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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-Q
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Quarterly Report Pursuant to Section 13 or 15(d)
Of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2003
Commission file number 0-15204
National Bankshares, Inc.
(Exact name of registrant as specified in its charter)
State or other jurisdiction of incorporation or organization - Virginia
Internal Revenue Service - Employer Identification No. 54-1375874
101 Hubbard Street, P.O. Box 90002, Blacksburg, VA 24062-9002
(540) 951-6300
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such requirements
for the past 90 days.
Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b - 2 of the Exchange Act)
Yes X No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at May 1, 2003
- ----------------------------- ---------------------------
Common Stock, $2.50 Par Value 3,512,877
(This report contains 27 pages)
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4 NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-Q
Index
Page
Part I Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets, March 31, 2003 (Unaudited) 3-4
and December 31, 2002
Consolidated Statements of Income for the 5-6
Three Months Ended
March 31, 2003 and 2002 (Unaudited)
Consolidated Statements of Changes in 7
Stockholders' Equity, Three Months Ended
March 31, 2003 and 2002 (Unaudited)
Consolidated Statements of Cash Flows, 8-9
Three Months Ended March 31, 2003 and 2002 (Unaudited)
Notes to Consolidated Financial Statements 10-14
Item 2 - Management's Discussion and Analysis of 15-19
Financial Condition and Results of Operations
Item 3 - Quantitative and Qualitative Disclosures about 20
Market Risk
Item 4 - Controls and Procedures 20
Part II Other Information
Items 1 - 3 - Legal Proceedings; Changes in 21
Securities and Use of Proceeds;
Defaults Upon Senior Securities
Item 4 - Submission of Matters to a Vote of 21
Security Holders
Item 5 - Other Information 21
Item 6 - Exhibits and Reports on Form 8-K 21
Signatures 22-23
- ----------
Index to Exhibits 24-25
- -----------------
2
Part I
Financial Information
Item 1. Financial Statements
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
March 31, 2003 and December 31, 2002
(Unaudited) (Audited)
March December 31,
($ In thousands except share and per share data) 2003 2002
============= =============
Assets
Cash and due from banks $13,618 $12,316
Interest-bearing deposits 22,421 18,818
Federal funds sold 2,129 1,724
Securities available for sale 123,079 119,734
Securities held to maturity (fair value
$108,292 in 2003 and $103,187 in 2002) 104,666 99,560
Mortgage loans held for sale 737 846
Loans:
Real estate construction loans 27,166 22,294
Real estate mortgage loans 80,895 82,193
Commercial and industrial loans 210,571 209,368
Loans to individuals 92,547 96,762
------------- -------------
Total loans 411,179 410,617
Less unearned income and deferred fees (1,104) (1,278)
------------- -------------
Loans, net of unearned income
and deferred fees 410,075 409,339
Less: allowance for loan losses (5,390) (5,092)
------------- -------------
Loans, net 404,685 404,247
------------- -------------
Bank premises and equipment, net 9,558 9,938
Accrued interest receivable 5,179 4,290
Other real estate owned, net 751 537
Intangible assets and goodwill, net 10,674 10,912
Other assets 2,245 2,013
------------- -------------
Total assets $699,742 $684,935
============= =============
Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits $79,081 $74,032
Interest-bearing demand deposits 166,238 165,216
Savings deposits 50,448 48,956
Time deposits 325,006 320,067
------------- -------------
Total deposits 620,773 608,271
------------- -------------
Other borrowed funds 178 748
Accrued interest payable 627 700
Other liabilities 2,438 2,115
------------- -------------
Total liabilities 624,016 611,834
------------- -------------
3
Stockholders' Equity Preferred stock of no par value.
Authorized 5,000,000 shares; none
issued and outstanding --- ---
Common stock of $2.50 par value.
Authorized 5,000,000 shares; issued and
outstanding 3,511,377 shares in 2003 and
3,511,377 in 2002 8,778 8,778
Retained earnings 65,157 62,525
Accumulated other comprehensive income 1,791 1,798
------------- -------------
Total stockholders' equity 75,726 73,101
------------- -------------
Total liabilities and
stockholders' equity $699,742 $684,935
============= =============
See accompanying notes to the consolidated financial statements
4
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended March 31, 2003 and 2002
(Unaudited)
March 31, March 31,
($000's except share and per share data) 2003 2002
=============== ================
Interest income
- ---------------
Interest and fees on loans $7,654 $8,059
Interest on interest-bearing deposits 64 45
Interest on federal funds sold 4 9
Interest on securities - taxable 1,444 1,403
Interest on securities - nontaxable 1,310 1,078
--------------- ----------------
Total interest income 10,476 10,594
--------------- ----------------
Interest expense
- ----------------
Interest on time deposits $100,000 or more 833 920
Interest on other deposits 2,644 3,344
Interest on borrowed funds 1 2
--------------- ----------------
Total interest expense 3,478 4,266
--------------- ----------------
Net interest income 6,998 6,328
Provision for loan losses 440 646
--------------- ----------------
Net interest income after
provision for loan losses 6,558 5,682
--------------- ----------------
Noninterest income
- ------------------
Service charges on deposit accounts 526 535
Other service charges and fees 75 55
Credit card fees 346 305
Trust income 259 239
Other income 172 255
Realized securities losses, net (9) (20)
--------------- ---------------
Total noninterest income 1,369 1,369
--------------- ----------------
Noninterest expense
- -------------------
Salaries and employee benefits 2,405 2,227
Occupancy and furniture and fixtures 434 397
Data processing and ATM 252 284
Credit card processing 287 257
Intangibles and goodwill amortization 238 238
Net costs of other real estate owned 6 84
Other operating expenses 945 902
--------------- ----------------
Total noninterest expense 4,567 4,389
--------------- ----------------
Income before income tax expense 3,360 2,662
Income tax expense 728 558
--------------- ----------------
Net income $2,632 $2,104
=============== ================
5
Net income per share, basic and diluted $0.75 $0.60
=============== ================
Weighted average number of common
shares outstanding - basic 3,511,377 3,511,377
- diluted 3,527,864 3,512,824
Dividends declared per share $--- $---
=============== ================
See accompanying notes to consolidated financial statements.
6
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Three Months Ended March 31, 2003 and 2002
(Unaudited)
Accumulated
Other
($000's, except for per Common Retained Comprehensive Comprehensive
share data) Stock Earnings Income (Loss) Income Total
=========== ============= ================ ================ ===========
Balances, December 31, 2001 $8,778 55,917 566 --- $65,261
Net income --- 2,104 --- 2,104 2,104
Other comprehensive income, net of tax:
Unrealized gains
on securities
available for sale, net
of income tax $13 --- --- --- 25 ---
Reclass adjustment net
of tax $7 --- --- --- 13 ---
Other comprehensive income --- --- 38 38 38
----------- ------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- 2,142 ---
=========== ============= ================ ================ ===========
Balances, March 31, 2002 $8,778 58,021 604 --- $67,403
=========== ============= ================ ================ ===========
Balances, December 31, 2002 $8,778 62,525 1,798 --- 73,101
Net income --- 2,632 --- 2,632 2,632
Other comprehensive income,
net of tax
Unrealized losses on
securities available for
sale, net of income tax
$(7) --- --- --- (13) ---
Reclass adjustment net of
income tax $3 --- --- --- 6 ---
Other comprehensive income (loss) --- --- (7) (7) (7)
----------- ------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- 2,625 ---
=========== ============= ================ ================ ===========
Balances, March 31,2003 $8,778 65,157 1,791 --- $75,726
=========== ============= ================ ================ ===========
See accompanying notes to consolidated financial statements.
7
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2003 and 2002
(Unaudited)
March 31, March 31,
($000's) 2003 2002
=============== =================
Cash flows from operating activities
- ------------------------------------
Net income $2,632 $2,104
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 440 646
Depreciation of bank premises and equipment 222 251
Amortization of intangibles 238 238
Amortization of premiums and accretion of
discount, net 128 122
Losses on sales of bank premises and equipment 36 ---
Losses on sales and calls of securities
available for sale, net 9 20
Losses and writedowns on other real estate owned 3 70
(Increase) decrease in:
Mortgage loans held for sale 109 438
Accrued interest receivable (889) (75)
Other assets (266) 59
Increase (decrease) in:
Accrued interest payable (73) (191)
Other liabilities 323 329
--------------- -----------------
Net cash provided by operating
activities 2,912 4,011
--------------- -----------------
Cash flows from investing activities
- ------------------------------------
Net (increase) in federal funds sold (405) (740)
Net (increase) decrease in interest-bearing
deposits (3,603) 5,742
Proceeds from calls, principal payment and maturities of
securities available for sale 5,380 5,976
Proceeds from calls principal payments and maturities of
securities held to maturity 4,425 4,259
Purchases of securities available for sale (8,800) (2,753)
Purchases of securities held to maturity (9,566) ---
Purchases of loan participations (43) (1,581)
Collections of loan participations 1,095 801
Net (increase) in loans to customers (2,288) (11,595)
Proceeds from disposal of other real estate owned 14 13
Recoveries on loans charged off 127 40
Purchase of bank premises and equipment (281) (144)
Proceeds from disposal of bank premises and equipment 403 ---
--------------- -----------------
Net cash (used in)provided by investing
activities (13,542) 18
-------------- -----------------
8
Cash flows from financing activities
- ------------------------------------
Net increase (decrease) deposits 7,563 (9,573)
Net increase in time deposits 4,939 3,502
Net increase(decrease)in other borrowed funds (570) 465
--------------- ----------------
Net cash provided by (used in) provided by financing
activities 11,932 (5,606)
--------------- ----------------
Net (decrease) increase in cash and due from banks 1,302 (1,577)
Cash and due from banks at beginning of period 12,316 12,293
--------------- ----------------
Cash and due from banks at end of period $13,618 $10,716
=============== ================
Supplemental disclosure of cash flow information
- ------------------------------------------------
Cash paid for interest $3,551 $4,457
=============== ================
Cash paid for income taxes $--- $---
=============== ================
Loans charged to the allowance for loan losses $269 $344
=============== ================
Loans transferred to other real estate owned $231 $97
=============== ================
Unrealized gains (losses) on securities available for sale $(11) $58
=============== ================
See accompanying notes to consolidated financial statements.
9
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2003
(Unaudited)
Note (1)
The consolidated financial statements of National Bankshares, Inc.
(Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg
(NBB), Bank of Tazewell County (BTC) and National Bankshares Financial Services
(NBFS), (the Company), conform to accounting principles generally accepted in
the United States of America and to general practices within the banking
industry. The accompanying interim period consolidated financial statements are
unaudited; however, in the opinion of management, all adjustments consisting of
normal recurring adjustments which are necessary for a fair presentation of the
consolidated financial statements have been included. The results of operations
for the three months ended March 31, 2003 are not necessarily indicative of
results of operations for the full year or any other interim period. The interim
period consolidated financial statements and financial information included
herein should be read in conjunction with the notes to consolidated financial
statements included in the Company's 2002 Annual Report to Stockholders and
additional information supplied in the 2002 Form 10-K.
Note (2) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended
March 31, December 31,
2003 2002 2002
============== ============== =================
($000's, except for % data)
Balance at beginning of period $5,092 $4,272 $4,272
Provision for loan losses 440 646 2,251
Loans charged off (269) (344) (1,571)
Recoveries 127 40 140
-------------- -------------- -----------------
Balance at the end of period $5,390 $4,614 $5,092
============== ============== =================
Ratio of allowance for loan losses to the end
of period loans net of unearned income and
deferred fees 1.31% 1.12% 1.24%
============== ============== =================
Ratio of net charge-offs (recoveries) to
average loans, net of unearned income and
deferred fees(1) .14% .31% .35%
Ratio of allowance for loan losses to
nonperforming loans(2) 3,934.31% 1,243.67% 1,768.06%
============== ============== =================
(1) Net charge-offs are on an annualized basis.
(2) The Company defines nonperforming loans as total nonaccrual and
restructured loans. Loans 90 days past due and still accruing are
excluded.
10
March 31, December 31,
2003 2002 2002
============= ============ ================
($000's, except for % data)
Nonperforming Assets
- --------------------
Nonaccrual loans $137 $371 $288
Restructured loans --- --- ---
------------- ------------ ----------------
Total nonperforming loans 137 371 288
Foreclosed property 751 224 537
------------- ------------ ----------------
Total nonperforming assets $888 $595 $825
============= ============ ================
Ratio of nonperforming assets to loans, net of
unearned income and deferred fees, plus other real
estate owned .22% .14% .20%
============= ============ ================
11
March 31, December,31
2003 2002 2002
============= ============ ==============
Accruing Loans Past Due 90 Days or More
- ---------------------------------------
Past due 90 days or more and
still accruing $903 $473 $977
============= ============ ==============
Ratio of loans past due 90 days or
more to loans, net of unearned
income and deferred fees 0.22% .12% .24%
============= ============ ==============
Impaired Loans
- --------------
Total impaired loans $133 $437 $139
============= ============ ==============
Impaired loans with a
valuation allowance $93 $311 $93
Valuation allowance (33) (122) (33)
------------- ------------ --------------
Impaired loans net of allowance $60 $189 $60
============= ============ ==============
Impaired loans with no
valuation allowance $40 $126 $46
============= ============ ==============
Average recorded investment
in impaired loans $120 $389 $397
============= ============ ==============
Income recognized on impaired
loans $1 $4 $11
============= ============ ==============
Amount of income recognized
on a cash basis --- --- ---
============= ============ ==============
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 at March
31, 2003 were $27. If interest on these loans had been accrued, such income
would have been approximately $1.
12
Note (3) Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for the sale by major security type as of
March 31, 2003 are as follows:
March 31, 2003
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Available for sale:
U.S. Treasury $3,747 181 --- 3,928
U.S. Government agencies and
corporations 7,039 64 --- 7,103
State and political
subdivisions 71,847 2,126 110 73,863
Mortgage-backed
securities 15,631 484 6 16,109
Corporate debt
securities 18,054 585 112 18,527
Federal Reserve Bank stock 209 --- --- 209
Federal Home Loan
Bank stock 1,655 --- --- 1,655
Other securities 1,566 119 --- 1,685
----------------- ----------------- ----------------- ------------------
Total securities
available for sale $119,748 3,559 228 123,079
================= ================= ================= ==================
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of March
31, 2003 are as follows:
March 31, 2003
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Held to Maturity:
U.S. Government agencies and
corporations $8,010 240 --- 8,250
State and political
subdivisions 58,336 1,824 121 60,039
Mortgage-backed
securities 7,579 317 --- 7,896
Corporate securities 30,741 1,620 254 32,107
----------------- ----------------- ----------------- ------------------
Total securities
held to maturity $104,666 4,001 375 108,292
================= ================= ================= ==================
13
Note (4) Stock-Based Compensation
At March 31, 2003, the Company had a stock-based employee compensation
plan which is described more fully in the Company's Form 10-K dated December 31,
2002. The Company accounts for this plan under the recognition and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and
related Interpretations. No stock-based employee compensation cost is reflected
in net income, as all options granted under the plan had an exercise price equal
to the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share if
the company had applied the fair value recognition provisions of FASB Statement
No. 123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
Period ended March 31,
($ In thousands, except per share data) 2003 2002
---- ----
Net income, as reported $2,632 $2,104
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all awards (7) (6)
------------- -------------
Pro forma net income $2,625 $2,098
============= =============
Earnings per share:
Basic-as reported $.75 $.60
============= =============
Basic-pro forma $.75 $.60
============= =============
Diluted-as reported $.75 $.60
============= =============
Diluted-pro forma $.74 $.60
============= =============
There were no stock options granted, exercised, or forfeited in the
first quarter of 2003.
14
National Bankshares, Inc. and Subsidiaries
(In 000's, except for per share data)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The purpose of this discussion is to provide information about the
financial condition and results of operations of National Bankshares, Inc. and
its wholly-owned subsidiaries (the Company), which are not otherwise apparent
from the consolidated financial statements and other information included in
this report. Reference should be made to the financial statements and other
information included in this report as well as the 2002 Annual Report and Form
10-K for an understanding of the following discussion and analysis.
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. The Company's actual results could
differ materially from those set forth in the forward-looking statements.
Critical Accounting Policies
General
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States (GAAP). The
financial information contained within our statements is, to a significant
extent, financial information that is based on measures of the financial effects
of transactions and events that have already occurred. A variety of factors
could affect the ultimate value that is obtained either when earning income,
recognizing an expense, recovering an asset or relieving a liability. We use
historical loss factors as one factor in determining the inherent loss that may
be present in our loan portfolio. Actual losses could differ significantly from
the historical factors that we use. In addition, GAAP itself may change from one
previously acceptable method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that
losses be accrued when they are probable of occurring and estimatable and (ii)
SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that
losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
Our allowance for loan losses has three basic components: the formula
allowance, the specific allowance and the unallocated allowance. Each of these
components is determined based upon estimates that can and do change when the
actual events occur. The formula allowance uses a historical loss view as an
indicator of future losses and, as a result, could differ from the loss incurred
in the future. However, since this history is updated with the most recent loss
information, the errors that might otherwise occur are mitigated. The specific
allowance uses various techniques to arrive at an estimate of loss. Historical
loss information, expected cash flows and fair market value of collateral are
used to estimate these losses. The use of these values is inherently subjective
and our actual losses could be greater or less than the estimates. The
unallocated allowance captures losses that are attributable to various economic
15
events, industry or geographic sectors whose impact on the portfolio have
occurred but have yet to be recognized in either the formula or specific
allowance.
Core deposit intangibles
Effective January 1, 2002, the Corporation adopted Financial Accounting
Standards Board Statement No. 142, Goodwill and Other Intangible Assets.
Accordingly, goodwill is no longer subject to amortization over its estimated
useful life, but is subject to at least an annual assessment for impairment by
applying a fair value based test. Additionally, Statement 142 requires that
acquired intangible assets (such as core deposit intangibles) be separately
recognized if the benefit of the asset can be sold, transferred, licensed,
rented, or exchanged, and amortized over its estimated useful life. Branch
acquisition transactions were outside the scope of the Statement and therefore
any intangible asset arising from such transactions remained subject to
amortization over their estimated useful life.
In October 2002, the Financial Accounting Standards Board issued
Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement
amends previous interpretive guidance on the application of the purchase method
of accounting to acquisitions of financial institutions, and requires the
application of Statement No. 141, Business Combinations, and Statement No. 142
to branch acquisitions if such transactions meet the definition of a business
combination. The provisions of the Statement do not apply to transactions
between two or more mutual enterprises. In addition, the Statement amends
Statement No. 144, Accounting for the Impairment of Long-Assets, to include in
its scope core deposit intangibles of financial institutions. Accordingly, such
intangibles are subject to a recoverability test based on undiscounted cash
flows, and to the impairment recognition and measurement provisions required for
other long-lived assets held and used. The Company has determined that the
acquisitions that generated the intangible assets and goodwill on the
consolidated balance sheets in the amount of $10,912 and $11,866 at December 31,
2002 and 2001, respectively, did not constitute the acquisition of a business,
and therefore will continue to be amortized.
Analysis of Financial Condition and Results of Operations for the Three
Months Ended March 31, 2003
- -----------------------------------------------------------------------
Net income for the three months ended March 31, 2003 was $2,632, which
represents an increase of $528 or 25.10% when compared to the same period in
2002. The annualized return on average assets for the three months ended March
31, 2003 was 1.55% and 1.34% for March 31, 2002. The annualized return on
average equity was 14.31% for the period ended March 31, 2003 and 12.77% for
March 31, 2002.
Earnings per share for the period ended March 31, 2003 was $0.75 and
$0.60 in 2002 for the same period.
Net Interest Income
Net interest income at the end of the first quarter of 2003 was $6,998,
an increase of $670 or 10.59% over the same period in 2002. Interest income
decreased $118 or 1.11%, when the periods ending March 31, 2003 and 2002 are
compared. Interest expense decreased $788, or 18.47%, when the two periods are
compared. The yield on earning assets was 6.92%, decreasing 60 basis points from
March 31, 2002. The cost to fund earning assets for the period ending March 31,
2003 was 2.15% or a 25 basis point decrease from the same period in 2002. This
resulted in an increase in the net interest margin. Substantially lower funding
costs due to the low rate environment accounted for most of the improvement in
net interest income.
16
Following is a table showing the year-to-date average balances for
interest-earning assets, interest-bearing liabilities and the related yield and
cost.
Average Yield Cost
Balance Interest
Loans, net (1) 407,318 7,679 7.65%
Taxable securities 101,344 1,444 5.78%
Nontaxable securities (1) 121,814 1,993 6.63%
Federal funds sold 1,558 4 1.04%
Interest-bearing deposits 23,014 64 1.13%
----------------- ---------------- -------------
Total interest-earning assets 655,048 11,184 6.92%
================= ================ =============
Interest-bearing demand deposits 165,206 469 1.15%
Savings deposits 49,664 104 0.85%
Time deposits 321,806 2,904 3.66%
Short-term borrowings 239 1 1.70%
================= ================ =============
Total interest-bearing liabilities $536,915 3,478 2.62%
---------------- -------------
Net interest income/interest spread 7,706 4.30%
================ =============
Net interest margin 4.77%
================ =============
(1) Yield is on a tax equivalent basis.
Provision and Allowance for Loan Losses
The adequacy of the allowance for loan losses is based on management's
judgement and analysis of current and historical loss experience, risk
characteristics of the loan portfolio, concentrations of credit and asset
quality, as well as other internal and external factors such as general economic
conditions.
An internal credit review department performs pre-credit analyses of
large credits and also conducts credit review activities that provide management
with an early warning of asset quality deterioration. Changing trends in the
loan mix are also evaluated in determining the adequacy of the allowance for
loan losses.
The ratio of the allowance for loan losses to loans net of unearned
income was 1.31% at March 31, 2003. This compares to 1.12% at March 31, 2002.
The provision for the first three months of 2003 was $440, down $206 over the
same period the prior year.
While management continues to believe that overall credit quality
remains satisfactory, the level of exposure to loss has increased, particularly
in the loans to individuals category. In addition, much of the growth recently
experienced has been in the commercial loan category. While the number of
possible defaults would only constitute a small number of loans, the sizable
dollar amount of the individual credits tends to increase the possibility of
greater loss.
Noninterest Income
Noninterest income is an important source of the Company's income. This
category is comprised of service charges on deposit accounts, other service
charges and fees, credit card fees, trust income and other income. Net
securities gains and losses are also included in this category. Noninterest
income for the period ending March 31, 2003 and 2002 was $1,369.
17
Service charges on deposit accounts decreased $9 or 1.7%, a slight
decrease when compared to the same period in 2002.
Other service charges and fees increased $20 when March 31, 2003 and
March 31, 2002 are compared. The majority of this increase came from credit life
insurance commissions.
Credit card fees increased $41, or 13.4%. This increase was the result
of an increased volume of merchant and interchange fees.
Trust income increased by 8.4% in 2003, when compared to the first three
months of 2002. Trust income is dependent on market conditions as well as the
types of accounts being handled at any given point in time. The level of estate
business, for example, cannot be predicted with any degree of precision.
Realized securities losses were $(9) for the first quarter of 2003. The
net losses were primarily associated with the adjustment of the Company's
investment in certain limited liability corporations.
Noninterest Expense
Noninterest expense for the period ended March 31, 2003 was $4,567, an
increase of $178 or 4.1%.
Salaries and employee benefits increased by $178 or 8.0% when the
periods ended March 31, 2003 and 2002 are compared. Rising pension costs and
normal salary adjustments accounted for the majority of the increase.
Occupancy expenses increased $37 when the first quarters of 2003 and
2002 are compared. Equipment maintenance costs accounted for most of the
increase.
Data processing costs decreased $32 or 11.3%. A decrease in depreciation
of $23 and a decline of $6 in data processing supplies accounted for a majority
of the difference.
Credit card processing increased $30 or 11.7% due to volume. As
previously noted credit card income was also up for the year because of volume.
Intangibles expense for the first quarters of 2003 and 2002 was $238.
There were no impairment write downs during the first quarter.
Other operating costs increased a nominal $43 or 4.8% when the periods
March 31, 2003 and 2002 are compared.
Balance Sheet
Total assets at March 31, 2003 were $699,742, an increase of $14,807 or
2.2% from period end assets at December 31, 2002. This increase was primarily
due to deposit growth, which was $12,502 or 2.1%.
Securities
Securities available for sale increased by 2.8%, while securities held
to maturity increased 5.1%. (Refer to the table previously presented for
portfolio composition.) Funds for these increases came primarily from deposit
growth.
Loans
Loans net of unearned income grew by $736 or 0.18% from December 31,
2002. Since December 31, 2002, construction loans increased by $4,872 or 21.9%,
18
with real estate mortgage loans decreasing $1,298 or 1.58%. The commercial loan
category grew by $1,203 or .57% due to demand. Loans to individuals declined by
$4,215 or 4.4%. It is not known to what extent loans to individuals will
ultimately decline or when growth in this area will resume, given the general
economic conditions.
Deposits
Total deposits increased $12,502 or 2.1% when March 31, 2003 and
December 31, 2002 are compared.
Noninterest-bearing demand deposits increased $5,049 or 6.8% when March
31, 2003 and December 31, 2002 are compared. During the same period
interest-bearing demand deposits increased by .6%, while savings deposits were
up 3.1%. Time deposits rose by $4,939 or 1.5%.
Daily Averages
Daily averages for the major categories are as follows:
(000's) March 31, 2003 December 31,2002
------------------- ---------------------
Loans, net $400,899 $404,717
Securities available for sale 120,678 96,877
Securities held to maturity 102,480 94,616
Total assets 687,922 655,783
Total deposits 610,397 583,298
Stockholders' equity 74,614 69,895
Liquidity
Liquidity is the ability to provide sufficient cash levels to meet
financial commitments and to fund loan demand and deposit withdrawals.
Cash from operating activities was $2,912. The primary sources were net
income and net sales of real estate loans held for sale.
Cash used in investing activities was $13,542. As can be seen from the
cash flow statement, the principal use of cash was for securities.
Financing activities during the period produced $11,932 in cash, mainly
due to an increase in deposits.
Management is not aware of any commitments that will result in, or are
likely to result in, a material and adverse decrease in liquidity.
Capital Resources
Total stockholders' equity increased by $2,625 from December 31, 2002 to
March 31, 2003. Of that change, $(7) was due to the change in accumulated
comprehensive income. Net income of $2,632 accounted for the remainder of the
increase. The Company's risk based capital ratios at March 31, 2003 are as
follows.
Total capital 13.17%
Tier I 13.06%
Leverage ratio 9.39%
The Company's banking affiliates continue to meet the regulatory criteria
for well capitalized.
19
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Derivatives
The Company is not a party to derivative financial instruments with
off-balance sheet risks such as futures, forwards, swaps and options. The
Company is a party to financial instruments with off-balance sheet risks such as
commitments to extend credit, standby letters of credit, and recourse
obligations in the normal course of business to meet the financing needs of its
customers. Management does not plan any future involvement in high risk
derivative products. The Company has investments in collateralized mortgage
obligations, structured notes and other similar instruments that are included in
securities available for sale and securities held to maturity. The fair value of
these investments at March 31, 2003 approximated $3,864. Amortized cost for
these securities approximated $3,730.
Interest Rate Sensitivity
The Company considers interest rate risk to be a significant market risk
and systems in place to measure the exposure of net interest income to adverse
movement in interest rates. Interest rate shock analyses provides management
with an indication of potential economic loss due to future rate changes. There
have not been any changes, which would significantly alter the results disclosed
as of December 31, 2002.
Item 4. Controls and Procedures
Under the supervision and with the participation of management, including our
principal executive officer and principal financial officer, we have evaluated
the effectiveness of the design and operation of our disclosure controls and
procedures within 90 days of the filing of this annual report. Based on that
evaluation, our principal executive officer and principal financial officer have
concluded that these controls and procedures are effective. There were no
significant changes in our internal controls or in other factors that could
significantly affect these controls subsequent to the date of their evaluation.
Disclosure controls and procedures are our controls and procedures that are
designed to ensure that information required to be disclosed by us in the
reports that we file or submit under the Exchange Act is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate, to allow timely decisions regarding
required disclosure.
20
National Bankshares, Inc. and Subsidiaries
Part II
Other Information
Items 1-3. Legal Proceedings; Changes in Securities and Use of Proceeds;
Defaults upon Senior Securities
None for the three months ended March 31, 2003.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
The Company had no filings on Form 8-K for the period ended
March 31, 2003. See the index to exhibits for Items
incorporated by reference to this filing.
21
Signatures
National Bankshares, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
NATIONAL BANKSHARES, INC.
I, James G. Rakes, certify that:
1. I have reviewed this quarterly report on Form 10-Q of National Bankshares,
Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a - 14 and 15d - 14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial date and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weakness.
Date: May 14, 2003
/s/ James G. Rakes
- ---------------------------
James G. Rakes
Chief Executive Officer
22
I, J. Robert Buchanan certify that:
1. I have reviewed this quarterly report on Form 10-K of National Bankshares,
Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a - 14 and 15d - 14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial date and have identified for the registrant's
auditors any material weaknesses in internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weakness.
Date: May 14, 2003
/s/ J. Robert Buchanan
- ---------------------------
J. Robert Buchanan
Chief Financial Officer
23
Index to Exhibits
Page No. In
Exhibit No. Description Sequential System
- ----------- ----------- -----------------
3(i) Articles of Incorporation, as amended, (incorporated herein by
of National Bankshares, Inc. reference to Exhibit
3(a) of the Annual
Report on Form 10K for
fiscal year ended
December 31, 1993)
4(i) Specimen copy of certificate for (incorporated herein by
National Bankshares, Inc. common stock, reference to Exhibit
$2.50 par value 4(a) of the Annual
Report on Form 10K for
fiscal year ended
December 31, 1993)
4(i) Article Fourth of the Articles of (incorporated herein by
Incorporation of National Bankshares, reference to Exhibit
Inc. 4(b) of the Annual
Report on Form 10K for
fiscal year ended
December 31, 1993)
10(ii)(B) Computer software license agreement (incorporated herein by
dated June 18, 1990, by and between reference to Exhibit
Information Technology, Inc. and The 10(e) of the Annual
National Bank of Blacksburg Report on Form 10K for
fiscal year ended
December 31, 1992)
*10(iii)(A) National Bankshares, Inc. 1999 Stock (incorporated herein by
Option Plan reference to Exhibit
4.3 of the Form S-8,
filed as Registration
No. 333-79979 with the
Commission on June 4,
1999)
*10(iii)(A) Employment Agreement dated January (incorporated herein by
2002 between National Bankshares, Inc. reference to Exhibit
and James G. Rakes 10(iii)(A) of Form 10Q
for the period ended
June 30, 2002)
*10(iii)(A) Employee Lease agreement dated August (incorporated herein by
14, 2002, by and between National reference to Exhibit
Bankshares and The National Bank of 10(iii)(A) of Form 10Q
Blacksburg for the period ended
September 30, 2002)
*10(iii)(A) Change in Control Agreement dated (incorporated herein by
January 5, 2003, between National reference to Exhibit
Bankshares, Inc. and Marilyn B. 10(iii) on Form 10K for
Buhyoff. the Fiscal Year ended
December 31, 2002)
*10(iii)(A) Change in Control Agreement dated (incorporated herein by
January 8, 2003, between National reference to Exhibit
Bankshares, Inc. and F. Brad Denardo. 10(iii) on Form 10K for
the Fiscal Year ended
December 31, 2002)
*10(iii)(A) Change in Control Agreement dated (incorporated herein by
June 1, 1998, between Bank of Tazewell reference to Exhibit
County and Cameron L. Forester 10(iii) on Form 10K for
the Fiscal Year ended
December 31, 2002)
24
99(a) Certification of Chief Executive Officer Page 26
Pursuant to 18 U.S.C. Section 350
99(b) Certification of Chief Financial Officer Page 27
Pursuant to 18 U.S.C. Section 350
25