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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 June 30, 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 August 1, 2003
- ------------------------------ -----------------------------
Common Stock, $2.50 Par Value 3,512,877
(This report contains 33 pages)
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8 NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-Q
Index
Page
Part I Financial Information
Item 1 - Financial Statements
Consolidated Balance Sheets, June 30, 2003 (Unaudited) 3-4
and December 31, 2002
Consolidated Statements of Income for the 5-6
Three Months Ended
June 30, 2003 and 2002 (Unaudited)
Consolidated Statements of Income for the 7-8
Six Months Ended June 30, 2003 and 2002 (Unaudited)
Consolidated Statements of Changes in 9
Stockholders' Equity, Six Months Ended
June 30, 2003 and 2002 (Unaudited)
Consolidated Statements of Cash Flows, 10-11
Six Months Ended June 30, 2003 and 2002 (Unaudited)
Notes to Consolidated Financial Statements 12-16
Item 2 - Management's Discussion and Analysis of 17-23
Financial Condition and Results of Operations
Item 3 - Quantitative and Qualitative Disclosures about 24
Market Risk
Item 4 - Controls and Procedures 24
Part II Other Information
Items 1 - 3 - Legal Proceedings; Changes in 25
Securities and Use of Proceeds;
Defaults Upon Senior Securities
Item 4 - Submission of Matters to a Vote of 25
Security Holders
Item 5 - Other Information 25
Item 6 - Exhibits and Reports on Form 8-K 26
Signatures 27
Index to Exhibits 28-29
2
Part I
Financial Information
Item 1. Financial Statements
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
June 30, 2003 and December 31, 2002
(Unaudited) (Audited)
June 30, December 31,
($ In thousands except share and per share data) 2003 2002
================== ===================
Assets
Cash and due from banks $15,047 $12,316
Interest-bearing deposits 17,782 18,818
Federal funds sold 3,442 1,724
Securities available for sale 126,159 119,734
Securities held to maturity (fair value
$111,062 in 2003 and $103,187 in 2002) 104,401 99,560
Mortgage loans held for sale 185 846
Loans:
Real estate construction loans 32,134 22,294
Real estate mortgage loans 83,421 82,193
Commercial and industrial loans 211,330 209,368
Loans to individuals 92,176 96,762
------------------ -------------------
Total loans 419,061 410,617
Less unearned income and deferred fees (1,057) (1,278)
------------------ -------------------
Loans, net of unearned income
and deferred fees 418,004 409,339
Less: allowance for loan losses (5,493) (5,092)
------------------ -------------------
Loans, net 412,511 404,247
------------------ -------------------
Bank premises and equipment, net 9,950 9,938
Accrued interest receivable 5,060 4,290
Other real estate owned, net 743 537
Intangible assets and goodwill, net 10,435 10,912
Other assets 1,666 2,013
------------------ -------------------
Total assets $707,381 $684,935
================== ===================
Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits $87,917 $74,032
Interest-bearing demand deposits 167,667 165,216
Savings deposits 52,369 48,956
Time deposits 317,894 320,067
------------------ -------------------
Total deposits 625,847 608,271
------------------ -------------------
Other borrowed funds 521 748
Accrued interest payable 574 700
Other liabilities 1,968 2,115
------------------ -------------------
Total liabilities 628,910 611,834
------------------ -------------------
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 10,000,000 shares; issued and
outstanding 3,512,877 shares in 2003 and
3,511,377 in 2002 8,782 8,778
Retained earnings 66,086 62,525
Accumulated other comprehensive income 3,603 1,798
----------------- -------------------
Total stockholders' equity 78,471 73,101
----------------- -------------------
Total liabilities and
stockholders' equity $707,381 $684,935
================= ===================
See accompanying notes to the consolidated financial statements
4
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended June 30, 2003 and 2002
(Unaudited)
June 30, June 30,
($000's except share and per share data) 2003 2002
============================================== ================ =================
Interest income
- ---------------
Interest and fees on loans $7,617 $8,107
Interest on interest-bearing deposits 73 53
Interest on federal funds sold 7 10
Interest on securities - taxable 1,356 1,369
Interest on securities - nontaxable 1,343 1,106
---------------- -----------------
Total interest income 10,396 10,645
---------------- -----------------
Interest expense
Interest on time deposits $100,000 or more 782 867
Interest on other deposits 2,474 3,092
Interest on borrowed funds --- 1
---------------- -----------------
Total interest expense 3,256 3,960
---------------- -----------------
Net interest income 7,140 6,685
Provision for loan losses 402 546
---------------- -----------------
Net interest income after
provision for loan losses 6,738 6,139
---------------- -----------------
Noninterest income
Service charges on deposit accounts 647 569
Other service charges and fees 66 79
Credit card fees 448 378
Trust income 245 241
Other income 93 94
Realized securities gains, net 5 185
---------------- -----------------
Total noninterest income 1,504 1,546
---------------- -----------------
Noninterest expense
- -------------------
Salaries and employee benefits 2,360 2,216
Occupancy and furniture and fixtures 398 427
Data processing and ATM 289 302
Credit card processing 338 227
Intangibles and goodwill amortization 239 240
Net costs of other real estate owned 13 39
Other operating expenses 932 897
---------------- -----------------
Total noninterest expense 4,569 4,348
---------------- -----------------
Income before income tax expense 3,673 3,337
Income tax expense 872 790
---------------- -----------------
Net income $2,801 $2,547
================ =================
5
Net income per share - basic $0.80 $0.72
================= =================
- diluted 0.79 0.72
================= =================
Weighted average number of common
shares outstanding - basic 3,512,514 3,511,377
- diluted 3,532,960 3,516,142
Dividends declared per share $0.54 $0.46
================= =================
See accompanying notes to consolidated financial statements.
6
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Six Months Ended June 30, 2003 and 2002
(Unaudited)
June 30, June 30,
($000's except share and per share data) 2003 2002
======================================== =============== =================
Interest income
- ---------------
Interest and fees on loans $15,271 $16,166
Interest on interest-bearing deposits 137 98
Interest on federal funds sold 11 19
Interest on securities - taxable 2,800 2,772
Interest on securities - nontaxable 2,653 2,184
--------------- -----------------
Total interest income 20,872 21,239
--------------- -----------------
Interest expense
- ----------------
Interest on time deposits $100,000 or more 1,615 1,787
Interest on other deposits 5,118 6,436
Interest on borrowed funds 1 3
--------------- -----------------
Total interest expense 6,734 8,226
--------------- -----------------
Net interest income 14,138 13,013
Provision for loan losses 842 1,192
--------------- -----------------
Net interest income after
provision for loan losses 13,296 11,821
--------------- -----------------
Noninterest income
- ------------------
Service charges on deposit accounts 1,173 1,104
Other service charges and fees 141 134
Credit card fees 794 683
Trust income 504 480
Other income 265 349
Realized securities gains (losses), net (4) 165
--------------- -----------------
Total noninterest income 2,873 2,915
--------------- -----------------
Noninterest expense
- -------------------
Salaries and employee benefits 4,765 4,443
Occupancy and furniture and fixtures 832 824
Data processing and ATM 541 586
Credit card processing 625 484
Intangibles and goodwill amortization 477 478
Net costs of other real estate owned 19 123
Other operating expenses 1,877 1,799
--------------- -----------------
Total noninterest expense 9,136 8,737
--------------- -----------------
Income before income tax expense 7,033 5,999
Income tax expense 1,600 1,348
--------------- -----------------
Net income $5,433 $4,651
=============== =================
7
Net income per share - basic $1.55 $1.32
================ ==================
- diluted 1.54 1.32
================ ==================
Weighted average number of common
shares outstanding - basic 3,511,949 3,511,377
- diluted 3,530,416 3,513,013
Dividends declared per share $0.54 $0.46
================ ==================
See accompanying notes to consolidated financial statements.
8
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Six Months Ended June 30, 2003 and 2002
(Unaudited)
Accumulated
Other
($000's, except for per Common Retained Comprehensive Comprehensive
share data) Stock Earnings Income Income Total
=========== ============= ================ ================ ===========
Balances, December 31, 2001 $8,778 55,917 566 --- $65,261
Net income --- 4,651 --- 4,651 4,651
Dividend ($0.46 per share) (1,616) (1,616)
Other comprehensive income, net of tax:
Unrealized gains
on securities
available for sale, net
of income expense tax $661 --- --- --- 1,291 ---
Reclass adjustment net
of tax $56 --- --- --- (109) ---
Other comprehensive income --- --- 1,182 1,182 1,182
----------- ------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- 5,833 ---
=========== ============= ================ ================ ===========
Balances, June 30, 2002 $8,778 58,952 1,748 --- $69,478
=========== ============= ================ ================ ===========
Balances, December 31, 2002 $8,778 62,525 1,798 --- $73,101
Net income --- 5,433 --- 5,433 5,433
Dividend ($0.54 per share) (1,897) (1,897)
Exercise of stock options 4 25 29
Other comprehensive income,
net of tax
Unrealized gains on
securities available for
sale, net of income tax
$(970) --- --- --- 1,802 ---
Reclass adjustment net of
income tax $1 --- --- --- 3 ---
Other comprehensive income --- --- 1,805 1,805 1,805
----------- ------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- 7,238 ---
=========== ============= ================ ================ ===========
Balances, June 30,2003 $8,782 66,086 3,603 --- $78,471
=========== ============= ================ ================ ===========
See accompanying notes to consolidated financial statements.
9
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2003 and 2002
(Unaudited)
June 30, June 30,
($000's) 2003 2002
================ ===============
Cash flows from operating activities:
Net income $5,433 $4,651
Adjustments to reconcile net income to net cash provided by
operating activities:
Provision for loan losses 842 1,192
Depreciation of bank premises and equipment 442 499
Amortization of intangibles 477 478
Amortization of premiums and accretion of
discount, net 377 196
Losses on sales of bank premises and equipment 40 ---
(Gains) Losses on sales and calls of securities
available for sale, net 6 (153)
(Gains) on calls of securities held to maturity (2) (12)
Losses and writedowns on other real estate owned 9 94
(Increase) decrease in:
Mortgage loans held for sale 661 754
Accrued interest receivable (770) (289)
Other assets 347 (195)
Increase (decrease) in:
Accrued interest payable (126) (328)
Other liabilities (1,117) (226)
---------------- ---------------
Net cash provided by operating
activities 6,619 6,661
---------------- ---------------
Cash flows from investing activities:
Net (increase) in federal funds sold (1,718) (3,149)
Net decrease in interest-bearing
deposits 1,036 11,538
Proceeds from calls, principal payment and maturities of
securities available for sale 12,284 7,491
Proceeds from calls principal payments and maturities of
securities held to maturity 8,222 8,715
Purchases of securities available for sale (16,127) (13,984)
Purchases of securities held to maturity (13,251) ---
Purchases of loan participations (1,975) (3,200)
Collections of loan participations 215 2,225
Net (increase) in loans to customers (7,789) (16,717)
Proceeds from disposal of other real estate owned 67 35
Recoveries on loans charged off 161 77
Purchase of bank premises and equipment (894) (274)
Proceeds from disposal of bank premises and equipment 400 ---
---------------- ---------------
Net cash (used in) investing
activities (19,369) (7,243)
--------------- ---------------
10
Cash flows from financing activities:
Net (decrease)in time deposits (2,173) (16,414)
Net increase in other deposits 19,749 17,833
Net increase(decrease)in other borrowed funds (227) 118
Exercise of stock options 29 ---
Dividends paid on common stock (1,897) (1,616)
---------------- ----------------
Net cash provided by (used in) financing
activities 15,481 (79)
---------------- ----------------
Net increase (decrease) in cash and due from banks 2,731 (661)
Cash and due from banks at beginning of period 12,316 12,293
---------------- ----------------
Cash and due from banks at end of period $15,047 $11,632
================ ================
Supplemental disclosure of cash flow information:
Cash paid for interest $6,860 $8,554
================ ================
Cash paid for income taxes $1,603 $1,439
================ ================
Loans charged to the allowance for loan losses $602 $698
================ ================
Loans transferred to other real estate owned $282 $219
================ ================
Unrealized gains on securities available for sale $2,776 $1,791
================ ================
See accompanying notes to consolidated financial statements.
11
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 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,
Inc. (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 and six months ended June 30, 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) Stock-Based Compensation
At June 30, 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.
Six months ended Three months ended June 30,
June 30,
($ In thousands, except per share data) 2003 2002 2003 2002
---- ---- ---- ----
Net income, as reported $5,433 $4,651 $2,801 $2,547
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards (20) (12) (13) (6)
-------------- --------------- -------------- -------------
Pro forma net income $,5,413 $4,639 $2,788 $2,541
-------------- --------------- -------------- -------------
Earnings per share:
Basic-as reported $1.55 $1.32 $0.80 $0.72
-------------- --------------- -------------- -------------
Basic-pro forma $1.54 $1.32 $0.79 $0.72
-------------- --------------- -------------- -------------
Diluted-as reported $1.54 $1.32 $0.79 $0.72
-------------- --------------- -------------- -------------
Diluted-pro forma $1.53 $1.32 $0.79 $0.72
-------------- --------------- -------------- -------------
There were no stock options granted, exercised, or forfeited in the
first quarter of 2003. There were 1,500 options exercised during the second
quarter, 500 at an original grant price of $22.00 per share and 1000 at $18.75
per share.
12
Note (3) Allowance for Loan Losses, Nonperforming Assets and Impaired
Loans
For the periods ended
June 30, 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 842 1,192 2,251
Loans charged off (602) (698) (1,571)
Recoveries 161 77 140
-------------- -------------- -----------------
Balance at the end of period $5,493 $4,843 $5,092
============== ============== =================
Ratio of allowance for loan losses to the end
of period loans net of unearned income and
deferred fees 1.31% 1.17% 1.24%
============== ============== =================
Ratio of net charge-offs (recoveries) to
average loans, net of unearned income and
deferred fees(1) .22% .31% .35%
Ratio of allowance for loan losses to
nonperforming loans(2) 5,182.08% 836.44% 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.
June 30, December 31,
2003 2002 2002
============= ============ ================
($000's, except for % data)
Nonperforming Assets:
Nonaccrual loans $106 $579 $288
Restructured loans --- --- ---
------------- ------------ --------------
Total nonperforming loans 106 579 288
Foreclosed property 743 301 537
------------- ------------ --------------
Total nonperforming assets $849 $880 $825
============= ============ ==============
Ratio of nonperforming assets to loans, net of
unearned income and deferred fees, plus other real
estate owned .21% .21% .20%
============= ============ ==============
13
June 30, December,31
2003 2002 2002
============= ============ ==============
Accruing Loans Past Due 90 Days or More
Past due 90 days or more and
still accruing $1,088 $876 $977
============= ============ ==============
Ratio of loans past due 90 days or
more to loans, net of unearned
income and deferred fees .26% .21% .24%
============= ============ ==============
Impaired Loans:
Total impaired loans $276 $682 $139
============= ============ ==============
Impaired loans with a
valuation allowance --- $231 $93
Valuation allowance --- (110) (33)
------------- ------------ --------------
Impaired loans net of allowance --- $121 $60
============= ============ ==============
Impaired loans with no
valuation allowance $276 $451 $46
============= ============ ==============
Average recorded investment
in impaired loans $172 $486 $397
============= ============ ==============
Income recognized on impaired
loans $8 $6 $11
============= ============ ==============
Amount of income recognized
on a cash basis --- --- ---
============= ============ ==============
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 at June
30, 2003 were $14.
14
Note (4) Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for the sale by major security type as of
June 30, 2003 are as follows:
June 30, 2003
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Available for sale:
U.S. Treasury $3,747 167 --- 3,914
U.S. Government agencies and
corporations 5,642 54 --- 5,696
State and political
subdivisions 73,694 3,996 27 77,663
Mortgage-backed
securities 12,860 461 --- 13,321
Corporate debt
securities 21,139 1,302 --- 22,441
Federal Reserve Bank stock-
restricted 208 --- --- 208
Federal Home Loan
Bank stock-restricted 1,644 --- --- 1,644
Other securities 1,153 119 --- 1,272
----------------- ----------------- ----------------- ------------------
Total securities
available for sale $120,087 6,099 27 126,159
================= ================= ================= ==================
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of June
30, 2003 are as follows:
June 30, 2003
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Held to Maturity:
U.S. Government agencies and
corporations $9,005 178 --- 9,183
State and political
subdivisions 57,214 3,521 50 60,685
Mortgage-backed
securities 6,329 292 --- 6,621
Corporate securities 31,853 2,731 11 34,573
----------------- ----------------- ----------------- ------------------
Total securities
held to maturity $104,401 6,722 61 111,062
================= ================= ================= ==================
15
Recent Accounting Announcements
In April 2003, the Financial Accounting Standards Board issued Statement
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. This Statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts (collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities. This Statement is effective for contracts
entered into or modified after June 30, 2003 and is not expected to have an
impact on the Company's consolidated financial statements.
In May 2003, the Financial Accounting Standards Board issued Statement
No. 150, Accounting for Certain Financial Instruments with Characteristics of
both Liabilities and Equity. This Statement establishes standards for how an
issuer classifies and measures certain financial instruments with
characteristics of both liabilities and equity. It requires that an issuer
classify a financial instrument that is within its scope as a liability (or an
asset in some circumstances). Many of those instruments were previously
classified as equity. This Statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003, except for
mandatory redeemable financial instruments of nonpublic entities. Adoption of
the Statement did not result in an impact on the Company's consolidated
financial statements.
16
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
17
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-Lived 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 Six Months
Ended June 30, 2003
- -------------------------------------------------------------------------------
Net income for the six months ended June 30, 2003 was $5,433, which
represents an increase of $782 or 16.81% when compared to the same period in
2002. The annualized return on average assets for the six months ended June 30,
2003 was 1.58% and 1.46% for June 30, 2002. The annualized return on average
equity was 14.44% for the period ended June 30, 2003 and 13.86% for June 30,
2002.
Basic earnings per share for the period ended June 30, 2003 was $1.55
and $1.32 in 2002 for the same period.
Net Interest Income
Net interest income at the end of the second quarter of 2003 was
$14,138, an increase of $1,125 or 8.65% over the same period in 2002. Interest
income decreased $367 or 1.73%, when the periods ending June 30, 2003 and 2002
are compared. Interest expense decreased $1,492, or 18.14%, when the two periods
are compared. The yield on earning assets was 6.88%, decreasing 56 basis points
from June 30, 2002. The cost to fund earning assets for the period ending June
30, 2003 was 2.07% or a 66 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 interest rate environment accounted for most of the
improvement in net interest income.
18
Following is a table showing the quarter-to-date average balances for
interest-earning assets, interest-bearing liabilities and the related yield and
cost.
Average
Balance Interest Yield Cost
---------- ---------- ---------
Loans, net (1) $414,116 $7,645 7.41%
Taxable securities 103,396 1,356 5.26%
Nontaxable securities (1) 124,614 2,044 6.58%
Federal funds sold 2,364 7 1.19%
Interest-bearing deposits 23,777 73 1.23%
---------- ---------- ---------
Total interest-earning assets $668,267 $11,125 6.68%
========== ========== =========
Interest-bearing demand deposits 165,692 392 .95%
Savings deposits 51,281 107 .84%
Time deposits 323,374 2,757 3.42%
Short-term borrowings 167 --- ---
========== ========== =========
Total interest-bearing liabilities $540,514 $3,256 2.42%
========== ========== =========
Net interest income/interest spread $7,869 4,26%
========== =========
Net interest margin 4.72%
========== =========
(1) Yield is on a tax equivalent basis.
Risk factors and forward looking statements apply as discussed in the
Company's 2002 Form 10-K in the Security, Liquidity, Interest Rate Sensitivity,
Securities and Net Interest Income sections.
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 June 30, 2003. This compares to 1.17% at June 30, 2002. The
provision for the first six months of 2003 was $842, down $1,192 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 June 30, 2003 and 2002 was $2,873 and $2,915,
respectively, which represents a 1.44% decrease.
19
Service charges on deposit accounts increased to $1,173 or 6.25%, when
compared to the same period in 2002. A portion of this increase was due to
modifications in the terms of certain demand deposit products and the associated
service charges.
Other service charges and fees increased $7 when June 30, 2003 and June
30, 2002 are compared.
Credit card fees increased $111, or 16.25%. This increase was primarily
the result of an increased volume of merchant and interchange fees.
Trust income increased by 5% in 2003, when compared to the first six
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 $(4) for the first six months of 2003.
The net losses were primarily associated with the adjustment of the Company's
investment in certain limited liability companies. Previous year net gains were
associated with the sale of certain equity securities by Bankshares.
Noninterest Expense
Noninterest expense for the period ended June 30, 2003 was $9,136, an
increase of $399 or 4.57%.
Salaries and employee benefits increased by $322 or 7.25% when the
periods ended June 30, 2003 and 2002 are compared. Rising pension costs and
normal salary adjustments accounted for the majority of the increase.
Occupancy expenses increased $8 when the first six months of 2003 and
2002 are compared. Equipment maintenance costs accounted for most of the
increase.
Data processing costs decreased $45 or 7.68%. A decrease in depreciation
in data processing supplies and maintenance costs accounted for a majority of
the decline.
Credit card processing increased $141 or 29.13% due to volume. As
previously noted credit card income was also up for the year because of volume
in the merchant and debit card areas.
Intangibles expense for the first six months of 2003 and 2002 was $477.
There were no impairment write downs during the period.
Other operating costs increased a by $78 or 4.34% when the periods June
30, 2003 and 2002 are compared.
Income Taxes
In the second quarter of 2003, the Company's level of profits resulted
in an increase from 34% to 35% in the federal income tax rate applicable to the
Company. In addition to the actual taxes paid to the Government, this change
affects other areas including the book tax provisions, deferred taxes and tax
equivalency calculations.
Balance Sheet
Total assets at June 30, 2003 were $707,381, an increase of $22,446 or
3.28% from period end assets at December 31, 2002. This increase was primarily
due to deposit growth, which was $17,576 or 2.89%.
20
Securities
Securities available for sale increased by 5.37%, while securities held
to maturity increased 4.86%. (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 $8,665 or 2.12% from December 31,
2002. Since December 31, 2002, construction loans increased by $9,840 or 44.14%,
with real estate mortgage loans increasing $1,228 or 1.49%. The commercial loan
category grew by $1,962 or 0.94% due to demand. Loans to individuals declined by
$4,586 or 4.74%. 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. In addition, given the many financing alternatives
available to customers, it is unknown whether percentage of loans to individuals
to total loans will return to previous levels.
Deposits
Total deposits increased $17,576 or 2.89% when June 30, 2003 and
December 31, 2002 are compared.
Noninterest-bearing demand deposits increased $13,885 or 18.76% when
June 30, 2003 and December 31, 2002 are compared. During the same period,
interest-bearing demand deposits increased by 1.48%, while savings deposits were
up 6.97%. Time deposits declined by $2,173 or 0.68%. As can be seen by this data
depositors continue to gravitate toward the more liquid short-term deposit
instruments. This trend is expected to continue until rising rates make longer
term time deposits a more attractive investment.
Daily Averages
Daily averages for the major categories are as follows:
(000's) June 30, 2003 December 31,2002
-------------------- -------------------
Loans, net $409,504 $404,717
Securities available for sale 122,696 96,877
Securities held to maturity 102,894 94,616
Total assets 694,276 655,783
Total deposits 615,646 583,298
Stockholders' equity 75,849 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 $6,619. The primary sources were net
income and net sales of real estate loans held for sale.
Cash used in investing activities was $19,369. As can be seen from the
cash flow statement, the principal use of cash was for securities.
Financing activities during the period produced $15,481 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 impact on liquidity.
21
Capital Resources
Total stockholders' equity increased by $5,370 from December 31, 2002 to
June 30, 2003. Of that change, $1,805 was due to the change in accumulated
comprehensive income. Net income of $5,433 accounted for most of the increase,
offset by a dividend to shareholders in the amount of $1,897. The Company's risk
based capital ratios at June 30, 2003 are as follows.
Total capital 14.11%
Tier I 13.00%
Leverage ratio 9.34%
The Company's banking affiliates continue to meet the regulatory criteria
for well capitalized.
Analysis of Financial Condition and Results of Operations for the Three Months
Ended June 30, 2003
- --------------------------------------------------------------------------------
Net income for the second quarter of 2003 was $2,801 an increase of $254
or 9.97% over the same period in 2002. The return on average assets for the
three months ended June 30, 2003 was 1.60%, which compared to 1.58% for the same
quarter in 2002. The return on average equity for the second quarter of 2003 was
14.57%, a slight decrease from 2002, when the return or average equity was
14.92%.
Net Interest Income
Net interest income for the second quarter of 2003 was $7,140 an
increase of 6.81% over the same period in 2002. Previously established trends
continued during the second quarter due to the continued low interest rate
environment. Higher rate earning assets continued to mature and/or reprice and
move into lower rate earning assets. At the same time interest bearing
liabilities also continued to mature and/or reprice into liabilities with lower
rates. The net interest margin for the second quarter of 2003 was 4.72% compared
to 4.78% for the same period in 2002.
Provision for Loan Losses
The provision for loan losses for the second quarter of 2003 was $402 a
decrease of $144 from the second quarter of 2002.
Management continues to expect net charge-off levels to be higher in
2003, particularly in the area of loans to individuals.
Noninterest Income
Service charges for the second quarter were up $78 when compared to the
second quarter of 2002. During the second quarter the Company made certain
modifications to its demand deposit products that have so far resulted in an
increase in service charge income. It is not known whether this level of income
will be sustainable, as the ongoing acceptance of product changes by the
Company's customer base is as yet uncertain.
Other Service Charges
This category shows a decline of $13 when compared to the same quarter
in 2002. This category is comprised of various miscellaneous types of income
which vary from period to period.
22
Credit Card Income
Credit Card income for the quarter ended June 30, 2003 was $448 an
increase of $70 or 18.52%. The majority of the increase was due to the volume of
business in merchant and debit cards.
Trust Income
Trust income increased by $4 or 1.66% when the second quarter of 2003
and 2002 are compared. Trust income varies due to the nature of the business.
Estate income, for example, is unpredictable. Market values of trust assets
which can vary widely also affect the level of income.
Realized Gains or Losses on Securities
Net Securities gains were $5 in the second quarter of 2003. In 2002 the
Company sold certain stock owned by Bankshares for a substantial gain, resulting
in $185 in net gains for that quarter.
Salaries and Wages
Salaries and Wages are up $144 or 6.5% when the second quarter of 2003
and 2002 are compared. As previously mentioned, rising pension costs and normal
salary reviews accounted for most of the increase.
Other Expense
Other expenses including occupancy, data processing, and other expense
normally fluctuate to a degree. Credit Card Processing expenses were up $111 due
primarily to increase in volume related to merchant and debit cards.
Following are quarterly averages for selected categories:
Major Categories June 30, 2003 June 30, 2002
- ---------------- ------------- -------------
Loan, net $412,829 $410,825
Securities available for sale 124,705 89,285
Securities held to maturity 103,305 97,023
Total assets 700,575 646,533
Total deposits 620,838 575,750
Stockholders equity 77,091 68,449
Loans and Deposits June 30, 2003 June 30, 2002
- ------------------ ------------- -------------
Construction loans $29,861 $22,250
Real estate loans 82,853 79,142
Commercial loans 209,886 204,445
Loan to individuals 91,308 106,571
Noninterest bearing demand deposits 80,491 74,917
Interest bearing demand deposits 165,692 144,317
Saving deposits 51,281 49,280
Time deposits 323,374 307,236
23
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 June 30, 2003 was approximately $3,577. Amortized cost for
these securities was approximately $3,472.
Interest Rate Sensitivity
The Company considers interest rate risk to be a significant market risk
and has 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 as of the end of the period covered by this 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.
24
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 June 30, 2003.
Item 4. Submission of Matters to a Vote of Security Holders
Three class 1 Directors of the Company were elected by a
vote of the security holders for a term of three years
each.
(a) This matter was submitted to a vote at the Company's
Annual Meeting of Stockholders held on April 8, 2003.
(b) The name of each director elected at the meeting follows:
L. Allen Bowman
Paul A. Duncan
Mary G. Miller
The name of each director whose term of office continued
after the meeting is listed:
Alonzo A. Crouse
James A. Deskins, Sr.
William T. Peery
James G. Rakes
James M. Shuler
Jeffery R. Stewart
(c) The number of votes cast for or against each nominee is
provided below. There were no abstaining votes and no
broker non-votes.
Election of Directors
Director Votes For Votes Against
-------- --------- -------------
L. Allen Bowman 3,179,770 15,458
Paul A. Duncan 3,175,064 20,164
Mary G. Miller 3,170,632 24,596
The stockholders approved a proposed amendment to the
articles of incorporation increasing the number of
authorized shares of common stock from 5 million to 10
million shares.
(a) The number of votes cast for or against the proposal
and the number of abstentions is provided below.
Votes For Votes Against Abstain
--------- ------------- -------
3,051,535 112,940 30,753
Item 5. Other Information
None
25
Item 6. Exhibits and Reports on Form 8-K
The Company had no filings on Form 8-K for the period ended
June 30, 2003. See the index to exhibits for Items
incorporated by reference to this filing.
26
Signatures
National Bankshares, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
DATE: August 14, 2003 NATIONAL BANKSHARES, INC.
/s/ JAMES G. RAKES
-----------------------------
James G. Rakes
Chief Executive Officer
/s/ J. ROBERT BUCHANAN
-----------------------------
J. Robert Buchanan
Chief Financial Officer
27
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 Four of the Articles of (incorporated herein by
Incorporation of National Bankshares, reference to Exhibit
Inc. 4(b) of the Annual
Report on Form 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 2002 (incorporated herein by
between National Bankshares, Inc. and reference to Exhibit
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) of 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)
28
31(a) Section 302 Certification of Chief Page 30
Executive Officer
31(b) Section 302 Certification of Chief Page 31
Financial Officer
32(a) Certification of Chief Executive Page 32
Officer Pursuant to 18 U.S.C.
Section 350
32(b) Certification of Chief Financial Page 33
Officer Pursuant to 18 U.S.C.
Section 350
29