
Securities 138,033 130,241 127,248 84,514 86,000
Loans, net 190,685 194,071 179,831 191,488 184,481
Deposits 309,134 291,373 263,642 242,523 247,681
Borrowings 23,471 36,720 34,285 26,374 22,744
Shareholders` equity 38,981 38,903 36,881 34,991 34,680
Total assets 374,096 370,228 338,002 306,651 308,358
Share and per share data:
Net income $ 0.60 $ 0.73 $ 1.00 $ 0.77 $ 0.52
Cash dividends 0.32 0.32 0.64 0.64 0.64
Book value at period end 17.67 17.64 16.75 15.85 15.52
Weighted average number
of shares outstanding 2,205,973 2,202,457 2,203,218 2,231,369 2,234,488
Performance ratios:
Return on average equity 3.34% 4.21% 6.20% 4.94% 3.29%
Return on average assets 0.35% 0.46% 0.70% 0.56% 0.38%
Dividend payout percentage 53.28% 43.82% 64.00% 83.58% 122.87%
Efficiency ratio (1) 76.56% 74.76% 74.70% 81.69% 88.60%
Full-time equivalent staff 113 101 108 105 132
Average total assets to
full-time equivalent staff $3,370 $3,491 $2,916 $2,903 $2,296
Asset quality ratios:
Allowance for loan losses
to ending total loans 1.34% 1.48% 0.95% 1.05% 1.07%
Net loan charge-offs
to average loans 1.30% 0.35% 0.41% 0.06% 0.03%
Capital ratios:
Average equity to average
assets 10.40% 10.84% 11.24% 11.35% 11.66%
Leverage ratio (2) 7.46% 7.40% 7.78% 8.26% 8.57%
Total risk-based capital
ratio (2) 13.59% 12.64% 12.60% 12.78% 13.26%
(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.
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SELECTED FINANCIAL DATA
The following table shows quarterly results of operations for 2010 and 2009.
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)
2010
First quarter $3,958 $3,112 $ 507 $ 301 $ 293 $0.13
Second quarter 3,920 3,101 615 96 158 0.07
Third quarter 3,919 3,120 228 1,154 866 0.39
Fourth quarter 3,704 2,949 879 (155) 8 0.01
2009
First quarter $4,208 $2,993 $ 123 $ 780 $ 573 $0.26
Second quarter 4,149 3,013 228 596 454 0.21
Third quarter 4,026 3,072 576 285 267 0.12
Fourth quarter 4,082 3,150 902 346 315 0.14
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, 2010, 2009 and 2008. 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 2011 and beyond could differ materially from those
expressed in or implied by the forward-looking statements.
Forward-looking statements are based upon a variety of estimates and
assumptions. The estimates and assumptions involve judgments about a number
of things, including future economic, competitive, and financial market
conditions and future business decisions. These matters are inherently
subject to significant business, economic, and competitive uncertainties,
all of which are difficult to predict and many of which are beyond National
Bancshares Corporation`s control. Although we believe the estimates and
assumptions are reasonable, actual results could vary materially from those
shown. Inclusion of forward-looking information does not constitute a
representation by National Bancshares Corporation or any other person that
the indicated results will be achieved. You are cautioned not to place
undue reliance on forward-looking information.
Management Strategy
The Corporation is a community-oriented financial institution offering a
variety of financial services to meet the needs of the communities it
serves. The Corporation attracts deposits from the general public and uses
such deposits, together with borrowings and other funds, primarily to
originate commercial and commercial real estate loans, single-family and
multi-family residential mortgage loans, home equity loans and lines of
credit and consumer loans.
During 2010, the Corporation operated under a strategic plan which is
updated, modified and adopted annually by the Board of Directors. The plan
calls for achieving an above peer return on equity, achieving a loan to
asset ratio of 60%, reducing the net overhead ratio to 2.30%, maintaining
cash-type deposits above 70%, achieving a net interest margin of at least
3.58%, maintaining a risk based capital ratio of at least 12% and holding
the classification ratio at 20% or less.
Historically, the Corporation`s low loans-to-assets ratio has been
detrimental to the net interest margin and return on equity. Accordingly,
the Board and Management have established a goal of changing the
Corporation`s asset mix by increasing the loan to asset ratio to 60%. On
December 31, 2010, the loan-to-asset ratio was 51.7% and this change will
take place over several years as growth in the loan portfolio is
accomplished by the increased capacity of the Corporation`s lending
divisions. Business bankers and mortgage originators have been added
and office managers have undergone increased consumer loan training. An
integral component of increasing the loan-to-asset ratio is credit
underwriting. In 2010, the Bank added a new senior credit officer and
two credit analysts to its underwriting staff. These additions have
increased the credit administration staff to five and the result is
improved credit underwriting and loan monitoring.
Reducing the net overhead ratio, excluding securities gains and losses
on the sale of other real estate owned from 2.41% to 2.30% will be
accomplished as the loan-to-asset ratio is achieved without adding to
expenses. Lending divisions and support personnel are in place to support
the $31.2 million increase in loan volume which will be required to reach
the 60% loan-to-asset ratio. Negatively impacting the net overhead ratio
is the high number of office locations relative to the small asset size of
the offices which is a primary reason Corporation`s higher than peer
overhead expense ratio. The personnel costs associated with expansion of
the loan divisions also negatively impacts the overhead ratio since the
increased number of bankers not yet managing the size of a fully developed
portfolio of loans has increased. In other words the cost of lending is
too high given the size of the loan portfolio. That will change as growth
in the loan portfolio is achieved.
The Corporation benefits from a cash-type deposit ratio of 78.1%. The goal
of maintaining cash type deposits above 70% will be challenging but can be
accomplished through the increased productivity of the Corporation`s retail
office system which generates core funding cash-type deposits. The
Corporation benefits from its strong core deposit base which is much higher
than peer and its strong core deposit base significantly enhances value and
makes it possible
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for assets to be supported by stable and relatively low cost funding. But
while the Corporation enjoys a low cost of funds this cost advantage comes
at the price of increased overhead expenses discussed above which is a
result of the relatively small size of many of its offices.
The Corporation`s net interest margin for 2010 was 3.43%. Achieving a net
interest margin of at least 3.58% will be accomplished through loan growth
which will result in the reduction of securities as a percentage of assets.
The banking business starts with loans. Loans are supported by deposits and
capital is needed to support the volume of loans and deposits. Without
loans there is no need for deposits and certainly there is no need for
capital. The Corporation has historically relied too heavily on income
from its securities portfolio and that was a reasonable plan when the term
structure of interest rates accommodated such a business plan.
Unfortunately that reliance is misplaced in a nearly zero interest rate
environment. In this low rate environment the only way to increase yield
with securities is by extending the duration of the securities portfolio
which is exactly the wrong action to take since longer duration securities
will decline in value significantly should interest rates rise. Securities
are of course needed for liquidity and income but the overreliance on
securities as a source of interest income is inappropriate.
A Strong capital ratio is critical to the subsidiary Bank`s safety and
soundness. A bank must have a risk-based capital ratio over 10% to be
considered well capitalized by its regulators. The Corporation`s Board
of Directors has established a goal of maintaining a risk-based capital
ratio of 12 to protect the financial stability of the organization. The
risk-based capital ratio was 13.59% as of December 31, 2010.
The classification ratio is calculated using total adversely classified
assets (excluding special mention loans) divided by Tier 1 capital plus
allowance for loan losses. The classification ratio was 32.0% and 39.5%
as of December 31, 2010 and 2009. Prior to 2009, the classification ratio
was consistently less than 20%. As the economy improves and the current
number of classified loans is reduced through monitoring and working with
borrowers, the classification ratio will improve.
In 2010, loans, net of allowance for loan losses decreased $3.4 million
from year-end 2009. The volume of new commercial loans remained strong at
$24 million and fee income generated from commercial loans totaled
$247,000. The primary reason for the decline in loans is that a number
of large commercial loans paid off in 2010 and borrowers with lines of
credit scaled back their usage of the lines. However, the Bank has been
taking advantage of the opportunity to lend to businesses in search of a
bank that will be responsive to their credit needs as other banks have
tightened lending requirements. The Bank opened a full-service office in
Fairlawn, Ohio in May, 2009. The office is staffed by four business
bankers, one corporate services specialist, a retail office manager
and two client service representatives. Total loans at the Fairlawn
office reached $30.1 million and deposits totaled $6.8 million as of
December 31, 2010.
In August 2010, the Bank formed a new Agribusiness and Community Banking
Group. The new group is made up of five community bankers and focuses
primarily on agriculture lending, small business lending and corporate
services. The Bank has not historically been focused on agricultural-type
lending and yet it is headquartered in a perfect market to do so.
Establishing the Agribusiness and Community Banking Group has been a goal
for several years, but the goal could only be accomplished if personnel
could be found to make formation of this group possible. Formation of this
group, while extremely important in the loan run, puts pressure on
accomplishing the overhead ratio goal outlined above since the group is
currently not managing a sufficiently large loan asset base.
The securities portfolio is a significant source of income. However income
from securities will decline unless interest rates rise significantly, as
cash flow from maturing securities and cash flow from mortgage backed
securities is reinvested at lower interest rates. Changing market
conditions could affect the profitability of the portfolio, as well as
the level of interest rate risk exposure. The Bank invests in securities
it believes offer good relative value at the time of purchase, and it will,
as needed reposition its securities portfolio. In making its decisions to
sell or purchase securities, the Bank considers credit ratings, call
features, maturity dates, relative yields, current market factors, interest
rate risk and other relevant factors. In 2010, the Bank increased the
amount of state and municipal bonds in the portfolio by $16.3 million.
Attractive taxable-equivalent yields make state and municipal bonds an
appealing alternative to U.S. Treasury, federal agency bonds and
mortgage-backed securities in the current interest rate environment.
The average yield of the securities portfolio was 3.55% as of
December 31, 2010. The portfolio duration was 2.0 years and based on
current interest rates and payment assumptions, cash flows of $29.7 million
are projected over the next twelve months. The yield on securities is
expected to decline in 2011 as cash flows are reinvested in the current
low interest rate environment. The Bank will continue to monitor market
conditions and invest in securities with good relative value.
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Platinum Checking, a high-interest checking account for clients with
balances above $10 thousand accounted for $55.4 million or 17.9% of total
deposits at December 31, 2010. Reward Checking, an account that pays bonus
interest to clients that use the Bank`s Visa debit card, receive their
account statement online, and make at least one electronic direct deposit
accounted for $8.6 million of deposits at December 31, 2010. In 2010 these
two accounts grew 23% and 302% respectively. In March 2010, the Corporation
introduced `Reward Savings`, a high-yield savings account that is available
to customers have a Reward Checking account. Reward Savings accounted for
$4.0 million as of December 31, 2010. In 2010 total deposits grew
$17.8 million or 6.1%.
Office of the Comptroller of the Currency (`OCC`) regulations require banks
to maintain certain minimum levels of regulatory capital. Additionally,
the regulations establish a framework for the classification of banks into
five categories: well-capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized. Generally,
an institution is considered well-capitalized if it has a core (Tier 1)
capital ratio of at least 5.0% (based on adjusted total assets); a core
(Tier 1) risk-based capital ratio of a least 6.0%; and a total risk-based
capital ratio of at least 10.0%. At December 31, 2010 the bank`s capital
ratios were well above regulatory minimums.
The Corporation is not aware of any market or institutional trends, events
or uncertainties that are expected to have a material effect on liquidity,
capital resources or operations. The Corporation is not aware of any
current recommendations by its regulators which would have a material
effect if implemented. The Corporation has not engaged in sub-prime
lending activities and does not plan to engage in those activities in
the future.
Financial Condition
Total assets increased 1.0% to $374.1 million as of December 31, 2010, from
$370.2 million at December 31, 2009. Securities available for sale totaled
$138.0 million as of December 31, 2010, compared to $130.2 million at
December 31, 2009. Loans, net of allowance for loan losses decreased
$3.4 million to $190.7 million as of December 31, 2010, compared to
$194.1 million at December 31, 2009. Deposits increased 6.1% to
$309.1 million as of December 31, 2010, compared to $291.4 million at
December 31, 2009. Shareholders` equity increased 0.2% to $39.0 million
at the end of 2010, from $38.9 million at the end of 2009. Accumulated
other comprehensive income decreased to $1.9 million as of
December 31, 2010, compared to $2.5 million as of December 31, 2009.
The change in accumulated other comprehensive income was a result of a
decrease in unrealized gains on securities available for sale.
Loans
Total loans decreased by $3.7 million or 1.9% from year-end 2010 to
year-end 2009. The Bank continues to focus its efforts on attracting
commercial loan business. Average loans, net of allowance for loan losses
increased from $183.0 million in 2009 to $192.8 million in 2010.
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%.
The Bank purchased $1.2 million of automobile loans from another Ohio
bank during 2010. All of the purchased loans were underwritten
individually using the same underwriting standards used for loans generated
in our offices.
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Loan portfolio composition at December 31,
2010 2009 2008 2007 2006
(Dollar amounts in thousands)
Real estate:
Commercial and land development $58,047 $54,787 $43,972 $45,820 $45,737
One-to-four family 47,204 50,390 54,924 80,113 83,491
Home equity 27,766 26,526 24,442 20,857 19,383
Multifamily 14,397 10,353 4,062 5,643 3,161
Real Estate Construction:
Commercial and land development 9,942 11,797 11,725 4,460 4,196
One-to-four family 301 598 1,121 3,907 1,883
Commercial 26,158 30,621 27,241 19,539 20,128
Consumer:
Auto:
Direct 2,474 3,171 3,171 4,392 5,524
Indirect 6,401 8,605 10,923 7,206 1,337
Credit Cards - - - 1,614 1,521
Other 989 567 260 390 661
Total loans 193,679 197,415 181,841 193,941 187,022
Less:
Unearned and deferred income (409) (438) (292) (425) (548)
Allowance for loan losses (2,585) (2,906) (1,718) (2,028) (1,993)
Net loans $190,685 $194,071 $179,831 $191,488 $184,481
Net loans as a percent of
total assets 50.97% 52.42% 53.20% 62.45% 59.83%
Ranked by North American Industry Classification System ~ or NAICS ~ codes,
the industries most represented by First National Bank`s commercial
borrowers include lessors of non-residential buildings and lessors of
residential buildings and dwellings, in that order, accounting for 12.0%
and 10.3% of the total loans at year-end 2010, respectively.
Approximately 37% of the conventional mortgage loans secured by one-to-four
family and multifamily 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 63% of the
portfolio of conventional mortgage loans secured by one-to-four family and
multifamily real estate at year-end 2010 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`s liquidity position,
the interest rate environment and general economic conditions.
Allowance for Loan Losses
As explained in Note 1 of the consolidated financial statements, the
allowance for loan losses is a valuation allowance for probable incurred
credit losses, increased by the provision for loan losses and recoveries,
and decreased by charge-offs. The allowance for loan losses is the sum of
components recognized and measured either: (1) according to Accounting
Standards Codification (ASC) 450-10-05, `Accounting for Contingencies,`
for pools of homogenous loans, or (2) according to ASC 310-10-35,
`Accounting by Creditors for Impairment of a Loan,` for loans the Bank
considers impaired based upon individual loan review. Management
determines the necessary allowance balance using the Bank`s loan loss
experience, the nature and volume of the portfolio, information about
specific borrower situations and estimated collateral values, economic
conditions, and other factors. Loan losses are charged against the
allowance when management believes the uncollectibility of a loan
balance is confirmed.
Loans Analyzed Individually
Determining the loan loss allowance begins with the Bank`s assessment
of credit risk for loans analyzed individually. Individual loans are
assigned credit-risk grades based on the Bank`s assessment of conditions
affecting a borrower`s ability to satisfy its contractual obligation under
the loan agreement. The assessment process includes reviewing a borrower`s
current financial information, historical payment experience, credit
documentation, public information, current economic trends and other
information specific to each borrower. Loans reviewed individually are
12
reviewed at least annually or more frequently if management becomes aware
of information affecting a borrower`s ability to fulfill its obligation.
All loans over $250 thousand or to borrower`s whose aggregate total
borrowing exceeds $250 thousand are reviewed individually, except for
first and second mortgage loans on a borrower`s personal residence.
Loans or borrowers with balances under $250 thousand may also be
reviewed individually if considered necessary by the board and management.
A borrower`s risk rating may be downgraded at any point during the year
if the creditworthiness of a borrower deteriorates. In addition, risk
ratings are reviewed annually by a qualified independent third party.
The independent third party reviews all aggregate loan relationships
of $300 thousand or greater along with a sampling of loan relationships
under $300 thousand. Loans analyzed individually are ranked as follows:
Loans Graded 1, 2, 3 and 4 are loans that are considered satisfactory,
with lower than average risk and low probability of serious financial
deterioration on the borrower`s part.
Loans Graded 5 (`Watch`) are performing according to the terms of the
loan agreement but that nevertheless require enhanced management
supervision because of factors such as an unusual payment history or
a deterioration in the borrower`s financial condition.
Loans Graded 6 (`Special Mention`) have more than average risk, with
identified potential weaknesses that deserve management`s close attention.
Left uncorrected, the potential weaknesses may result in deterioration
of the repayment prospects for the loan or of the institution`s credit
position at some future date. In the case of a commercial borrower, for
example, potential weaknesses could include adverse trends in the
borrower`s operations or adverse economic or market conditions that
could affect the borrower in the future.
Loans Graded 7 (`Substandard`) are inadequately protected by the current
financial condition and paying capacity of the borrower or by the
collateral securing the loan. Substandard loans have a well-defined
weakness or weaknesses jeopardizing collection of the debt in full, with
a distinct possibility of loss if the weakness or weaknesses are not
corrected. Loans may be classified substandard even if payments are not
90 days or more past due. Loans 90 days or more past due are classified
as substandard or lower unless the loan is adequately collateralized and
in the process of collection.
Loans Graded 8 (`Doubtful`) have all the weaknesses inherent in those
classified as substandard, with the added characteristic that the
weaknesses make collection or liquidation in full, on the basis of
currently existing facts, condition and values, highly questionable and
improbable. The possibility of loss is extremely high, but because of
factors that could work to the borrower`s advantage classification of
the `doubtful` loan as `loss` is deferred.
Loans Graded 9 (`Loss`) are those considered uncollectible or portions
of loans that are considered uncollectable. Loans in this category are
charged-off by management.
If it is probable that the Bank will be unable to collect all principal
and interest due on a commercial or non-homogenous loan then that loan
is considered impaired. The measure of impairment is based on the present
value of expected future cash flows discounted at the loan`s effective
interest rate or the value of collateral less estimated costs to sell
for collateral dependent loans, compared to the recorded investment in the
loan (including accrued interest, net deferred loans fees or costs, and
unamortized premium or discount). The Bank considers commercial or
non-homogenous loans graded doubtful or loss to be impaired. Some loans
graded substandard are considered impaired. Special mention and watch
loans are not considered to be impaired. Impairment is evaluated in
total for smaller-balance loans of similar type and purpose ~ such as
residential mortgage and consumer, ~ and on an individual loan basis
for other loans (other loans consists of loans to non-profit organizations
and loans collateralized with cash). If a loan is impaired, a portion of
the loan loss allowance is allocated so that the loan is reported net, at
the present value of estimated future cash flows using the loan`s existing
rate or at the fair value of collateral if repayment is expected solely
from the collateral. Increases in the allowance for loan losses are made
by expensing a provision for loan losses. No specific provision for loan
losses expense would result if an individually reviewed loan is graded
higher than `watch`, but such loans are included in the pools of loans
analyzed under ASC 450-10-05. Loans classified `special mention` or
`substandard`, and smaller-balance loans classified `doubtful` are
assigned a provision based upon a historical migration analysis performed
on classified loans. The migration analysis identifies the percentage of
classified loans by category that has historically been ultimately
charged-off. The migration percentages are reviewed and adjusted by
management to reflect various factors such as the growth and change in
mix of the loan portfolio and the regulator`s guidelines. Loans ranked
`loss` are charged off in their entirety because at that point the
unconfirmed loss that the loan loss allowance is intended to approximate
is considered to be confirmed.
13
As of December 31, 2010, 2009 and 2008 classified assets were as follows:
Classified assets at December 31,
2010 2009 2008
Percent of Percent of Percent of
Amount total loans Amount total loans Amount total loans
(Dollar amounts in thousands)
Classified Loans:
Special mention $ 2,667 1.4% $ 2,841 1.4% $ 3,294 1.8%
Substandard 9,878 5.1% 11,783 6.0% 3,874 2.1%
Doubtful - 0.0% - 0.0% - 0.0%
Loss - 0.0% - 0.0% - 0.0%
Total classified loans 12,545 6.5% 14,624 7.4% 7,168 3.9%
Other real estate owned 58 0.0% 104 0.1% 354 0.2%
Total classified assets $12,603 6.5% $14,728 7.5% $ 7,522 4.1%
Total classified loans decreased from $14.6 million at December 31, 2009
to $12.5 million at December 31, 2010. The Bank`s classification ratio
was 32.0% and 39.5% as of December 31, 2010 and December 31, 2009. The
classification ratio is calculated using total adversely classified
assets (excluding special mention loans) divided by Tier 1 capital plus
allowance for loan losses.
Pools of Loans Analyzed under ASC 450
The total loan loss allowance is derived both from analysis of individual
impaired loans under ASC 310-10-35 and analysis of aggregated pools of
loans under ASC 450. Smaller balance loans (such as automobile or home
equity loans, for example), groups of loans (such as residential mortgage
loans), and less severely classified loans reviewed individually may be
analyzed on an aggregated or pooled basis under ASC 450.
Under ASC 450, loans are segmented into groups of loans having similar
risk characteristics based on purpose, loan type, and collateral, for
example residential mortgage loans, home equity loans, and consumer
loans. Losses inherent in pools of loans are estimated using average
historical losses over a period of years for loans of those types, but
with adjustments to account for changes in loan policies, changes in
underwriting or loan recovery practices, changes in prevailing economic
conditions, changes in the nature or volume of the loan portfolio, and
changes in other internal and external factors. Loans secured by real
estate ~ particularly residential mortgage loans ~ generally have less
credit risk than other types of loans.
Changes in the Allowance for Loan Losses and Classified Assets
An effective loan review function is vital to the establishment of an
appropriate loan loss allowance. Loan officers and the Bank`s credit
analysts are responsible for the assignment of risk ratings for loans
reviewed individually. Each quarter, a committee consisting of the Bank`s
Chief Financial Officer and Senior Credit Officer evaluates the loan loss
allowance and reports the results of its evaluation to senior management
and the Bank`s Board of Directors. The Bank may adjust its loan loss
allowance methodology as well, making adjustments in its estimates and
assumptions as necessary to account for variances of estimated loan losses
from actual loan loss experience. The Bank`s determination about
classification of its assets and the amount of its allowances is subject
to review by the Office of the Comptroller of the Currency (OCC), which
may order the establishment of additional loss allowances.
First National Bank`s allowance for loan losses decreased $321 thousand
during the year to $2.6 million as of December 31, 2010. The allowance for
loan losses to total loans was 1.34% at December 31, 2010. This is a
decrease of 14 basis points when compared to December 31, 2009. The
percentage of the allowance for loan losses to total loans was 1.48%
at December 31, 2009. Total nonperforming loans have decreased from $5.2
million as of December 31, 2009 to $4.9 million at December 31, 2010. In
2010, total classified loans decreased from $14.6 million to $12.5 million
or 14.4%. The amount of allowance for loan losses specifically allocated
to impaired loans decreased from $916 thousand at December 31, 2009 to
$269 thousand at December 31, 2010. Management believes the allowance for
loan losses is adequate as of December 31, 2010.
Loan review and monitoring is integral to effective credit administration
and risk management. In order to minimize the credit risk inherent in the
lending process, management and the Board of Directors has adopted a more
formal and systematic approach with credit administration and loan review.
As part of this systematic approach, a qualified independent third party
was engaged to perform loan reviews in both 2010 and 2009. 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 its efforts to
recover the loss. Recoveries of previously charged-off amounts are
credited to the allowance for loan losses.
14
The increase in charge-offs in 2010 relate primarily to two commercial
loans totaling $1.7 million. The Bank recorded a $400 thousand partial
charge-off of a $1.6 million commercial real estate loan in 2009. The
Bank recorded a $676 thousand partial charge-off of a $1.7 million
commercial real estate loan in 2008. Transactions in the allowance for
loan losses are summarized in following table:
Year ended December 31,
2010 2009 2008 2007 2006
(Dollar amounts in thousands)
Balance, beginning of period $2,906 $1,718 $2,028 $1,993 $1,903
Loans charged off:
Real estate:
Commercial and land development 340 - 688 - 39
One-to-four family 82 38 16 12 42
Home equity 45 25 9 - -
Multifamily - - - - -
Real estate construction:
Commercial and land development 272 400 - - -
One-to-four family - - - - -
Commercial 1,797 - 42 67 17
Consumer 40 195 69 72 43
Credit cards - 1 21 - 21
Total loans charged off 2,576 659 845 151 162
Recoveries of loans
previously charged off:
Real estate:
Commercial and land development - - 5 - -
One-to-four family - - 14 1 14
Home equity 2 2 2 - -
Multifamily - - - - -
Real estate construction:
Commercial and land development - - - - 55
One-to-four family - - - - -
Commercial - 1 20 - 1
Consumer 24 15 11 37 16
Credit cards - - 1 1 6
Total recoveries 26 18 53 39 92
Net loans charged off (2,550) (641) (792) (112) (70)
Provision charged to operations 2,229 1,829 482 147 160
Balance, end of period $2,585 $2,906 $1,718 $2,028 $1,993
Loans outstanding:
Average $195,730 $184,965 $192,472 $187,888 $186,146
End of period 193,270 196,977 181,549 193,941 187,022
Ratio of allowance for loan
losses to total loans
outstanding at end of period 1.34% 1.48% 0.95% 1.05% 1.07%
Net charge offs to average loans 1.30% 0.35% 0.41% 0.06% 0.04%
15
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,
2010 2009 2008 2007 2006
Amount Percent(1) Amount Percent(1) Amount Percent(1) Amount Percent(1) Amount Percent(1)
(Dollar amounts in thousands)
Real estate:
Commercial and
land development $1,019 30% $1,142 28% $ 501 24% $ 779 24% $ 654 24%
One-to-four family 510 24% 163 26% 283 30% 321 41% 150 45%
Home equity 100 14% 73 13% 74 14% 86 11% 33 10%
Multifamily 164 8% 29 5% 41 2% 20 3% 6 2%
Real estate
construction:
Commercial and
land development 248 5% 424 6% 42 6% 16 2% 8 2%
One-to-four family 1 0% 2 0% 4 1% 14 2% 3 1%
Commercial 460 14% 929 16% 579 15% 552 10% 1,064 11%
Consumer:
Auto:
Direct 13 1% 37 2% 43 2% 60 2% 32 3%
Indirect 35 3% 100 4% 147 6% 99 4% 8 1%
Other 5 1% 7 0% 4 0% 5 1% 4 1%
Credit cards - 0% - 0% - 0% 48 0% 31 0%
Unallocated 30 0% - 0% - 0% 28 0% - 0%
Total $2,585 100% $2,906 100% $1,718 100% $2,028 100% $1,993 100%
(1) ~ Percent of loans in each category to total loans.
16
Management reviews nonperforming assets on a regular basis and assesses the
requirement for specific reserves on those assets. Any loan past due 90
days or more and any loan on nonaccrual is considered to be a nonperforming
asset. Any loan 90 days or more past due that is not both adequately
collateralized and in a positive cash-flow position and any loan to a
borrower experiencing serious financial deterioration may be placed on
nonaccrual by the Senior Credit Officer with the concurrence of senior
management. Interest received on nonaccrual loans ~ also referred to as
nonperforming loans ~ is recorded as a reduction of principal. The
table to follow summarizes nonperforming assets and other nonperforming
assets by category.
Problem assets at December 31,
2010 2009 2008 2007 2006
(Dollar amounts in thousands)
Nonaccrual loans $ 4,373 $ 4,716 $ 1,752 $ 2,645 $ 2,061
Past due 90 days or more
and still accruing 487 458 261 158 247
Restructured loans and leases(1) - - - - -
Total nonperforming loans 4,860 5,174 2,013 2,803 2,308
Other real estate owned 58 104 354 194 103
Total nonperforming assets $ 4,918 $ 5,278 $ 2,367 $ 2,997 $ 2,411
Loans outstanding, net $190,685 $194,071 $179,831 $191,488 $184,481
Nonperforming loans
to total net loans 2.55% 2.67% 1.12% 1.46% 1.25%
Nonperforming assets
to total assets 1.31% 1.43% 0.70% 0.98% 0.78%
Allowance for loan losses
to total loans 1.34% 1.48% 0.95% 1.05% 1.07%
Allowance for loan losses
to nonperforming loans 53.19% 56.17% 85.35% 72.35% 86.38%
(1) All restructured loans and leases as of the dates shown were on
nonaccrual status and are included as nonaccrual loans and leases
in this table.
17
Securities
Total securities increased $7.8 million or 6.0% at December 31, 2010 when
compared to December 31, 2009. Securities are primarily comprised of
mortgage-backed securities, municipal securities and securities issued by
corporations. The Bank actively purchases bonds issued by local
municipalities, school systems and other public entities when opportunities
arise. Securities are classified either as held to maturity or as available
for sale. The Bank does not hold any securities for trading purposes. If
management has the intent and the Bank has the ability at the time of
purchase to hold a security until maturity, the security is classified as
held to maturity and it is reflected on the balance sheet at amortized
cost. Securities to be held for indefinite periods and not intended to be
held to maturity or on a long-term basis are classified as available for
sale, and they are reflected on the balance sheet at their fair value.
Management generally believes that all securities should be classified as
available for sale but makes that determination at the time of purchase.
In order to more effectively manage securities and to be in a better
position to react to market conditions, at December 31, 2010, all
securities were classified as available for sale. At year-end 2010 and
2009 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, 2010
Available for sale:
U.S. Government and federal agency $ 2,954 $ 21 $ - $ 2,975
State and municipal 44,656 833 (484) 45,005
Corporate bonds and notes 1,487 29 - 1,516
Mortgage-backed: residential 86,001 2,766 (240) 88,527
Equity securities 23 - (13) 10
Total securities $135,121 $ 3,649 $ (737) $138,033
December 31, 2009
Available for sale:
U.S. Government and federal agency $ 819 $ - $ - $ 819
State and municipal 28,019 763 (99) 28,683
Corporate bonds and notes 7,640 137 - 7,777
Mortgage-backed: residential 89,972 3,058 (87) 92,943
Equity securities 23 - (4) 19
Total securities $126,473 $ 3,958 $ (190) $130,241
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: residential 101,220 2,616 - 103,836
Equity securities 23 - (7) 16
Total securities $125,046 $ 2,855 $ (653) $127,248
18
The contractual maturity of securities available for sale at
December 31, 2010 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 Fair
Average yield Average yield Average yield Average yield Average yield value
(Dollar amounts in thousands)
U.S. Government and $ - $ 2,200 $ 754 $ - $ 2,954 $ 2,975
federal agency - 2.48% 4.45% - 2.99%
State and municipal 3,879 5,060 15,532 20,185 44,656 45,005
1.53% 3.63% 3.62% 3.59% 3.43%
Corporate bonds
and notes 1,487 - - - 1,487 1,516
4.28% - - - 4.28%
Mortgage-backed:
residential - 5,883 53,256 28,862 86,001 88,527
- 2.01% 3.58% 4.02% 3.61%
Total $ 5,366 $ 13,143 $ 69,542 $ 47,047 $135,098 $138,023
2.29% 2.72% 3.60% 3.84% 3.55%
Restricted Equity Securities
As of December 31, 2010, the Bank held 24,855 shares of $100 par value
Federal Home Loan Bank of Cincinnati stock, which are restricted-equity
securities. FHLB stock represents an equity interest in the FHLB, but it
does not have a readily determinable fair value. The stock can be sold at
its par value only, and only to the FHLB or to another member institution.
Member institutions are required to maintain a minimum stock investment in
the FHLB, based on total assets, total mortgages, and total mortgage-backed
securities.
Total Liabilities
Total liabilities increased by $3.8 million or 1.1% from 2009 to 2010. This
increase is primarily a result of a $17.8 million increase in deposits,
partially offset by a decrease of $12.0 million in Federal Home Loan Bank
advances.
Deposits
Deposits increased during 2010 by $17.8 million or 6.1%. The increase is
primarily attributed to a growth in interest-bearing demand deposits of
$16.1 million or 13.7%. This increase was partially offset by a decrease
in time deposits. Savings accounts increased by $3.4 million or 7.4% from
the end of 2009 to the end of 2010. Time deposits decreased by $4.9 million
or 6.8%. This decrease is a result of the success of our premium money
market and interest-bearing checking accounts, and management`s decision
to maintain a reasonable time deposit rate structure. Much of the increase
in this category is attributed to the Bank`s success in marketing our
`Platinum Checking` and `Reward Checking` accounts.
Maturity of time deposits of $100,000 or more at December 31, 2010
(Dollar amounts in thousands)
Time Remaining to maturity: Amount Percent of Total
Three months or less $ 5,774 35.9%
Over three through 12 months 5,395 33.5%
Over one year through 3 years 1,590 9.9%
Over 3 years 3,330 20.7%
Total $ 16,089 100.0%
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
2010 consisted of $12.8 million in cash and due from banks. At year-end
2009 cash and cash equivalents consisted of $8.1 million in cash and due
from banks. Federal
19
funds sold are overnight investments with correspondent banks, an
investment and liquidity tool used to maximize earning assets.
Securities classified as available for sale that are not pledged are
another source of liquidity. We consider the Bank`s loans-to-deposits
ratio to assess liquidity, seeking to cap the ratio of loans to deposits
at 90%. The ratio of total loans to deposits at year-end 2010 was 62.5%.
At the end of 2010 the fair value of securities available for sale was
approximately $138.0 million, while the fair value of securities pledged
was approximately $58.8 million, representing securities pledged to
secure public deposits and repurchase agreements.
The Corporation`s operating activities, as described in the Consolidated
Statements of Cash Flows in the attached consolidated financial statements,
include net cash provided of $5.1 million in 2010, $1.4 million in 2009 and
$2.3 million in 2008, generated principally from net income in those years.
The Bank reported $11.9 and $12.5 million in originations and proceeds from
sales of mortgage loans held for sale as operating activities in 2010.
The Corporation`s investing activities, as described in the Consolidated
Statements of Cash Flows in the attached consolidated financial statements,
consist primarily of loan originations and repayments, along with
securities purchases, sales and maturities. The purchases of securities,
offset by maturities, repayments and sales accounted for the use of
$9.0 million. Proceeds from the maturities and repayments of time deposits
with other financial institutions provided $8.9 million. Purchases of
property and equipment, primarily related to our office rebranding
project, were $4.2 million. In 2009, net cash used in investing activities
was $33.6 million. The increase in loans over the year and the purchase of
loans utilized $16.3 million of cash. Net cash used to purchase time
deposits with other financial institutions was $13.6 million in 2009.
Purchases of property and equipment, primarily related to our office
rebranding project, were $3.4 million.
The Corporation`s financing activities, as described in the Consolidated
Statements of Cash Flows in the attached consolidated financial
statements, include the solicitation and repayment of customer deposits,
borrowings and repayments, treasury stock activity, and the payment of
dividends. In 2010, net cash provided by financing activities was
$3.8 million. The increase in deposits over the year provided $17.8
million of cash. At December 31, 2010, the Bank had $15.0 million of
borrowings outstanding with FHLB, maturing in the years 2011, 2012 and
2014. This amount represents a $12.0 million decrease from the $27.0
million that was owed at the end of 2009.
First National Bank has approximately $14.0 million available in
short-term funding arrangements with its correspondent banks and
the FHLB as of December 31, 2010. 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,
2010 2009 2008
(Dollar amounts in thousands)
Balance at year-end $ 7,747 $ 6,105 $10,469
Average balance outstanding 8,032 7,442 10,134
Maximum month-end balance 12,083 8,965 11,136
Weighted-average rate at year-end 0.15% 0.25% 0.50%
Average rate during the year 0.15% 0.26% 1.42%
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, 2010, the Bank exceeded
minimum risk-based and leverage capital ratio requirements. The Bank`s
ratio of total capital to risk-based assets was 13.59% on
December 31, 2010. The minimum required ratio to be considered adequately
capitalized is 8%. Additional information concerning capital ratios at
year-end 2010 and 2009 is contained in Note 14 of the consolidated
financial statements.
20
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, 2010, 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 $ 67,908 $ 41,883 $ 13,809 $ 12,216 $ -
Deposits without a stated
maturity 241,226 241,226 - - -
Repurchase agreements with
customers 7,747 7,747 - - -
Long-term obligations 15,000 7,000 3,000 5,000 -
Information system
contract obligations 4,592 1,061 1,960 1,571 -
Operating lease obligations 264 72 98 94 -
Total $336,737 $298,989 $ 18,867 $ 18,881 $ -
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 2010:
Expiration of funding commitments
One year More than
or less one year Total
(Dollar amounts in thousands)
Unused loan commitments $42,239 $25,046 $67,285
Commitment to make loans 1,658 - 1,658
Letters of credit 398 - 398
Total $44,295 $25,046 $69,341
Of the unused loan commitments, $11,622 are fixed-rate commitments and
$55,663 are variable-rate commitments. Rates on unused fixed-rate loan
commitments range from 3.38% to 21.90%. The funding commitments shown in
the table above do not necessarily represent future cash requirements
since experience demonstrates that a large percentage of funding
commitments expire unused or partially used.
The Bank is required by regulations of the Federal Reserve Board to
maintain cash reserves on hand or on deposit with the Federal Reserve
Bank. Reserve requirements vary according to the amount of a Bank`s
transaction accounts, checking accounts principally. First National Bank
was required to maintain cash reserve balances with the Federal Reserve
Bank of $100 thousand at year-end 2010 and $100 thousand at year-end 2009.
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
$22.1 million of residential mortgage loans sold.
Shareholders` Equity
The $78 thousand or 0.2% increase in shareholders` equity from year-end
2009 to year-end 2010 was caused by an increase in retained earnings of
$619 thousand, partially offset by a $564 thousand decrease in accumulated
other comprehensive income, which resulted from a decline in the fair value
of securities available for sale. Accumulated other comprehensive income
represents the unrealized appreciation or depreciation (net of taxes) in
the fair value of securities available for sale. Interest rate volatility,
economic and interest rate conditions could cause material fluctuations in
accumulated other comprehensive income. The dividend payout ratio for 2010
was 53.28% versus 43.82% in 2009.
National Bancshares Corporation is dependent on the Bank for earnings and
funds necessary to pay dividends, and the payment of dividends, by the
Bank to National Bancshares Corporation, is subject to bank regulatory
restrictions. According to the National Bank Act and Office of the
Comptroller of the Currency (OCC) Rule 5.64, a national bank may never
pay a cash dividend without advance OCC approval if the amount of the
dividend exceeds retained net income for the year and for the two
preceding years (after any required transfers to surplus). The Bank
could, without prior approval, pay dividends to the holding company of
approximately $3.1 million as of December 31, 2010.
21
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 risk is the risk that a change in prevailing interest rates will
lead to an adverse impact on earnings or capital caused by changes in the
timing of cash flows from investments, loans and deposits. Cash flows may
be received earlier than expected as a result of the exercise of the
option to prepay or withdraw early embedded in the financial contracts.
The option a borrower has to prepay a loan is similar to the option a
depositor has to make an early withdrawal from a deposit account. This
form of embedded option gives the customer the opportunity to benefit
when interest rates change in their favor and ordinarily occurs at the
Bank`s expense in the form of higher interest expense or lower interest
income. Residential mortgage loans tend to have higher option risk
because of the borrower`s option to prepay the loan, primarily through
refinancing when rates decline, and higher interest rate risk because
of the longer term associated with residential mortgage loans. Option
risk in the form of prepayments also affects the value of mortgage-backed
securities.
Basis risk is the risk that changes in interest rates will cause
interest-bearing deposit liabilities to reprice at a different rate
than interest-bearing assets, creating an asset-liability mismatch. If
for example, a bank lends at a rate which changes as the prime rate
changes and finances the loan with deposits not tied to the prime rate
as an index; it faces basis risk due to the possibility that the prime
rate-deposit rate spread might change.
Economic Value of Equity
The economic value of equity, (EVE), is the difference between the net
present value of the assets and the net present value of liabilities.
EVE can be thought of as the liquidation value of the Bank on the date
the calculation is made. Calculating EVE involves using a discount rate
to calculate the net present value of assets and liabilities after making
assumptions about the duration of assets and liabilities. As interest
rates change, the discount rate changes and the change in interest rates
effects the duration of assets and liabilities. If interest rates fall,
for example, the duration of loans shortens since borrowers tend to
prepay. Conversely the duration of loans increases if interest rates rise
since borrowers are inclined to hold on to the favorable rate they were
able to obtain in the lower interest rate environment.
The Board of Directors has established revised limits on a decline in the
economic value of equity (EVE) and earnings at risk (EAR) given changes in
interest rates. These limits are that EVE shall not decline by more than
10%, 20% and 30% given a 1%, 2% and 3% increase or decrease in interest
rates respectively and that EAR shall not be greater than 8%, 16% or 24%
given a 1%, 2% or 3% increase or decrease in interest rates respectively.
The following illustrates our equity at risk in the economic value of
equity model.
December 31, 2010
Basis Point Change in Rates +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp
Increase (decrease) in EVE (12.9)% (6.8)% (1.9)% (4.3)% nm nm
22
December 31, 2009
Basis Point Change in Rates +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp
Increase (decrease) in EVE (13.4)% (7.4)% (2.3)% (4.4)% nm nm
nm ~ not meaningful
The Bank is in compliance with the interest rate risk policy limits
related to EVE as of December 31, 2010 and 2009.
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, 2010
Basis Point Change in Rates +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp
Increase (decrease) in Earnings (0.7)% (0.4)% (0.3)% (1.4)% nm nm
December 31, 2009
Basis Point Change in Rates +300 bp +200 bp +100 bp -100 bp -200 bp -300 bp
Increase (decrease) in Earnings (1.6)% (1.1)% (0.3)% (0.1)% nm nm
nm ~ not meaningful
The Bank is in compliance with the interest rate risk policy limits
related to EAR as of December 31, 2010 and 2009.
One way to minimize interest rate risk is to maintain a balanced or
matched interest-rate sensitivity position. However, matched funding
does not generally maximize profits. To increase net interest income,
the Bank mismatches asset and liability repricing to take advantage of
interest rate conditions. The magnitude of the mismatch depends on
management`s assessment of the risks presented by the interest rate
environment.
Interest rate risk can significantly affect income and expense on
interest sensitive assets and liabilities, and can also affect the
underlying value of the Bank`s assets. The goal in managing interest
rate sensitivity is to maintain an appropriate balance between interest
sensitive assets and liabilities in order to minimize the impact of
volatility in market interest rates.
Management of maturity distributions of assets and liabilities between
the most and least sensitive extremes is as important as the balances
on hand. Management of maturity distributions involves matching interest
rate maturities as well as principal maturities, which can influence net
interest income significantly. In periods of rapidly changing interest
rates, a negative or positive gap can cause major fluctuations in net
interest income and earnings. Managing asset and liability sensitivities,
and insulating net interest income from changes in market and interest
rate conditions is one of the objectives of the Bank`s asset/liability
management strategy.
Management attempts to maintain consistent net interest income and net
income while managing interest rate risk within Board approved policy
limits. Evaluating the Bank`s exposure to changes in interest rates is the
responsibility of Bank management which reports directly to the Board of
Directors. Bank management assesses both the adequacy of the management
process used to control interest rate risk and the quantitative level of
exposure, monitoring and managing interest rate risk to control the effect
of changing interest rates on net interest income and net income.
Evaluating the quantitative level of interest rate risk exposure requires
assessment of existing and potential effects of changes in interest rates
on the Bank`s financial condition, including capital adequacy, earnings,
liquidity and asset quality. Bank management also monitors the Bank`s
liquidity levels. Interest rate risk exposure is reviewed quarterly with
the Board of Directors. Risk is mitigated by matching maturities or
repricing opportunities.
Results of Operations
First National Bank derives substantially all of its income from banking
and bank-related services, including interest earnings on residential real
estate, commercial real estate, commercial and consumer loans and
investment securities along with fee income from deposit services.
National Bancshares Corporation`s business consists almost exclusively
of acting as holding company for the Bank. First National Bank`s business
is not complex: the Bank gathers deposits and it makes loans, principally
in Wayne, Stark, Summit, Medina and Holmes counties, Ohio.
23
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)
2010 2009 2008
Average Yield/ Average Yield/ Average Yield/
Balance Interest Cost Balance Interest Cost Balance Interest Cost
Assets
Interest earning assets:
Securities:
Taxable $ 99,508 $ 3,541 3.70% $113,608 $ 5,397 4.88% $ 79,522 $ 4,095 5.14%
Nontaxable (1) 35,072 1,839 5.43% 20,557 1,226 6.09% 16,491 991 6.07%
Federal funds sold - - - 6,063 12 0.20% 3,353 63 1.88%
Interest bearing deposits 25,704 210 0.82% 1,906 25 1.31% 1,019 18 1.77%
Net loans (including
nonaccrual loans) 192,836 10,536 5.46% 183,001 10,222 5.59% 192,472 12,241 6.36%
Total interest-earning assets 353,120 16,126 4.57% 325,135 16,882 5.19% 292,857 17,408 5.94%
All other assets 27,689 27,502 22,059
Total assets $308,809 $352,637 $314,916
Liabilities and
Shareholder`s Equity
Interest-bearing liabilities:
Deposits:
Interest-bearing checking $123,993 683 0.55% $109,400 1,026 0.94% $ 73,243 1,342 1.83%
Savings 48,721 62 0.13% 48,198 123 0.26% 51,963 291 0.56%
Time, $100,000 and over 18,962 357 1.88% 13,901 340 2.45% 13,197 497 3.77%
Time, other 55,742 1,086 1.95% 58,822 1,627 2.77% 65,248 2,527 3.87%
Other funds purchased 33,767 1,031 3.05% 34,166 1,121 3.28% 31,138 1,128 3.62%
Total interest-bearing liabilities 281,185 3,219 1.14% 264,487 4,237 1.60% 234,789 5,785 2.46%
Demand deposits 56,657 46,265 42,004
Other liabilities 3,345 3,662 2,741
Shareholders` equity 39,622 38,223 35,382
Total liabilities and
shareholders` equity $380,809 $352,637 $314,916
Net interest income (1) $12,907 $12,645 $11,623
Interest rate spread (2) 3.43% 3.59% 3.48%
Net yield on interest-
earning assets (3) 3.66% 3.89% 3.97%
Ratio of average interest-
earning assets to average
interest-bearing liabilities 125.58% 122.93% 124.73%
(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.
24
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.
2010 over 2009 2009 over 2008
(Dollar amounts in thousands)
Volume Rate Net change Volume Rate Net change
Interest Income
Securities:
Taxable $ (658) $(1,198) $(1,856) $ 1,516 $ (214) $ 1,302
Nontaxable 722 (109) 613 221 14 235
(tax-equivalent basis)
Federal funds sold (12) - (12) 5 (56) (51)
Interest bearing deposits 194 (9) 185 12 (5) 7
Loans (including
nonaccrual loans) 537 (223) 314 (529) (1,490) (2,019)
Total interest income
(tax-equivalent basis) $ 783 $(1,539) $ (756) $ 1,225 $(1,751) $ (526)
Interest Expense
Deposits
Interest bearing checking $ 80 $ (423) $ (343) $ 339 $ (655) $ (316)
Savings 1 (62) (61) (10) (158) (168)
Time, $100,000 and over 95 (78) 17 17 (174) (157)
Time, other (60) (481) (541) (178) (722) (900)
Other funds purchased (12) (78) (90) 99 (106) (7)
Total interest expense $ 104 $(1,122) $(1,018) $ 267 $(1,815) $(1,548)
Change in net
interest income
(tax-equivalent basis)* $ 679 $ (417) $ 262 $ 958 $ 64 $ 1,022
*Tax equivalence based on highest statutory tax rates of 34%.
2010 versus 2009
During 2010, net income decreased $284 thousand or 17.6% to $1.3 million.
Accordingly, basic and diluted earnings per share decreased from $0.73 per
share in 2009 to $0.60 per share in 2010. Earnings for 2010 were
negatively impacted by an increase in the provision for loan loss and
noninterest expense, partially offset by an increase in noninterest
income and a decrease in income tax expense. Returns on average equity
and average assets for the year ending December 31, 2010, were 3.34% and
0.35%, respectively, compared to 4.21% and 0.46% for the year ending
December 31, 2009.
Total interest and dividend income decreased $964 thousand or 5.9% in
2010. Interest and fees on loans increased $314 thousand or 3.1%, due to
an increase in the average balance of loans in 2010, offset by a decrease
in the yield on loans. Securities interest and dividend income decreased
$1.5 million or 23.4% over 2009. Much of this decrease is attributable
to a lower yield on securities.
Interest expense decreased by $1.0 million or 24.0% during 2010, as the
Bank`s deposits and short-term borrowings were affected by the falling
interest rate environment. The cost of interest-bearing liabilities fell
from 1.60% in 2009 to 1.14% in 2010. Most of the growth in
interest-bearing liabilities occurred in interest-bearing demand
deposit accounts. The cost of interest-bearing demand deposits is
relatively low compared to other interest-bearing liabilities. Interest
expense on deposits decreased $928 thousand or 29.8% in 2010. Federal
Home Loan Bank advances interest expense decreased $92 thousand or
8.6% as the amount of advances decreased from $27 million to $15
million during 2010.
The provision for loan losses was $2.2 million in 2010, compared to
$1.8 million in 2009. The allowance for loan losses and the related
provision for loan losses is based on management`s judgment and
evaluation of the loan portfolio. Net charge-offs were $2.6 million
for 2010, compared to $641 thousand for 2009. The increase in
charge-offs in 2010 relate primarily to two commercial loans totaling
$1.7 million. One of the aforementioned loans was graded substandard
and considered impaired as of December 31, 2009. Management allocated
$500 thousand for the loan as of December 31, 2009. The allowance as
a percentage of loans decreased from 1.48% at December 31, 2009 to
1.34% at December 31, 2010. Classified loans have decreased from
$14.6 million as of December 31, 2009 to $12.5 million as of
December 31, 2010. Total nonperforming loans have decreased from
$5.2 million as of December 31, 2009 to $4.9 million as of
December 31, 2010. Management believes the current allowance for
loan losses is adequate, however changing economic and other
conditions may require future adjustments to the allowance for
loan losses.
25
Noninterest income increased $218 thousand or 7.3% during 2010. The change
is primarily related to an increase in Visa check card interchange fees
and a reduction in the loss on sales of other real estate owned, partially
offset by a decline in net gains recorded on the sale of investments.
Noninterest expense was $11.8 million for the year ended December 31, 2010
compared to $11.4 million for 2009, an increase of 4.2%. Salaries and
employee benefits, data processing, occupancy expense and professional
and consulting fees were slightly higher in 2010, compared to 2009 levels.
Professional and consulting fees, which includes legal fees, increased
$103 thousand in 2010, compared to 2009. Legal fees were higher in 2010
due to the cost of managing and resolving problem assets. The
amortization of intangibles decreased $135 thousand in 2010, compared to
2009, due to the branch acquisition and customer relationship intangibles
becoming fully amortized in 2009.
Income tax expense was $71 thousand for the year ended December 31, 2010,
representing a decrease of $327 thousand or 82.2% compared to 2009. The
change is primarily related to a decrease in income before income taxes
and an increase in interest income from nontaxable securities.
2009 versus 2008
During 2009, net income decreased $585 thousand or 26.7% to $1.6 million.
Accordingly, basic and diluted earnings per share decreased from $1.00
per share in 2008 to $0.73 per share in 2009. Earnings for 2009 were
negatively impacted by a $1.3 million increase in the provision for loan
loss and a $570 increase in FDIC insurance expense, partially offset by
an increase in net interest income of $942 thousand. Returns on average
equity and average assets for the year ending December 31, 2009, were
4.21% and 0.46%, respectively, compared to 6.20% and 0.70% for the year
ending December 31, 2008.
Total interest and dividend income decreased $606 thousand or 3.5% in
2009. Interest and fees on loans decreased $2.0 million or 16.5%, due
to the decrease in interest rates during the year, and the mortgage
loan securitization transaction with the Federal Home Loan Mortgage
Corporation in December 2008 which decreased loans by $20.9 million.
Securities interest and dividend income increased $1.5 million or
30.7% over 2008. Much of this increase is attributable to an increase
in the average balance of securities related to the aforementioned
mortgage loan securitization.
Interest expense decreased by $1.5 million or 26.8% during 2009, as the
Bank`s deposits and short-term borrowings were affected by the falling
interest rate environment. Interest expense on deposits decreased
$1.5 million or 33.1% in 2009. 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 2009. Interest expense for short-term borrowings decreased by
$119 thousand or 72.6%, primarily due to the significant decrease in
short-term market interest rates during 2009. Federal Home Loan Bank
advances interest expense increased $112 thousand or 11.6% as the
amount of advances increased from $21 million to $27 million during 2009.
The provision for loan losses was $1.8 million in 2009, compared to
$482 thousand in 2008. 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 $641 thousand
for 2009, compared to $792 thousand for 2008. The allowance as a
percentage of loans increased from 0.95% at December 31, 2008 to
1.48% at December 31, 2009. Classified loans have increased from
$7.2 million as of December 31, 2008 to $14.6 million as of
December 31, 2009 as some of our borrowers have struggled with the
challenging business environment created by the current economic
recession. Total nonperforming loans have increased from $2.0 million
as of December 31, 2008 to $5.2 million as of December 31, 2009.
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 $639 thousand or 27.4% during 2009. The
increase is primarily related to net gains recorded on the sale of
securities of $770 thousand. Income from mortgage banking activities
increased from $126 thousand in 2008 to $310 thousand in 2009 as the
Corporation originated $16.8 million in mortgage loans for sale on the
secondary market. The 2009 originations represent an amount significantly
higher than the $7.1 million originated in 2008.
Noninterest expense was $11.4 million for the year ended December 31, 2009
compared to $10.2 million for 2008, an increase of 11.7%. The increase in
noninterest expense was due primarily to an increase in the FDIC deposit
insurance premium from $35 thousand in 2008 to $605 thousand in 2009.
Salaries and employee benefits, occupancy and professional and consulting
fees were slightly higher in 2009 compared to 2008 levels.
Income tax expense was $398 thousand for the year ended December 31, 2009,
representing a decrease of $372 thousand or 48.3% compared to 2008. The
change is primarily related to a decrease in income before income taxes
and an increase in interest income from nontaxable securities.
Critical Accounting Policies
National Bancshares Corporation`s consolidated financial statements are
prepared in accordance with accounting principles generally accepted in
the United States of America ~ GAAP ~ and follow general practices within
the industry in which it operates. Application of these principles
requires management to make estimates, assumptions, and judgments based on
26
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, 2010, future adjustments could be necessary if
circumstances or economic conditions differ substantially from the
assumptions used in making the initial determinations. A downturn in the
local economy and employment could result in increased levels of
non-performing assets and charge-offs, increased loan loss provisions,
and reductions in income. Additionally, as an integral part of the
examination process, bank regulatory agencies periodically review a
bank`s loan loss allowance. The Office of the Comptroller of the
Currency (OCC) could require the recognition of additions to the loan
loss allowance based on the OCC`s judgment of information available to
it at the time of its examination of First National Bank.
Valuation of Securities
The portfolio of available for sale securities is reported at fair value.
The fair value of a security is determined based on quoted market prices.
If quoted market prices are not available, fair value is determined based
on quoted prices of similar instruments. Available for sale and held to
maturity securities are reviewed quarterly for possible other than
temporary impairment. The review includes an analysis of the facts and
circumstances of each individual investment, such as the length of time
the fair value has been below cost, the expectation for that security`s
performance, the credit worthiness of the issuer, and the bank`s ability
to hold the security to maturity. A decline in value that is considered
to be other than temporary and related to a deterioration of the credit
worthiness of the issuer would be recorded as a loss within noninterest
income in the consolidated statements of income.
Goodwill and Other Intangible Assets
Goodwill results from business acquisitions and represents the excess of
the purchase price over the fair value of acquired tangible assets and
liabilities and identifiable intangible assets. Goodwill is assessed at
least annually for impairment and any such impairment will be recognized
in the period identified. Other intangible assets consist of core deposit
and acquired customer relationship intangible assets arising from whole
bank and branch acquisitions. They are initially measured at fair value
and then are amortized on a straight line or accelerated method over their
estimated useful lives, which is 7 to 10 years.
The Corporation performed a goodwill impairment analysis as of
September 30, 2010. The fair value of the single reporting unit was
determined to be greater than the carrying value. The fair value was
determined by using estimated sales price multiples based on recent
observable market transactions.
New Accounting Pronouncements
See Note 1 of the consolidated financial statements for details on new
accounting pronouncements.
27
CONSOLIDATED BALANCE SHEETS
December 31, 2010 and 2009
(Dollar amounts in thousands, except per share data)
2010 2009
ASSETS
Cash and due from banks $ 12,837 $ 8,124
Time deposits with other financial institutions 5,697 13,580
Securities available for sale 138,033 130,241
Restricted equity securities 3,219 3,218
Loans held for sale - 316
Loans, net of allowance for loan losses:
2010 ~ $2,585
2009 ~ $2,906 190,685 194,071
Premises and equipment, net 12,526 9,033
Goodwill 4,723 4,723
Identified intangible assets 107 197
Accrued interest receivable 1,270 1,334
Bank owned life insurance 2,862 2,771
Other assets 2,137 2,620
$374,096 $370,228
LIABILITIES AND SHAREHOLDERS` EQUITY
Liabilities
Deposits
Non-interest bearing $ 57,435 $ 54,290
Interest bearing 251,699 237,083
Total deposits 309,134 291,373
Repurchase agreements 7,747 6,105
Federal funds purchased - 3,300
Federal Reserve note account 724 315
Federal Home Loan Bank advances 15,000 27,000
Accrued interest payable 312 408
Accrued expenses and other liabilities 2,198 2,824
Total liabilities 335,115 331,325
Commitments and contingent liabilities
Shareholders` equity
Common stock, no par value; 6,000,000
shares authorized;
2,289,528 shares issued 11,447 11,447
Additional paid-in capital 4,775 4,752
Retained earnings 22,475 21,856
Treasury stock, at cost (83,555 shares) (1,639) (1,639)
Accumulated other comprehensive income (loss) 1,923 2,487
Total shareholders` equity 38,981 38,903
$374,096 $370,228
see accompanying notes.
28
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
2010 2009 2008
Interest and dividend income
Loans, including fees $ 10,536 $ 10,222 $ 12,241
Securities:
Taxable 3,541 5,397 4,095
Nontaxable 1,214 809 654
Federal funds sold and other 210 37 81
Total interest and dividend income 15,501 16,465 17,071
Interest expense
Deposits 2,188 3,116 4,657
Short-term borrowings 47 45 164
Federal Home Loan Bank advances 984 1,076 964
Total interest expense 3,219 4,237 5,785
Net interest income 12,282 12,228 11,286
Provision for loan losses 2,229 1,829 482
Net interest income after provision for
loan losses 10,053 10,399 10,804
Noninterest income
Checking account fees 1,125 1,070 1,218
Visa check card interchange fees 442 353 326
Deposit and miscellaneous service fees 338 280 312
Mortgage banking activities 285 310 126
Gain on sale of credit card portfolio - - 435
Loss on sales of other real estate owned (24) (112) (15)
Securities gains (losses), net 661 770 (344)
Other 363 301 275
Total noninterest income 3,190 2,972 2,333
Noninterest expense
Salaries and employee benefits 5,550 5,279 5,118
Data processing 1,033 909 947
Net occupancy 1,231 1,056 915
FDIC assessment 520 605 35
Professional and consulting fees 685 582 431
Franchise tax 348 327 326
Maintenance and repairs 203 187 212
Amortization of intangibles 90 225 232
Telephone 237 216 194
Marketing 240 233 144
Director fees and pension 291 224 312
Software license and maintenance fees 202 189 134
Postage and supplies 295 304 360
Other 922 1,028 813
Total noninterest expense 11,847 11,364 10,173
Income before income taxes 1,396 2,007 2,964
Income tax expense 71 398 770
Net income $ 1,325 $ 1,609 $ 2,194
Weighted average common shares outstanding 2,205,973 2,202,457 2,203,218
Basic and diluted earnings per common share $ 0.60 $ 0.73 $ 1.00
See accompanying notes.
29
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS` EQUITY
Years ended December 31, 2010, 2009 and 2008
(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, 2008 $11,447 $ 4,690 $20,182 $(1,623) $ 295 $34,991
Comprehensive income:
Net income 2,194 2,194
Other comprehensive income (loss), net of tax 1,158 1,158
Total comprehensive income 3,352
Cash dividends declared ($.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
Comprehensive income:
Net income 1,609 1,609
Other comprehensive income (loss), net of tax 1,034 1,034
Total comprehensive income 2,643
Cash dividends declared ($.32 per share) (705) (705)
Stock awards issued from Treasury Shares
(3,605) shares (20) 70 50
Compensation expense under stock-based
compensation plans 34 34
Balance at December 31, 2009 11,447 4,752 21,856 (1,639) 2,487 38,903
Comprehensive income
Net income 1,325 1,325
Other comprehensive income (loss), net of tax (564) (564)
Total comprehensive income 761
Cash dividends declared ($.32 per share) (706) (706)
Compensation expense under stock-based
compensation plans 23 23
Balance at December 31, 2010 $11,447 $ 4,775 $22,475 $(1,639) $ 1,923 $38,981
See accompanying notes.
30
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands except per share data)
2010 2009 2008
Cash flows from operating activities
Net income $ 1,325 $ 1,609 $ 2,194
Adjustments to reconcile net income
to net cash from operating activities
Provision for loan losses 2,229 1,829 482
Deferred income taxes 95 (382) 40
Depreciation, amortization and accretion 1,876 877 271
Earnings on Bank owned life insurance (91) (94) (90)
Restricted equity securities dividends (1) (1) (96)
Origination of mortgage loans held for sale (11,889) (16,751) (7,080)
Proceeds from sales of mortgage loans held
for sale 12,490 16,745 7,187
Gain on sale of loans (285) (310) (114)
Net security (gains) losses (661) (770) (100)
Securities impairment loss recognized in earnings - - 444
Gain on sale of credit card portfolio - - (435)
Loss on sale/write-down of other real estate owned 24 112 24
Compensation expense under stock-based
compensation plans 23 84 28
Change in other assets and liabilities (68) (1,503) (498)
Net cash from operating activitiess 5,067 1,445 2,257
Cash flows from investing activities
Purchases of time deposits with other financial
institutions (984) (13,580) -
Proceeds from time deposits with other financial
institutions 8,867 - -
Securities available for sale
Proceeds from maturities and repayments 38,526 36,757 28,426
Proceeds from sales 18,775 23,084 25,417
Purchases (66,312) (60,353) (74,179)
Purchases of property and equipment (4,241) (3,437) (1,462)
Proceeds from sale of credit card portfolio - - 1,871
Proceeds from sale of property and equipment - - 13
Proceeds from sale of other real estate owned 113 191 179
Proceeds from the sale of an impaired loan 930 - -
Purchase of loans (1,184) (1,151) (6,130)
Net change in loans to customers 1,350 (15,118) (5,210)
Net cash from investing activities (4,160) (33,607) (31,075)
Cash flows from financing activities
Net change in deposits 17,761 27,731 21,119
Net change in short-term borrowings (1,249) (3,565) 3,911
Proceeds from Federal Home Loan Bank advances - 10,000 4,000
Repayments Federal Home Loan Bank advances (12,000) (4,000) -
Dividends paid (706) (881) (1,410)
Purchase of common stock - - (86)
Net cash from financing activities 3,806 29,285 27,534
Net change in cash and cash equivalents 4,713 (2,877) (1,284)
Beginning cash and cash equivalents 8,124 11,001 12,285
Ending cash and cash equivalents $ 12,837 $ 8,124 $ 11,001
Supplemental cash flow information:
Interest paid $ 3,315 $ 4,519 $ 6,070
Income taxes paid 537 400 970
Supplemental noncash disclosures:
Transfer from loans to securities available for sale $ - $ - $ 20,810
Transfer from loans to other real estate owned 91 54 354
See accompanying notes.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation: The consolidated
financial statements include National Bancshares Corporation and its
wholly-owned subsidiaries, First National Bank, Orrville, Ohio (Bank)
and NBOH Properties, LLC, together referred to as `the Corporation.`
NBOH Properties, LLC owns a multi-tenant commercial building in Fairlawn,
Ohio. A portion of this building is utilized as our Fairlawn banking
office. This activity is not considered material for segment reporting
purposes. The Bank has a minority interest in First Kropf Title, LLC,
which is immaterial to the consolidated financial statements. Intercompany
transactions and balances are eliminated in consolidation.
The Corporation provides financial services through its main and branch
offices in Orrville, Ohio, and branch offices in surrounding communities
in Wayne, Medina, Stark and Summit counties. Its primary deposit products
are checking, savings, and term certificate accounts, and its primary
lending products are commercial and residential mortgage, commercial and
consumer installment loans. Most loans are secured by specific items of
collateral including business assets, consumer assets and real estate.
Commercial loans are expected to be repaid from cash flow from operations
of businesses. Real estate loans are secured by both residential and
commercial real estate. Other financial instruments, which potentially
represent concentrations of credit risk, include investment securities,
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 the
Corporation`s market area.
Segments: As noted above, the Corporation provides a broad range of
financial services to individuals and companies in northern Ohio. While
the Corporation`s chief decision makers monitor the revenue streams of
the various products and services, operations are managed and financial
performance is evaluated on a Corporation-wide basis. Accordingly, all of
the Corporation`s financial service operations are considered by
management to be aggregated in one reportable operating segment.
Use of Estimates: To prepare financial statements in conformity with U.S.
generally accepted accounting principles, management makes estimates and
assumptions based on available information. These estimates and
assumptions affect the amounts reported in the financial statements and
the disclosures provided, and actual results could differ. The allowance
for loan losses, fair values of financial instruments and carrying value
of intangible assets are particularly subject to change.
Cash Flows: Cash and cash equivalents include cash, deposits with other
banks with original maturities under 90 days, and federal funds sold.
Net cash flows are reported for customer loan and deposit transactions,
interest bearing deposits with other banks, repurchase agreements and
other short-term borrowings.
Time Deposits with Other Financial Institutions: Interest-bearing deposits
in other financial institutions mature within eight months and are carried
at cost.
Securities: Debt securities are classified as held to maturity and carried
at amortized cost when management has the positive intent and ability to
hold them to maturity. Debt securities are classified as available for
sale when they might be sold before maturity. Equity securities with
readily determinable fair values are classified as available for sale.
Securities available for sale are carried at fair value, with unrealized
holding gains and losses reported in other comprehensive income, net of
tax.
Interest income includes amortization of purchase premium or discount.
Premiums and discounts on securities are amortized on the level-yield
method without anticipating prepayments, except for mortgage-backed
securities where prepayments are anticipated. Gains and losses on
sales are recorded on the trade date and determined using the specific
identification method.
Management evaluates securities for other than temporary impairment
(`OTTI`) at least on a quarterly basis, and more frequently when economic
or market conditions warrant such an evaluation. For securities in an
unrealized loss position, management considers the extent and duration
of the unrealized loss, and the financial condition and near-term
prospects of the issuer. Management also assesses whether it intends to
sell, or it is more likely than not that it will be required to sell, a
security in an unrealized loss position before recovery of its amortized
cost basis. If either of the criteria regarding intent or requirement to
sell is met, the entire difference between amortized cost and fair value
is recognized as impairment through earnings. For debt securities that
do not meet the aforementioned criteria, the amount of impairment is
split into two components as follows: 1) OTTI related to credit loss,
which must be
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
recognized in the income statement and 2) other-than-temporary impairment
(OTTI) related to other factors, which is recognized in other
comprehensive income. The credit loss is defined as the difference
between the present value of the cash flows expected to be collected and
the amortized cost basis. For equity securities, the entire amount of
other-than-temporary impairment is recognized through earnings.
Loans Held for Sale: Mortgage loans originated and intended for sale in
the secondary market are carried at the lower of aggregate cost or market,
as determined by outstanding commitments from investors. Net unrealized
losses, if any, are recorded as a valuation allowance and charged to
earnings.
Mortgage loans held for sale may be sold with servicing rights retained or
released. The carrying value of mortgage loans sold is reduced by the
amount allocated to the servicing right for loans sold with servicing
retained. Gains and losses on sales of mortgage loans are based on the
difference between the selling price and the carrying value of the related
loan sold.
Loans: Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are reported at the
principal balance outstanding, net of unearned and deferred income and an
allowance for loan losses. Interest income is accrued on the unpaid
principal balance. Loan origination fees, net of certain direct
origination costs, are deferred and recognized in interest income using
the level-yield method without anticipating prepayments.
Interest income on 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
recorded as a reduction in principal, until qualifying for return to
accrual. Loans are returned to accrual status when all the principal
and interest amounts contractually due are brought current and future
payments are reasonably assured.
Concentration of Credit Risk: Most of the Corporation`s business activity
is with customers located within Wayne, Stark, Summit, Holmes and Medina
Counties. Therefore, the Corporation`s exposure to credit risk is
significantly affected by changes in the economy in these counties.
Purchased Loans: The Corporation purchases individual loans and groups
of loans. Purchased loans that show evidence of credit deterioration at
the time of purchase are recorded at the amount paid, such that there
is no carryover of the seller`s allowance for loan losses. After
acquisition, incurred losses are recognized by an increase in the
allowance for loan losses.
Allowance for Loan Losses: The allowance for loan losses is a valuation
allowance for probable incurred credit losses, increased by the provision
for loan losses and decreased by charge-offs less recoveries. Loan losses
are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Management estimates
the allowance balance required using past loan loss experience, the nature
and volume of the portfolio, information about specific borrower
situations and estimated collateral values, economic conditions, and
other factors. Allocations of the allowance may be made for specific
loans, but the entire allowance is available for any loan that, in
management`s judgment, should be charged-off.
The allowance consists of specific and general components. The specific
component relates to loans that are individually classified as impaired or
loans otherwise classified as substandard or doubtful. The general
component covers non classified loans and is based on historical loss
experience adjusted for current factors.
A loan is impaired when, based on current information and events, it is
probable that the Corporation will be unable to collect all amounts due
according to the contractual terms of the loan agreement. Loans, for which
the terms have been modified, and for which the borrower is experiencing
financial difficulties, are considered troubled debt restructurings and
classified as impaired.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Factors considered by management in determining impairment include payment
status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of payment
delays and payment shortfalls on case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the
borrower, including the length of the delay, the reasons for the delay,
the borrower`s prior payment record, and the amount of the shortfall in
relation to the principal and interest owed.
Commercial and commercial real estate loans over $250 thousand or to
borrowers whose aggregate total borrowing exceeds $250 thousand, except
for first and second mortgage loans on a borrower`s personal residence
are individually evaluated for impairment. If a loan is impaired, a
portion of the allowance is allocated so that the loan is reported,
net, at the present value of estimated future cash flows using the loan`s
existing rate or at the fair value of collateral if repayment is expected
solely from the collateral. Large groups of smaller balance homogeneous
loans, such as consumer and residential real estate loans, are
collectively evaluated for impairment, and accordingly, they are not
separately identified for impairment disclosures. Troubled debt
restructurings are separately identified for impairment disclosures and
are measured at the present value of estimated future cash flows using the
loan`s effective rate at inception. If a troubled debt restructuring is
considered to be a collateral dependent loan, the loan is reported, net,
at the fair value of the collateral. For troubled debt restructurings that
subsequently default, the Corporation determines the amount of reserve in
accordance with the accounting policy for the allowance for loan losses.
The general component covers non impaired loans and is based on historical
loss experience adjusted for current factors. The historical loss
experience is determined by portfolio segment and is based on the actual
loss history experienced by the Corporation over the most recent 5 years.
This actual loss experience is supplemented with other economic factors
based on the risks present for each portfolio segment. These economic
factors include consideration of the following: levels of and trends in
delinquencies and impaired loans; levels of and trends in charge-offs
and recoveries; trends in volume and terms of loans; effects of any
changes in risk selection and underwriting standards; other changes in
lending policies, procedures, and practices; experience, ability, and
depth of lending management and other relevant staff; national and local
economic trends and conditions; industry conditions; and effects of
changes in credit concentrations. The following portfolio segments have
been identified: commercial loans, commercial real estate loans,
residential real estate loans, home equity loans and consumer loans.
The majority of the Corporation`s loan portfolio is residential real
estate, home equity and consumer loans made to individuals in the
Corporation`s market area. These loans are largely secured by underlying
real estate or consumer collateral. Repayment of these loans is dependent
on general economic conditions and unemployment levels in the
Corporation`s market area.
Commercial and commercial real estate loans primarily consist of income
producing real estate and related business assets. Repayment of these
loans depends, to a large degree, on the results of operations, cash
flow and management of the related businesses. These loans may be affected
to a greater extent by adverse commerce conditions or the economy in
general, including today`s economic recession. Accordingly, the nature
of these loans makes them more difficult for management to monitor and
evaluate.
The historic loss ratio for each class of loans is based on the loss
experience for loans in that group. In 2010, the historic loss ratio for
each class was changed from a twelve quarter moving average to a blended
rate of the twelve quarter moving average and the twenty quarter moving
average. The change was made to enhance the time frame over which we
evaluate loss experience and emphasize the most recent loss experience.
Servicing Rights: When mortgage loans are sold, servicing rights are
initially recorded at fair value with the income statement effect recorded
in gains on sales of loans. Fair value is based on market prices for
comparable mortgage servicing contracts, when available, or alternatively,
is based on a valuation model that calculates the present value of
estimated future net servicing income. The valuation model incorporates
assumptions that market participants would use in estimating future net
servicing income, such as the cost to service, the discount rate, the
custodial earnings rate, an inflation rate, ancillary income, prepayment
speeds and default rates and losses. The Corporation compares the
valuation model inputs and results to published industry data in order
to validate the model results and assumptions. All classes of servicing
assets are subsequently measured using the amortization method which
requires servicing rights to be amortized into non-interest income in
proportion to, and over the period of, the estimated future net servicing
income of the underlying loans.
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
At December 31, 2010 and 2009, the servicing assets of the Corporation
totaled $76 and $115, respectively, and are 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. Servicing
assets are evaluated for impairment based upon the fair value of the
assets compared to carrying amount. Any impairment is reported as a
valuation allowance, to the extent that fair value is less than the
capitalized amount for a grouping.
Servicing fee income is recorded when earned for servicing loans based
on a contractual percentage of the outstanding principal or a fixed
amount per loan. The amortization of mortgage servicing rights is netted
against loan servicing fee income. Late fees and ancillary fees related
to loan servicing are not material.
Other Real Estate Owned: Assets acquired through or instead of loan
foreclosure are initially recorded at fair value less costs to sell when
acquired, establishing a new cost basis. If fair value declines
subsequent to foreclosure, a valuation allowance is recorded through
expense. Operating costs after acquisition are expensed.
Premises and Equipment: Land is carried at cost. Premises and equipment
are stated at cost less accumulated depreciation. Buildings and related
components are depreciated using the straight-line method with useful
lives ranging from 7 to 39 years. Furniture, fixtures and equipment are
depreciated using the straight-line method with useful lives ranging from
3 to 7 years.
Federal Home Loan Bank (FHLB) and Federal Reserve Bank (FRB) Stock: The
Bank is a member of the FHLB and FRB systems. FHLB members are required to
own a certain amount of stock based on the level of borrowings and other
factors, and may invest in additional amounts. The stocks are carried at
cost, classified as a restricted security, and periodically evaluated for
impairment based on ultimate recovery of par value. Both cash and stock
dividends are reported as income.
Bank Owned Life Insurance: The Corporation has purchased life insurance
policies on its directors. Life insurance is recorded at the amount that
can be realized under the insurance contract at the balance sheet date,
which is the cash surrender value adjusted for other amounts due that are
probable at settlement.
Goodwill and Other Intangible Assets: Goodwill resulting from business
combinations prior to January 1, 2009 represents the excess of the
purchase price over the fair value of the net assets of businesses
acquired. Goodwill resulting from business combinations after
January 1, 2009, is generally determined as the excess of the fair
value of the consideration transferred, plus the fair value of any
noncontrolling interests in the acquiree, over the fair value of the
net assets acquired and liabilities assumed as of the acquisition date.
Goodwill and intangible assets acquired in a purchase business
combination and determined to have an indefinite useful life are not
amortized, but tested for impairment at least annually. The Corporation
has selected September 30th as the date to perform the annual impairment
test. Intangible assets with definite useful lives are amortized over
their estimated useful lives to their estimated residual values. Goodwill
is the only intangible asset on the Corporation`s balance sheet with
an indefinite life.
Other intangible assets consist of core deposit and acquired customer
relationship intangible assets arising from whole bank and branch
acquisitions. They are initially measured at fair value and then are
amortized on an accelerated method over their estimated useful lives,
which range from 7 to 10 years.
Long-term Assets: These assets are reviewed for impairment when events
indicate their carrying amount may not be recoverable from future
undiscounted cash flows. If impaired, the assets are recorded at
fair value.
Repurchase Agreements: Substantially all repurchase agreement liabilities
represent amounts advanced by various customers. Securities are pledged to
cover these liabilities, which are not covered by federal deposit
insurance.
Benefit Plans: Retirement plan expense is the amount of discretionary
contributions to the Corporation`s 401(k) plan as determined by Board
decision. Director retirement plan expense allocates the benefits over
the estimated years of service.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Stock-Based Compensation: Compensation cost is recognized for stock
options and restricted stock awards issued to employees, based on the fair
value of these awards at the date of grant. A Black-Scholes model is
utilized to estimate the fair value of stock options, while the market
price of the Corporation`s common stock at the date of grant is used for
restricted stock awards. Compensation cost is recognized over the required
service period, generally defined as the vesting period, on an accelerated
basis.
Income Taxes: Income tax expense is the total of the current year income
tax due or refundable and the change in deferred tax assets and
liabilities. Deferred tax assets and liabilities are the expected future
tax amounts for the temporary differences between carrying amounts and tax
bases of assets and liabilities, computed using enacted tax rates. A
valuation allowance, if needed, reduces deferred tax assets to the amount
expected to be realized.
A tax position is recognized as a benefit only if it is `more likely than
not` that the tax position would be sustained in a tax examination, with a
tax examination being presumed to occur. The amount recognized is the
largest amount of tax benefit that is greater than 50% likely of being
realized on examination. For tax positions not meeting the `more likely
than not` test, no tax benefit is recorded.
The Corporation recognizes interest and/or penalties related to income tax
matters in income tax expense.
Transfers of Financial Assets: Transfers of financial assets are accounted
for as sales, when control over the assets has been relinquished. Control
over transferred assets is deemed to be surrendered when the assets have
been isolated from the Corporation, the transferee obtains the right
(free of conditions that constrain it from taking advantage of that right)
to pledge or exchange the transferred assets, and the Corporation does not
maintain effective control over the transferred assets through an
agreement to repurchase them before their maturity.
Loan Commitments and Related Financial Instruments: Financial instruments
include off-balance sheet credit instruments, such as commitments to make
loans and commercial letters of credit, issued to meet customer-financing
needs. The face amount for these items represents the exposure to loss,
before considering customer collateral or ability to repay. Such financial
instruments are recorded when they are funded.
Earnings Per Common Share: Earnings per common share is net income divided
by the weighted average number of shares outstanding during the period.
Diluted earnings per share includes the dilutive effect of additional
potential common shares issuable under stock options. 89,000, 53,000
and 58,000 stock options were not considered in computing diluted earnings
per common share for 2010, 2009 and 2008 because they were antidilutive.
Comprehensive Income: Comprehensive income consists of net income and
other comprehensive income. Other comprehensive income includes
unrealized gains and losses on securities available for sale, which is
also recognized as a separate component of equity.
Loss Contingencies: Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities
when the likelihood of loss is probable and an amount or range of loss can
be reasonably estimated. Management does not believe there now are such
matters that will have a material effect on the financial statements.
Restrictions on Cash: Cash on hand or on deposit with the Federal
Reserve Bank of $100 was required to meet regulatory reserve and
clearing requirements at year-end 2010 and 2009. 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 these estimates.
Reclassifications: Some items in the prior year financial statements were
reclassified to conform to the current presentation. Reclassification had
no affect on prior year net income or shareholder`s equity.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
Adoption of New Accounting Standards: On July 21, 2010, the FASB issued
ASU No. 2010-20, `Disclosures about the Credit Quality of Financing
Receivables and the Allowance for Credit Losses,` which requires
significant new disclosures about the allowance for credit losses and
the credit quality of financing receivables. The requirements are
intended to enhance transparency regarding credit losses and the credit
quality of loan and lease receivables. Under this statement, allowance
for credit losses and fair value are to be disclosed by portfolio segment,
while credit quality information, impaired financing receivables and
nonaccrual status are to be presented by class of financing receivable.
The disclosures are to be presented at the level of disaggregation that
management uses when assessing and monitoring the portfolio`s risk and
performance. This ASU is effective for interim and annual reporting
periods after December 15, 2010. See Note 3 ~ Loans.
NOTE 2 ~ SECURITIES
The amortized cost, fair value and the related gross unrealized gains and
losses of available for sale securities recognized in accumulated other
comprehensive income (loss) were as follows:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
2010
U.S. Treasury and federal agency $ 2,954 $ 21 $ - $ 2,975
State and municipal 44,656 833 (484) 45,005
Corporate bond and notes 1,487 29 - 1,516
Mortgage backed: residential 86,001 2,766 (240) 88,527
Equity securities 23 - (13) 10
Total debt securities $135,121 $ 3,649 $ (737) $138,033
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
2009
U.S. Treasury and federal agency $ 819 $ - $ - $ 819
State and municipal 28,019 763 (99) 28,683
Corporate bond and notes 7,640 137 - 7,777
Mortgage backed: residential 89,972 3,058 (87) 92,943
Equity securities 23 - (4) 19
Total debt securities $126,473 $ 3,958 $ (190) $130,241
Sales of available for sale securities were as follows:
2010 2009 2008
Proceeds $ 18,775 $ 23,084 $ 25,471
Gross gains 679 949 330
Gross losses (26) (179) (230)
Gross gains from calls 8 - -
Other than temporary impairment loss - - (444)
The tax provision (benefit) related to these net realized gains and losses
was $225, $262 and $(34), respectively.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 2 ~ SECURITIES (Continued)
The amortized cost and fair value of securities at year-end 2010 by
contractual maturity were as follows. Securities not due at a single
maturity date, primarily mortgage backed securities and equity securities,
are shown separately.
Amortized
Cost Fair Value
Due in one year or less $ 5,366 $ 5,392
Due from one to five years 7,260 7,493
Due from five to ten years 16,286 16,768
Due after ten years 20,185 19,843
Mortgage-backed: residential 86,001 88,527
Equity securities 23 10
$135,121 $138,033
Securities pledged at year-end 2010 and 2009 had a fair value of $58,827
and $45,882 and were pledged to secure public deposits and repurchase
agreements.
At year-end 2010 and 2009, there were no holdings of securities of any one
issuer, other than the U.S. Government, and its agencies and corporations,
in an amount greater than 10% of shareholders` equity.
All mortgage-backed securities are issued by the United States government
or any agency or corporation thereof as of December 31, 2010.
Securities with unrealized losses at year-end 2010 and 2009, aggregated by
investment category and length of time that individual securities have
been in a continuous unrealized loss position, are as follows:
Securities with unrealized losses at year-end 2010 and 2009, 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
2010 Value Loss Value Loss Value Loss
State and municipal $18,125 $ (484) $ - $ - $18,125 $ (99)
Mortgage-backed: residential 17,067 (240) - - 17,067 (240)
Equity securities - - 10 (13) 10 (13)
Total temporarily impaired $35,192 $ (724) $ 10 $ (13) $35,202 $ (737)
Less Than 12 Months 12 Months or More Total
Fair Unrealized Fair Unrealized Fair Unrealized
2009 Value Loss Value Loss Value Loss
State and municipal $ 4,375 $ (60) $ 455 $ (39) $ 4,830 $ (99)
Corporate bonds and notes 11,761 (87) - - 11,761 (87)
Equity securities 19 (4) - - 19 (4)
Total temporarily impaired $16,155 $ (151) $ 455 $ (39) $16,610 $ (190)
Unrealized losses have not been recognized into income because the
securities are of high credit quality, management does not intend to
sell and it is likely that management will not be required to sell
the securities prior to their anticipated recovery, and the decline
in fair value is largely due to changes in market interest rates or
normally expected market pricing fluctuations. The fair value of debt
securities is expected to recover as the securities approach their
maturity date.
National Bancshares Corporation purchased $467 of FHLMC preferred stock
in the first quarter of 2008. During 2008, management determined this
preferred stock was other than temporarily impaired and recorded $444 of
other than temporary impairment write-downs. The loss has been recorded
in Securities gains (losses), net in the Consolidated Statements of
Income. The fair value of these securities at December 31, 2010 and
2009 was $10 and $19 compared to an adjusted cost basis of $23.
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 3 ~ LOANS
Loans at year-end were as follows:
2010 2009
Real estate:
Commercial and land development $ 58,047 $ 54,787
One-to-four family 47,204 50,390
Home equity 27,766 26,526
Multifamily 14,397 10,353
Real estate construction:
Commercial and land development 9,942 11,797
One-to-four family 301 598
Commercial 26,158 30,621
Consumer:
Auto:
Direct 2,474 3,148
Indirect 6,401 8,605
Other 989 590
193,679 197,415
Unearned and deferred income (409) (438)
Allowance for loan losses (2,585) (2,906)
$190,685 $194,071
Activity in the allowance for loan losses was as follows:
2010 2009 2008
Beginning balance $ 2,906 $ 1,718 $ 2,028
Provision for loan losses 2,229 1,829 482
Loans charged-off (2,576) (659) (845)
Recoveries 26 18 53
Ending balance $ 2,585 $ 2,906 $ 1,718
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 3 ~ LOANS (Continued)
The recorded investment in loans includes the principal balance
outstanding, net of unearned and deferred income and including
accrued interest receivable. The following table presents the
balance in the allowance for loan losses and the recorded
investment in loans by portfolio segment and based on
impairment method as of December 31, 2010:
Commercial Residential Home
Commercial Real Estate Real Estate Equity Consumer Unallocated Total
Allowance for loan losses:
Ending allowance balance
attributable to loans:
Individually evaluated for
impairment $ - $ 30 $ 239 $ - $ - $ - $ 269
Collectively evaluated for
impairment 460 1,237 436 100 53 30 2,316
Total ending allowance balance $ 460 $ 1,267 $ 675 $ 100 $ 53 $ 30 $ 2,585
Recorded investment in loans:
Loans individually evaluated
for impairment $ 662 $ 2,881 $ 1,149 $ - $ - $ - $ 4,692
Loans collectively evaluated
for impairment 25,539 65,035 60,609 27,914 10,049 - 189,146
Total ending loans balance $ 26,201 $ 67,916 $ 61,758 $ 27,914 $ 10,049 $ - $193,838
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 3 ~ LOANS (Continued)
Individually impaired loans were as follows:
2010 2009
Year-end loans with no allocated allowance
for loan losses $ 3,298 $ 2,069
Year-end loans with allocated allowance
for loan losses 1,394 3,692
Amount of the allowance for loan losses 269 916
allocated
2010 2009 2008
Average of individually impaired
loans during year $ 3,888 $ 2,897 $ 1,846
The following table presents loans individually evaluated for impairment by
class of loans asof December 31, 2010:
Unpaid Allowance for
Principal Recorded Loan Losses
Balance Investment Allocated
With no related allowance recorded:
Real estate:
Commercial and land development $ 1,258 $ 1,256 $ -
One-to-four family 52 52 -
Real estate construction:
One-to-four family 1,326 1,325 -
Commercial 662 662 -
With an allowance recorded:
Real estate:
Commercial and land development 99 99 10
One-to-four family 1,097 1,097 239
Multifamily - - -
Real estate construction:
Commercial and land development 198 198 20
$ 4,692 $ 4,694 $ 269
Nonaccrual loans and loans past due 90 days still on accrual were as
follows:
2010 2009
Loans past due over 90 days still on accrual $ 487 $ 458
Nonaccrual loans 4,373 4,716
Nonaccrual loans and loans past due 90 days still on accrual include
both smaller balance homogeneous loans that are collectively evaluated
for impairment and individually classified impaired loans.
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 3 ~ LOANS (Continued)
The following table presents the recorded investment in nonaccrual and
loans past due over 90 days still on accrual by class of loans as of
December 31, 2010:
Loans Past
Due Over 90
Days Still
Nonaccrual Accruing
Real estate:
Commercial and land development $ 1,358 $ -
One-to-four family 448 360
Home equity 382 116
Real estate construction:
Commercial and land development 1,524 -
Commercial 661 -
Consumer:
Auto:
Indirect - 11
$ 4,373 $ 487
The following table presents the aging of the recorded investment in past
due loans as of December 31, 2010 by class of loans:
30 - 59 60 - 89 Greater Than
Days Days 90 Days Total Loans Not
Past Due(1) Past Due(2) Past Due(3) Past Due Past Due(4) Total
Real estate:
Commercial and land development $ - $ 165 $ 1,076 $ 1,241 $ 56,806 $ 58,047
One-to-four family 769 167 784 1,720 45,484 47,204
Home equity 2 45 498 545 27,221 27,766
Multifamily - - - - 14,397 14,397
Real estate construction:
Commercial and land development 930 396 198 1,524 8,418 9,942
One-to-four family - - - - 301 301
Commercial - 22 661 683 25,475 26,158
Consumer:
Auto:
Direct 22 - - 22 2,452 2,474
Indirect 52 - 11 63 6,338 6,401
Other 9 - - 9 980 989
$ 1,784 $ 795 $ 3,228 $ 5,807 $187,872 $193,679
(1) Includes $854 thousand of loans on nonaccrual status.
(2) Includes $399 thousand of loans on nonaccrual status.
(3) All loans are nonaccrual status except for $487 thousand
of loans past due over 90 days still on accrual.
(4) Includes $379 thousand of loans on nonaccrual status.
Troubled Debt Restructuring: The Company has $1,876 of loans individually
evaluated for impairment whose loan terms have been modified in troubled
debt restructurings as of December 31, 2010. No specific reserve has been
allocated for these loans. The Company has not committed to lend any
additional amounts as of December 31, 2010 to customers with outstanding
loans that are classified as troubled debt restructurings. There were no
loans whose terms have been modified in troubled debt restructurings as of
December 31, 2009.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 3 ~ LOANS (Continued)
Credit Quality Indicators: The Corporation categorizes loans into risk
categories based on relevant information about the ability of borrowers
to service their debt such as: current financial information, historical
payment experience, credit documentation, public information, and current
economic trends and other information specific to each borrower. The
Corporation analyzes loans individually by classifying the loans as to
credit risk. This analysis includes non-homogeneous loans, such as
commercial and commercial real estate loans. This analysis is performed
on an annual basis or more frequently if management becomes aware of
information affecting a borrower`s ability to fulfill its obligation.
The Corporation uses the following definitions for risk ratings:
Special Mention. Loans classified as special mention have a potential
weakness that deserves management`s close attention. If left uncorrected,
these potential weaknesses may result in deterioration of the repayment
prospects for the loan or of the institution`s credit position at some
future date.
Substandard. Loans classified as substandard are inadequately protected by
the current financial condition and paying capacity of the obligor or of
the collateral securing the loan. Substandard loans have a well-defined
weakness or weaknesses that jeopardize the liquidation of the debt with a
distinct possibility that the institution will sustain some loss if the
deficiencies are not corrected.
Doubtful. Loans classified as doubtful have all the weaknesses inherent in
those classified as substandard, with the added characteristic that the
weaknesses make collection or liquidation in full, on the basis of
currently existing facts, conditions, and values, highly questionable
and improbable.
Loans not meeting the criteria above that are analyzed individually as
part of the above described process are considered to be pass rated loans.
As of December 31, 2010, and based on the most recent analysis performed,
the risk category of loans by class of loans is as follows:
Special
Pass Mention Substandard Doubtful Total
Real estate:
Commercial and land development $ 53,794 $ 350 $ 3,903 $ - $ 58,047
Real estate construction:
Commercial and land development 6,352 1,788 1,802 - 9,942
Commercial 23,627 507 2,024 - 26,158
83,773 2,645 7,729 - 94,147
The Corporation considers the performance of the loan portfolio and its
impact on the allowance for loan losses. For residential and consumer loan
classes, the Corporation also evaluates credit quality based on the aging
status of the loan, which was previously presented, and by payment
activity. The following table presents the recorded investment in
residential and consumer loans based on payment activity as of
December 31, 2010:
Consumer Residential Real Estate
one-to-four
Direct Indirect Other Construction Multifamily Family Equity
Performing $ 2,474 $ 6,390 $ 989 $ 301 $14,397 $46,420 $27,268
Nonperforming - 11 - - - 784 498
$ 2,474 $ 6,401 $ 989 $ 301 $14,397 $47,204 $27,766
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.
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 3 ~ LOANS (Continued)
The Bank securitized $20,897 single-family residential mortgage loans
formerly held in its mortgage loan portfolio, with Freddie Mac in
December, 2008 as a guaranteed mortgage securitization and retained
the resulting securities as available for sale. 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. 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 accumulated other comprehensive income and capital by $554. During
2010, the Corporation sold a portion of the securities created by the
securitization resulting in proceeds of $8.9 million and a gross gain on
sale of $541. During 2009, the Corporation sold a portion of the
securities created by the securitization resulting in proceeds of $3.3
million and a gross gain on sale of $152. The Corporation continues to
service all of the underlying loans of the guaranteed mortgage
securitization, including the portion of the securitization sold during
2010 and 2009.
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:
2010 2009
Mortgage loan portfolios serviced for:
FHLMC $22,100 $29,255
There were no custodial escrow balances maintained in connection with
serviced loans at year-end 2010 and 2009.
Activity for mortgage servicing rights and the related valuation
allowance follows:
2010 2009 2008
Servicing rights:
Beginning balance $ 115 $ 173 $ 67
Additions 5 2 139
Amortized to expense (44) (60) (33)
End of year 76 115 173
NOTE 5 ~ PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
2010 2009
Land $ 1,758 $ 1,571
Buildings 11,503 8,518
Furniture, fixtures and equipment 5,332 4,997
Construction in progress - 183
18,593 15,269
Less: Accumulated depreciation (6,067) (6,236)
$12,526 $ 9,033
Depreciation expense was $748, $588 and $442 in 2010, 2009 and 2008.
Rent expense under operating leases included in occupancy was $37, $39
and $39 for the years ended December 31, 2010, 2009 and 2008. Future lease
payments are not material.
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 6 ~ INTANGIBLE ASSETS
During 2002, the Corporation acquired Peoples Financial Corporation and
merged the Corporation`s banking operations into the Bank. Identified
intangible assets totaling $1,791 were recognized and have useful lives
of 7 to 10 years. Goodwill of $4,723 was realized from this transaction.
Identified intangible assets at year-end were as follows:
2010 2009
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
Amortized intangible assets:
Core deposit intangibles $ 1,063 $ 956 $ 1,063 $ 866
Branch acquisition intangible 760 760 760 760
Customer relationship intangibles 728 728 728 728
$ 2,551 $ 2,444 $ 2,551 $ 2,354
Aggregate amortization expense was $90, $225 and $232 for 2010,
2009 and 2008.
Estimated amortization expense for each of the next two years:
2011 $ 86
2012 21
Goodwill impairment exists when a reporting unit`s carrying value of
goodwill exceeds its fair value, which is determined through a two-step
impairment test. Step 1 includes the determination of the carrying value
of our single reporting unit, including the existing goodwill and
intangible assets, and estimating the fair value of the reporting unit.
We determined the fair value of our reporting unit and compared it to its
carrying amount. If the carrying amount of a reporting unit exceeds its
fair value, we are required to perform a second step to the impairment
test.
Our annual impairment analysis as of September 30, 2010, indicated that
the Step 2 analysis was not necessary. Step 2 of the goodwill impairment
test is performed to measure the impairment loss. Step 2 requires that
the implied fair value of the reporting unit goodwill be compared to the
carrying amount of that goodwill. If the carrying amount of the reporting
unit goodwill exceeds the implied fair value of that goodwill, an
impairment loss shall be recognized in an amount equal to that excess.
NOTE 7 ~ DEPOSITS
2010 2009
Demand, noninterest-bearing $ 57,435 $ 54,290
Demand, interest-bearing 133,987 117,862
Savings 49,804 46,371
Time, $100,000 and over 16,089 15,712
Time, other 51,819 57,138
$309,134 $291,373
A summary of time deposits at year-end 2010 by maturity follows:
2011 $ 41,883
2012 7,072
2013 6,737
2014 11,764
2015 452
$ 67,908
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 8 ~ FEDERAL HOME LOAN BANK ADVANCES
At year-end, advances from the Federal Home Loan Bank were as follows:
2010 2009
Maturity in 2010, fixed rate at 6.26%, $ - $ 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%
to 5.79% at December 31, 2010 and 2009,
convertible to variable if 1-month LIBOR is at
or above fixed rate 3,000 13,000
Maturities in 2010, fixed rate at 3.19% - 1,000
Maturities in 2011, fixed rate at 2.31% to 2.88% 4,000 4,000
Maturities in 2012, fixed rate at 2.00% 3,000 3,000
Maturities in 2014, fixed rate at 2.86% to 2.88% 5,000 5,000
Total $ 15,000 $ 27,000
Each advance is payable at its maturity date; advances may be paid prior
to maturity subject to a prepayment penalty. As collateral for the
advances, the Bank has approximately $41,660 and $45,626 of first mortgage
loans available under a blanket lien arrangement at year-end 2010 and 2009.
Required payments over the next four years are:
2011 2.31 to 5.12% $ 7,000
2012 2.00% 3,000
2014 2.86 to 2.88% 5,000
NOTE 9 ~ REPURCHASE AGREEMENTS
Repurchase agreements generally mature within 30 days from the transaction
date. Information concerning repurchase agreements is summarized as
follows:
2010 2009 2008
Average balance during the year $ 8,032 $ 7,442 $10,134
Average interest rate during the year 0.15% 0.26% 1.42%
Maximum month-end balance during the year $12,083 $ 8,965 $11,136
Weighted average rate at year-end 0.15% 0.25% 0.50%
NOTE 10 ~ BENEFIT PLANS
The Corporation has a 401(k) retirement plan that covers substantially all
employees. The plan allows employees to contribute up to a predetermined
amount, subject to certain limitations. Matching contributions may be made
in amounts and at times determined by the Corporation. Total matching
discretionary contributions made by the Corporation during 2010, 2009
and 2008 amounted to $57, $73 and $81.
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
2010, 2009 and 2008 amounted to $2, $2 and $1.
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.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 10 ~ BENEFIT PLANS (Continued)
Interest credited to participant accounts associated with the deferrals
was $8, $9 and $12 in 2010, 2009 and 2008. The deferred directors` fee
liability was $193 at December 31, 2010 and $224 at December 31, 2009.
Expense recognized in 2010, 2009 and 2008 for the director retirement
and death benefit plan was $79, $25 and $117. The liability related to
the plan was $713 at December 31, 2010 and $670 at December 31, 2009.
NOTE 11 ~ INCOME TAXES
The components of deferred taxes were as follows:
2010 2009
Deferred tax assets:
Bad debts $ 719 $ 828
Deferred compensation 308 321
Deferred loan fees 195 223
FHLMC preferred stock impairment loss 151 151
Deferred income 37 43
Real estate owned write-down 26 26
Nonaccrual loan interest income 43 17
Stock-based compensation 26 19
Charitable contribution carryforward 21 -
ATM credit carryforward 17 -
Accrued bonus 14 -
Other - 1
Total $ 1,557 $ 1,629
Deferred tax liabilities:
Unrealized security gains, net $ 991 $ 1,281
Federal Home Loan Bank stock dividends 542 542
Depreciation 524 432
Purchase accounting adjustments 105 137
Mortgage servicing rights 33 50
Prepaid expenses 24 25
Securities accretion 27 47
Partnership income 3 2
Total 2,249 2,516
Net deferred tax asset (liability) $ (692) $ (887)
Federal income tax laws provided that the 2002 acquired entity could
claim additional bad debt deductions through 1987, totaling $1.9 million.
Accounting standards do not require a deferred tax liability to be
recorded on this amount, which liability otherwise would total $646 at
December 31, 2010. 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:
2010 2009 2008
Current $ (24) $ 780 $ 730
Deferred 95 (382) 40
$ 71 $ 398 $ 770
The following is a reconciliation of income tax at the federal statutory
rate to the effective rate of tax on the financial statements:
2010 2009 2008
Rate Amount Rate Amount Rate Amount
Tax at federal statutory rate 34% $ 475 34% $ 682 34% $1,008
Tax-exempt income (29) (399) (13) (270) (7) (214)
Other 0 (5) (1) (14) (1) (24)
Income tax expense 5% $ 71 20% 398 26% 770
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 11 ~ INCOME TAXES (Continued)
As of December 31, 2010 and December 31, 2009, the Corporation had no
unrecognized tax benefits or accrued interest and penalties recorded.
The Corporation does not expect the amount of unrecognized tax benefits
to significantly increase within the next twelve months. The Corporation
records interest and penalties as a component of income tax expense.
The Corporation and its subsidiaries are subject to U.S. federal income
tax as well as income tax in the state of Ohio for National Bancshares.
The Bank is subject to tax in Ohio based upon its net worth. The
Corporation is no longer subject to examination by state taxing
authorities for years prior to 2007.
NOTE 12 ~ RELATED-PARTY TRANSACTIONS
Loans to principal officers, directors, and their affiliates during 2010
were as follows:
Beginning balance $ 6,361
Effect of changes in composition of related parties (2,635)
New loans -
Repayments (1,305)
Ending balance $ 2,421
Unused commitments to these related parties totaled $1,798 and $3,762 at
year-end 2010 and 2009. Related party deposits totaled $3,955 and $4,749
at year-end 2010 and 2009.
The Corporation has minority ownership in a title agency affiliated with
a Director resulting in fee income to the Corporation of $35, $32 and $11
for 2010, 2009 and 2008, respectively.
NOTE 13 ~ STOCK-BASED COMPENSATION
The Corporation`s 2008 Equity Incentive Plan (`the Plan`), which is
shareholder-approved, permits the grant of stock options or restricted
stock awards, to its officers, employees, consultants and non-employee
directors for up to 223,448 shares of common stock.
Stock Option Awards
Option awards are granted with an exercise price equal to the market price
of the Corporation`s common stock at the date of grant; those option
awards have vesting periods determined by the Corporation`s compensation
committee and have terms that shall not exceed 10 years.
On May 20, 2008, the Corporation granted options to purchase 58,000 shares
of stock to directors and certain key officers, 46,000 of which remained
outstanding at December 31, 2010. The exercise price of the options is
$18.03 per share. The options vest in five equal installments over a
five-year period and have a term of 10 years. None of these options have
been exercised as of December 31, 2010.
On October 19, 2010, the Corporation granted options to purchase 43,000
shares of stock to directors and certain key officers, all of which
remained outstanding at December 31, 2010. The exercise price of the
options is $13.22 per share. The options vest in five equal installments
over a five-year period and have a term of 10 years. None of these options
have been exercised as of December 31, 2010.
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 Corporation`s common stock. The Corporation
has estimated the option exercise and post-vesting termination behavior
and expected term of options granted due to the lack of historical data.
The expected term of options granted represents the period of time that
options granted are expected to be outstanding, which takes into account
that the options are not transferrable. The risk-free interest rate for
the expected term of the option is based on the U.S. Treasury yield curve
in effect at the time of the grant.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 13 ~ STOCK-BASED COMPENSATION (Continued)
The fair value of options granted and the assumptions used for grants in
2010, 2009 and 2008 were as follows:
2010 2009 2008
Fair value of options granted $ 2.53 $ - $ 1.83
Risk-free interest rate 1.49% - 3.19%
Expected term (years) 6.5 - 6.5
Expected stock price volatility 24.67% - 13.76%
Dividend yield 2.42% - 3.60%
A summary of the activity in the stock option plan for 2010 follows:
Weighted
Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Term Value
Outstanding at beginning of year 53,000 $ 18.03
Granted 43,000 13.22
Exercised - -
Forfeited or expired (7,000) 18.03
Outstanding at end of year 89,000 15.71 8.6 $ -
Fully expected to vest (70,600) $ 15.10 8.9 $ -
Exercisable at end of year 18,400 $ 18.03 7.4 $ -
The total compensation cost that has been charged against income for the
plan was $23, $34 and $28 for 2010, 2009 and 2008. The total income tax
benefit was $8, $12 and $10 for 2010, 2009 and 2008. There was $117,
$38 and $78 of total unrecognized compensation cost related to nonvested
stock options granted under the Plan as of December 31, 2010, 2009 and
2008. The cost is expected to be recognized over a weighted-average period
of 3.6 years.
Restricted Stock Awards
On December 23, 2009, the Corporation issued restricted stock awards for
3,605 shares of the Corporation`s common stock to certain officers.
The awards vested immediately and the compensation expense related to the
awards of $50 was recorded in 2009. The fair value of the stock was
determined using closing market price of the Corporation`s common stock
on the date of the grant.
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, 2010, 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
2010 and 2009, 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.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 14 ~ REGULATORY CAPITAL MATTERS (Continued)
Actual and required capital amounts and ratios for the Bank 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
2010
Total capital to risk
weighted assets $31,032 13.59% $18,267 8.00% $22,834 10.00%
Tier 1 capital to risk
weighted assets 28,447 12.46% 9,134 4.00% 13,701 6.00%
Tier 1 capital to
average assets 28,447 7.46% 15,261 4.00% 19,077 5.00%
2009
Total capital to risk
weighted assets $29,842 12.46% $19,161 8.00% $23,952 10.00%
Tier 1 capital to risk
weighted assets 26,936 11.25% 9,581 4.00% 14,371 6.00%
Tier 1 capital to
average assets 26,936 7.40% 14,562 4.00% 18,202 5.00%
Dividend Restrictions ~ The Corporation`s principal source of funds for
dividend payments is dividends received from the Bank. Banking regulations
limit the amount of dividends that may be paid without prior approval of
regulatory agencies. Under these regulations, the amount of dividends
that may be paid in any calendar year is limited to the current year`s
net profits, combined with the retained net profits of the preceding
two years, subject to the capital requirements described above. The Bank
could, without prior approval, pay dividends to the holding Corporation
of approximately $3,057 as of December 31, 2010.
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:
2010 2009
Commitments to make loans $ 1,658 $ 2,531
Unused lines of credit 67,285 60,567
Letters of credit 398 308
Of the above unused instruments at December 31, 2010, approximately
$11,622 pertains to fixed-rate commitments and variable-rate commitments
account for approximately $55,663. At year-end 2009, approximately $9,974
of total commitments were fixed-rate and approximately $53,432 were
variable rate. Rates on fixed-rate unused lines of credit ranged from
3.38% to 21.90% at December 31, 2010 and 6.25% to 21.90% at
December 31, 2009.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 16 ~ FAIR VALUE
ASC 820-10 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.
Investment Securities: The fair values for investment securities are
determined by quoted market prices, if available (Level 1). For securities
where quoted prices are not available, fair values are calculated based on
market prices of similar securities (Level 2). For securities where quoted
prices or market prices of similar securities are not available, fair
values are calculated using discounted cash flows or other market
indicators (Level 3). Discounted cash flows are calculated using spread to
swap and LIBOR curves that are updated to incorporate loss severities,
volatility, credit spread and optionality. During times when trading is
more liquid, broker quotes are used (if available) to validate the model.
Rating agency and industry research reports as well as defaults and
deferrals on individual securities are reviewed and incorporated into
the calculations.
Derivatives: The fair value of derivatives is based on valuation models
using observable market data as of the measurement date (Level 2 inputs).
Impaired Loans: The fair value of impaired loans with specific allocations
of the allowance for loan losses is generally based on recent real estate
appraisals. These appraisals may utilize a single valuation approach or a
combination of approaches including comparable sales and the income
approach. Adjustments are routinely made in the appraisal process by the
appraisers to adjust for differences between the comparable sales and
income data available. Such adjustments are usually significant and
typically result in a Level 3 classification of the inputs for determining
fair value.
Other Real Estate Owned: Nonrecurring adjustments to certain commercial
and residential real estate properties classified as other real estate
owned are measured at the lower of carrying amount or fair value, less
cost to sell. Fair Values are generally based on third party appraisals
of the property, resulting in a Level 3 classification. In cases where
the carrying amount exceeds the fair value, less costs to sell, an
impairment loss is recognized.
Loans Held for Sale: Loans held for sale are carried at the lower of cost
or fair value, as determined by outstanding commitments, from third party
investors.
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, 2010 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:
U.S. Government and federal agency $ - $ 2,975 $ -
State and municipal - 44,705 300
Corporate bonds and notes - 1,516 -
Mortgage-backed securities: residential - 88,507 20
Equity securities 10 - -
Interest rate swaps - 47 -
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 16 ~ FAIR VALUE (Continued)
Fair Value Measurements
At December 31, 2010 Using
Quoted Prices in Significant
Active Markets Other Significant
for Identical Observable Unobservable
Assets Inputs Inputs
(Level 1) (Level 2) (Level 3)
Liabilities:
Interest rate swaps $ - $ 47 $ -
Fair Value Measurements
At December 31, 2009 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:
U.S. Government and federal agency $ - $ 819 $ -
State and municipal - 28,683 -
Corporate bonds and notes - 7,777 -
Mortgage-backed securities: residential - 92,943 -
Equity securities 19 - -
Interest rate swaps - 4 -
Fair Value Measurements
At December 31, 2009 Using
Quoted Prices in Significant
Active Markets Other Significant
for Identical Observable Unobservable
Assets Inputs Inputs
(Level 1) (Level 2) (Level 3)
Liabilities:
Interest rate swaps $ - $ 4 $ -
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, 2010 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 $ - $ - $ 3,116
Other real estate owned - - 58
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 16 ~ FAIR VALUE (Continued)
Fair Value Measurements
At December 31, 2009 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 $ - $ - $ 2,882
Other real estate owned - - 58
Impaired loans, which are measured for impairment using the fair value of
the collateral for collateral dependent loans, had a principal amount of
$3,385, with a valuation allowance of $269 at December 31, 2010, resulting
in an additional provision for loan loss of $1,790 for the year ended
December 31, 2010.
Impaired loans, which are measured for impairment using the fair value of
the collateral for collateral dependent loans, had a principal amount of
$3,798, with a valuation allowance of $916 at December 31, 2009, resulting
in an additional provision for loan loss of $1,091 for the year ended
December 31, 2009.
Other real estate owned measured at fair value less costs to sell, had a
net carrying amount of $58, which is made up of the outstanding balance of
$133, net of a valuation allowance of $75 at December 31, 2010. The
write-down of $75 occurred during the year end December 31, 2009. There
were no write-downs of other real estate owned for the year ended
December 31, 2010.
Carrying amount and estimated fair values of financial instruments at
year-end were as follows:
2010 2009
Carrying Fair Carrying Fair
Amount Value Amount Value
Financial assets
Cash and cash equivalents $ 12,837 $ 12,837 $ 8,124 $ 8,124
Time deposits with other financial
institutions 5,697 5,697 13,580 13,580
Securities available for sale 138,033 138,033 130,241 130,241
Restricted equity securities 3,219 na 3,218 na
Loans, net1 190,685 192,372 194,071 194,103
Accrued interest receivable 1,270 1,270 1,334 1,334
Interest rate swaps 47 47 4 4
Financial liabilities
Deposits 309,134 309,908 291,373 292,045
Short-term borrowings 8,471 8,471 9,720 9,720
Federal Home Loan Bank advances 15,000 15,337 27,000 27,779
Accrued interest payable 312 312 408 408
Interest rate swaps 47 47 4 4
The methods and assumptions used to estimate fair value are described
as follows:
Carrying amount is the estimated fair value for cash and cash equivalents,
time deposits with other financial institutions, interest bearing
deposits, accrued interest receivable and payable, demand deposits, short
term debt, and variable rate loans or deposits that reprice frequently and
fully. For fixed rate loans or deposits and for variable rate loans or
deposits with infrequent repricing or repricing limits, fair value is
based on discounted cash flows using current market rates applied to the
estimated life and credit risk. Fair value of debt is based on current
rates for similar financing. It was not practicable to determine the fair
value of restricted equity securities due to restrictions placed on its
transferability. The fair value of off balance sheet items is not
considered material.
NOTE 17 ~ DERIVATIVES
The Corporation utilizes interest-rate swap agreements as part of its
asset liability management strategy to help manage its interest rate risk
position, not for speculation. The notional amount of the interest-rate
swaps does not represent amounts exchanged by the parties. The amount
exchanged is determined by reference to the notional amount and the other
terms of the individual interest-rate swap agreements.
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 17 ~ DERIVATIVES (Continued)
The Corporation implemented a program in 2009 whereby it lends to its
borrowers at a fixed rate with the loan agreement containing a two-way
yield maintenance provision. The program has one participant as of
December 31, 2010. If the borrower prepays the loan, the yield maintenance
provision will result in a prepayment penalty or benefit depending on the
interest rate environment at the time of the prepayment. This provision
represents an embedded derivative which is required to be bifurcated
from the host loan contract. As a result of bifurcating the embedded
derivative, the Corporation records the transaction with the borrower
as a floating rate loan and a pay floating / receive fixed interest-rate
swap. To offset the risk of the interest-rate swap with the borrower,
the Corporation enters into an interest-rate swap with an outside
counterparty that mirrors the terms of the interest-rate swap between
the Corporation and the borrower. Both interest-rate swaps are carried
as freestanding derivatives with their changes in fair value reported
in current earnings. The interest-rate swaps are not designated as hedges.
The change in the fair value of the interest-rate swap between the
Corporation and its borrower was an increase of $43 for the year ended
December 31, 2010, which was offset by an equal decrease in value during
the year ended December 31, 2010 on the interest-rate swap with an outside
counterparty, with the result that there was no net impact on income in
2010.
Summary information about the interest-rate swap between the Corporation
and its borrower as of year-end is as follows:
2010 2009
Notional amount $ 1,485 $ 1,544
Weighted average receive rate 5.33% 5.33%
Weighted average pay rate 3.34% 3.88%
Weighted average maturity (years) 3.0 4.0
Fair value of interest-rate swap $ 47 4
Summary information about the interest-rate swaps between the Corporation
and outside parties is as follows:
2010 2009
Notional amount $ 1,485 $ 1,544
Weighted average receive rate 5.33% 5.33%
Weighted average pay rate 3.34% 3.88%
Weighted average maturity (years) 3.0 4.0
Fair value of interest-rate swap (47) (4)
NOTE 18 ~ OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related tax effects
were as follows:
2010 2009 2008
Unrealized holding gains (losses) on
available for sale securities $ (195) $ 2,337 $ 571
Reclassification adjustment for losses (gains)
later recognized in income (661) (770) 344
Net unrealized gains (losses) (856) 1,567 915
Initial unrealized gain on mortgage-backed
securities received in securitization - - 840
Tax effect 292 (533) (597)
Other comprehensive income (loss) $ (564) $ 1,034 $ 1,158
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 19 ~ PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial statements for National Bancshares Corporation
(parent only) are as follows:
BALANCE SHEETS December 31,
2010 2009
ASSETS
Cash and cash equivalents $ 1,314 $ 4,438
Investment in Bank subsidiary 35,239 34,389
Investment in real estate subsidiary 2,342 -
Securities available for sale 10 19
Other assets 253 234
Total assets $ 39,158 $ 39,080
LIABILITIES AND SHAREHOLDERS` EQUITY
Dividends payable $ 177 $ 177
Shareholders` equity 38,981 38,903
Total liabilities and shareholders` equity $ 39,158 $ 39,080
STATEMENTS OF INCOME Years ended December 31,
2010 2009 2008
INCOME
Dividends from Bank subsidiary $ - $ - $ 2,500
Securities gains (losses), net - - (444)
Dividend income - - 16
Total Income - - 2,072
EXPENSES
Miscellaneous expense (48) (59) (72)
Income (loss) before income tax and
undistributed subsidiary income (48) (59) 2,000
Income tax benefit 16 20 170
Undistributed equity in net income
of Bank subsidiary 1,385 1,648 24
Undistributed equity in net loss of
real estate subsidiary (28) - -
Net income $ 1,325 $ 1,609 $ 2,194
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2010, 2009 and 2008
(Dollar amounts in thousands, except per share data)
NOTE 19 ~ PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION (Continued)
STATEMENTS OF CASH FLOWS Years ended December 31,
2010 2009 2008
Cash flows from operating activities
Net income $ 1,325 $ 1,609 $ 2,194
Adjustments to reconcile net income
to net cash from operating activities:
Equity in undistributed net income of
Bank subsidiary (1,385) (1,648) (24)
Equity in undistributed net loss of
real estate subsidiary 28 - -
Net security (gains) loss - - 444
Change in other assets and liabilities (16) 31 (170)
Net cash from operating activities (48) (8) 2,444
Cash flows from investing activities
Proceeds from sale of securities - - -
Purchase of security available for sale - - (467)
Investment in real estate subsidiary (2,370) - -
Net cash from investing activities (2,370) - (467)
Cash flows from financing activities
Dividends paid (706) (881) (1,410)
Purchase of common stock - - (86)
Net cash from financing activities (706) (881) (1,496)
Net change in cash (3,124) (889) 481
Beginning cash and cash equivalents 4,438 5,327 4,846
Ending cash and cash equivalents $ 1,314 $ 4,438 $ 5,327
56
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, 2010 and 2009, 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, 2010. 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
Corporation 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, 2010 and 2009, and
the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2010 in conformity with U.S.
generally accepted accounting principles.
</Crowe Horwath LLP>
Crowe Horwath LLP
Cleveland, Ohio
March 15, 2011
57
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58
REPORT OF MANAGEMENT ON THE CORPORATION`S INTERNAL CONTROL OVER
FINANCIAL REPORTING
March 15, 2011
Management of National Bancshares Corporation is responsible for
establishing and maintaining adequate internal control over financial
reporting. Internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally accepted in
the United States. Internal control over financial reporting includes
those policies and procedures that (1) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of assets; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures are made only in accordance
with authorizations of management and directors; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. A control system,
no matter how well conceived and operated, can provide only reasonable,
not absolute, assurance that the objectives of the control system are met.
Because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that all control issues and
instances of fraud, if any, have been detected. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies and procedures may
deteriorate.
Management of National Bancshares Corporation, including the Chief
Executive Officer and the Chief Financial Officer, has assessed the
Corporation`s internal control over financial reporting as of
December 31, 2010, based on criteria for effective internal control
over financial reporting described in `Internal Control ~ Integrated
Framework` issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on this assessment, management has concluded
that the Corporation`s internal control over financial reporting was
effective as of December 31, 2010, based on the specified criteria.
This annual report does not include an audit report of the Corporation`s
independent registered public accounting firm regarding internal control
over financial reporting. Management`s report was not subject to audit by
the Corporation`s independent registered public accounting firm pursuant
to rules of the Securities and Exchange Commission that permit the
Corporation to provide only management`s report in this annual report.
</David C. Vernon>
David C. Vernon
Chief Executive Officer
</James R. VanSickle>
James R. VanSickle
Chief Financial Officer
59
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60
Set forth below is a line graph comparing the yearly percentage change
in the cumulative total shareholder return on National Bancshares` Common
Stock against the cumulative return of the S&P 500 Stock Index and the
S&P 500 Bank Index for the period of five fiscal years commencing
December 31, 2005 and ended December 31, 2010. The graph assumes that the
value of the investment in National Bancshares Common Stock and each index
was $100 of December 31, 2005 and that all dividends were reinvested.
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN OF NATIONAL BANCSHARES
CORPORATION, S&P 500 STOCK INDEX, AND S&P 500 BANK INDEX
2005 2006 2007 2008 2009 2010
National Bancshares Corp $100.00 105.65 75.71 61.87 71.55 66.88
S&P 500 Stock Index~ $100.00 115.79 122.16 76.96 97.33 111.99
S&P 500 Banks Index~ $100.00 116.10 81.52 42.80 39.98 47.92
~ National Bancshares Corporation is not included in the S&P 500 Bank
Index or S&P 500 Stock Index.
61
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 2010 and 2009 follows. This information does
not reflect retail mark-up, markdown or commissions, and does not
necessarily represent actual transactions.
High Low Dividends per share
2010
First Quarter $ 13.91 $ 12.20 $ .08
Second Quarter 14.47 12.77 .08
Third Quarter 13.98 12.56 .08
Fourth Quarter 13.66 12.62 .08
2009
First Quarter $ 14.65 $ 11.96 $ .08
Second Quarter 14.64 13.02 .08
Third Quarter 14.08 12.90 .08
Fourth Quarter 17.90 13.52 .08
SHAREHOLDER INFORMATION
Corporate Office
National Bancshares Corporation
112 West Market Street, PO Box 57
Orrville, OH 44667
www.discoverfirstnational.com
Stock Trading Information
The shares of common stock of National Bancshares Corporation are
traded on the OTC Bulletin Board. The ticker symbol for National
Bancshares Corporation is `NBOH.` The Corporation had 853 shareholders
of Record as of December 31, 2010.
Form 10-K
A copy of the Corporation`s 2010 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
ellengerber@discoverfirstnational.com
Transfer Agent
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016
1-800-368-5948
info@rtco.com
www.rtco.com
National Bancshares Corporation has a Dividend Reinvestment Plan and a
Dividend Direct Deposit Plan available at no cost. Please contact
Registrar and Transfer Company for enrollment.
62
OFFICERS
NATIONAL BANCSHARES CORPORATION
David C. Vernon, President and Chief Executive Officer
James R. VanSickle, Senior Vice President and Chief Financial Officer
FIRST NATIONAL BANK
David C. Vernon, President and Chief Executive Officer
Business Banking
Thomas R. Poe, Senior Vice President, Senior Loan Officer
John L. Falatok, Senior Vice President, Market Manager
John R. Macks, Vice President
Paul A. Manghillis, Vice President
Robert C. McConnell, Vice President
John D. Shultz, Jr., Vice President
Laura R. Yoder, Vice President
Credit Administration, Loan Operations and Managed Assets
Richard A. White, Vice President, Senior Credit Officer
Kathryn J. Barnes, Assistant Vice President, Credit Officer
Lisa M. Bryant, Consumer Credit Officer
Mindy L. Henderson, Loan Operations Officer
Dallas W. Falb, Credit Officer
Steven L. Riddick, Vice President, Managed Assets
Agribusiness and Community Banking
Mark R. Witmer, Group Vice President
Harold D. Berkey, Vice President, Relationship Manager
John P. Hall, Vice President, Wooster Market Manager
Darrell L. Smucker, Vice President
Dean M. Karhan, Assistant Vice President
Retail Banking, Mortgage and Consumer Lending
Myron Filarski, Senior Vice President
Cynthia A. Wagner, Vice President
Heather L. Kiner, Assistant Vice President, Relationship Manager
Patricia Massaro, Consumer Credit Officer
Jill R. Wachtel, Assistant Vice President, Relationship Manager
Amberly M. Wolf, Assistant Vice President, Retail Banking
Corporate
James R. VanSickle, Senior Vice President, Chief Financial Officer
James T. Griffith, Vice President, Information Technology
Pamela S. Null, Vice President, Compliance, BSA, CRA and Security
Michael G. Oberhaus, Vice President, Financial Analyst, Risk Manager
Maria A. Roush, Vice President, Auditor
Angela L. Smith, Controller
Jodi R. Blair, Deposit Operations Officer
63
BOARD OF DIRECTORS FIRST NATIONAL BANK OFFICES
NATIONAL BANCSHARES CORPORATION &
FIRST NATIONAL BANK
John P. Cook, CPA, Ph.D Orrville
Shareholder 112 W. Market St.
Long, Cook & Samsa, Inc. 330-682-1010
Bobbi E. Douglas 1320 W. High St.
Executive Director 330-682-2881
STEPS at Liberty Center
Every Woman's House 1720 N. Main St.
CASH ATM ONLY
John W. Kropf
Chairman of the Board Apple Creek
National Bancshares Corporation 7227 E. Lincoln Way
First National Bank 330-264-8070
Attorney,
Kropf, Wagner Dalton
& VanSickle, L.L.P. 12 W. Main St.
330-828-2227
John L. Muhlbach, Jr.
Vice President, Fairlawn
A.A. Hammersmith, Inc. 3085 West Market St.
330-475-1363
Victor B. Schantz
President, Kidron
Schantz Organ Company 4950 Kidron Rd.
330-857-3101
Steve Schmid
President, Lodi
Dairy Enterprises, Inc. 106 Ainsworth St.
330-857-3101
James R. Smail
Chairman/Director Massillon
J.R. Smail, Inc. 211 Lincoln Way E.
Poulson Drilling, Inc. 330-832-7441
Monitor Ranch, Inc.
MOnitor Bancorp, Inc. 2312 Lincoln Way N.W.
330-833-1622
David C. Vernon
President & CEO Mt. Eaton
National Bancshares Corporation 15974 E. Main St.
First National Bank 330-359-3105 or
330-857-4301
Howard J. Wenger
President, Seville
Wenger Excavating, Inc. 4885 Atlantic Dr.
Lake Region Oil, Inc. 330-769-3105
Northstar Asphalt, Inc.
Massillon Materials, Inc. Smithville
Stark Materials, Inc. 153 E. Main St.
Wooster
Albert W. Yeagley 4192 Burbank Rd.
Vice President, Industry & Government 330-263-5303
Affairs
The J.M. Smucker Company
1725 Cleveland Rd.
330-263-1725
64