- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
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 by check mark whether the registrant is a shell company (as defined in
Rule 12b - 2 of the Exchange Act).
Yes |_| No |X|
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 November 7, 2005
Common Stock, $2.50 Par Value 3,510,977
(This report contains 35 pages)
NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-Q
Index
Part I Financial Information Page
----------------------------
Item 1 Financial Statements
Consolidated Balance Sheets, September 30, 2005 (Unaudited) 3-4
and December 31, 2004
Consolidated Statements of Income for the Three Months Ended September 5-6
30, 2005 and 2004 (Unaudited)
Consolidated Statements of Income for the Nine Months Ended September 30, 7-8
2005 and 2004 (Unaudited)
Consolidated Statements of Changes in 9
Stockholders' Equity, Nine Months Ended
September 30, 2005 and 2004 (Unaudited)
Consolidated Statements of Cash Flows, 10-11
Nine Months Ended September 30, 2005 and 2004 (Unaudited)
Notes to Consolidated Financial Statements 12-17
Item 2 Management's Discussion and Analysis of 18-29
Financial Condition and Results of Operations
Item 3 Quantitative and Qualitative Disclosures about 29
Market Risk
Item 4 Controls and Procedures 29
Part II Other Information
Item 1 Legal Proceedings 30
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 30
Item 3 Defaults Upon Senior Securities 30
Item 4 Submission of Matters to a Vote of Security Holders 30
Item 5 Other Information 30
Item 6 Exhibits 30
Signatures 31
Index of Exhibits 31-32
2
Part I
Financial Information
Item 1. Financial Statements
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 2005 and December 31, 2004
(Unaudited)
September 30, December 31,
($ In thousands, except share and per share data) 2005 2004
================== ===================
Assets
Cash and due from banks $17,114 $12,493
Interest-bearing deposits 15,836 22,463
Securities available for sale, at fair value 151,685 145,323
Securities held to maturity (fair value
$113,668 in 2005 and $107,697 in 2004) 112,258 105,385
Mortgage loans held for sale 196 1,003
Loans:
Real estate construction loans 27,639 25,009
Real estate mortgage loans 120,240 115,388
Commercial and industrial loans 263,729 248,523
Loans to individuals 88,179 89,889
------------------ -------------------
Total loans 499,787 478,809
Less unearned income and deferred fees (927) (881)
------------------ -------------------
Loans, net of unearned income
and deferred fees 498,860 477,928
Less: allowance for loan losses (5,620) (5,729)
------------------ -------------------
Loans, net 493,240 472,199
------------------ -------------------
Bank premises and equipment, net 12,609 12,104
Accrued interest receivable 5,145 4,870
Other real estate owned, net 429 895
Intangible assets and goodwill, net 17,397 16,924
Other assets 2,998 2,495
------------------ -------------------
Total assets $828,907 $796,154
================== ===================
Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits $115,174 $106,189
Interest-bearing demand deposits 209,107 198,897
Savings deposits 55,685 62,817
Time deposits 352,211 338,029
------------------ -------------------
Total deposits 732,177 705,932
------------------ -------------------
Other borrowed funds 623 297
Accrued interest payable 630 483
Other liabilities 2,807 2,354
------------------ -------------------
Total liabilities 736,237 709,066
------------------ -------------------
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 3,511,977 shares in 2005 and
3,519,002 in 2004 8,780 8,797
Retained earnings 84,060 77,735
Accumulated other comprehensive income (loss), net (170) 556
----------------- -------------------
Total stockholders' equity 92,670 87,088
----------------- -------------------
Total liabilities and
stockholders' equity $828,907 $796,154
================= ===================
See accompanying notes to the consolidated financial statements.
4
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended September 30, 2005 and 2004
(Unaudited)
September 30, September 30,
($ In thousands, except share and per share data) 2005 2004
================== =================
Interest income
Interest and fees on loans $8,451 $7,837
Interest on interest-bearing deposits 141 23
Interest on federal funds sold --- 14
Interest on securities - taxable 1,607 1,654
Interest on securities - nontaxable 1,284 1,313
------------------ -----------------
Total interest income 11,483 10,841
------------------ -----------------
Interest expense
Interest on time deposits $100,000 or more 1,032 836
Interest on other deposits 2,781 2,053
Interest on borrowed funds 3 15
------------------ -----------------
Total interest expense 3,816 2,904
------------------ -----------------
Net interest income 7,667 7,937
Provision for loan losses 169 293
------------------ -----------------
Net interest income after
provision for loan losses 7,498 7,644
------------------ -----------------
Noninterest income
Service charges on deposit accounts 797 824
Other service charges and fees 68 52
Credit card fees 553 480
Trust income 326 274
Other income 149 131
Realized securities gains(losses), net (1) 104
------------------ -----------------
Total noninterest income 1,892 1,865
------------------ -----------------
Noninterest expense
Salaries and employee benefits 2,822 2,723
Occupancy, furniture and fixtures 491 473
Data processing and ATM 270 349
Credit card processing 431 398
Intangibles amortization 283 233
Net costs of other real estate owned 63 37
Other operating expenses 1,019 1,062
------------------ -----------------
Total noninterest expense 5,379 5,275
------------------ -----------------
Income before income tax expense 4,011 4,234
Income tax expense 957 1,019
------------------ -----------------
Net income $3,054 $3,215
================== =================
5
Net income per share - basic $0.87 $0.91
- diluted $0.86 $0.91
================= ===================
Weighted average number of common
shares outstanding - basic 3,511,977 3,519,491
================= ===================
- diluted 3,526,936 3,536,965
================= ===================
Dividends declared per share $--- $---
================= ===================
See accompanying notes to consolidated financial statements.
6
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Nine Months Ended September 30, 2005 and 2004
(Unaudited)
September 30, September 30,
($ In thousands, except share and per share data) 2005 2004
================== =================
Interest income
Interest and fees on loans $24,778 $21,868
Interest on interest-bearing deposits 286 137
Interest on federal funds sold 1 15
Interest on securities - taxable 4,858 4,648
Interest on securities - nontaxable 3,863 3,987
------------------ -----------------
Total interest income 33,786 30,655
------------------ -----------------
Interest expense
Interest on time deposits $100,000 or more 2,836 2,294
Interest on other deposits 7,228 5,852
Interest on borrowed funds 21 16
------------------ -----------------
Total interest expense 10,085 8,162
------------------ -----------------
Net interest income 23,701 22,493
Provision for loan losses 557 885
------------------ -----------------
Net interest income after
provision for loan losses 23,144 21,608
------------------ -----------------
Noninterest income
Service charges on deposit accounts 2,273 2,234
Other service charges and fees 224 182
Credit card fees 1,625 1,362
Trust income 1,062 1,105
Other income 408 311
Realized securities gains(losses), net (5) 91
------------------ -----------------
Total noninterest income 5,587 5,285
------------------ -----------------
Noninterest expense
Salaries and employee benefits 8,534 7,815
Occupancy, furniture and fixtures 1,450 1,337
Data processing and ATM 1,172 913
Credit card processing 1,270 1,100
Intangibles amortization 832 699
Net costs of other real estate owned 244 149
Other operating expenses 3,157 2,997
------------------ -----------------
Total noninterest expense 16,659 15,010
------------------ -----------------
Income before income tax expense 12,072 11,883
Income tax expense 2,873 2,772
------------------ -----------------
Net income $9,199 $9,111
================== =================
7
Net income per share - basic $2.62 $2.59
================= ===================
- diluted $2.60 $2.57
================= ===================
Weighted average number of common
shares outstanding - basic 3,515,855 3,517,923
================= ===================
- diluted 3,532,956 3,538,280
================= ===================
Dividends declared per share $0.70 $0.63
================= ===================
See accompanying notes to consolidated financial statements.
8
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Nine Months Ended September 30, 2005 and 2004
(Unaudited)
Accumulated
Other
($ In thousands) Common Retained Comprehensive Comprehensive
Stock Earnings Income (Loss) Income Total
============ ============== ================ ================ ===========
Balances, December 31, 2003 $8,788 $70,063 $1,790 $80,641
Net income --- 9,111 --- $9,111 9,111
Dividends ($0.63 per share) --- (2,216) --- --- (2,216)
Exercise of stock options 16 107 --- --- 123
Other comprehensive loss, net of tax:
Unrealized loss on securities
available for sale, net
of income tax $(61) --- --- --- (113) ---
Reclass adjustment, net
of tax $(32) --- --- --- (59) ---
------------ -------------- ---------------- ---------------- -----------
Other comprehensive loss --- --- (172) (172) (172)
------------ -------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- $8,939 ---
------------ -------------- ---------------- ---------------- -----------
Stock Repurchase (13) (204) --- (217)
------------ -------------- ---------------- ---------------- -----------
Balances, September 30, 2004 $8,791 $76,861 $1,618 $87,270
============ ============== ================ ================ ===========
Balances, December 31, 2004 $8,797 $77,735 $556 $87,088
Net income --- 9,199 --- $9,199 9,199
Dividends($0.70 per share) --- (2,464) --- --- (2,464)
Other comprehensive loss, net of tax
Unrealized losses on securities available for
sale, net of income tax $(327) --- --- --- (607) ---
Reclass adjustment, net of
income tax $(64) --- --- --- (119) ---
------------ -------------- ---------------- ---------------- -----------
Other comprehensive loss --- --- (726) (726) (726)
------------ -------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- $8,473 ---
------------ -------------- ---------------- ---------------- -----------
Exercise of stock options 11 95 --- --- 106
------------ -------------- ---------------- ---------------- -----------
Stock repurchase (28) (505) (533)
------------ -------------- ---------------- ---------------- -----------
Balances, September 30, 2005 $8,780 $84,060 $(170) $92,670
============ ============== ================ ================ ===========
See accompanying notes to consolidated financial statements.
9
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2005 and 2004
(Unaudited)
September 30, September 30,
($In thousands) 2005 2004
================ =================
Cash flows from operating activities
Net income $9,199 $9,111
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 557 885
Depreciation of bank premises and equipment 761 727
Amortization of intangibles 832 699
Amortization of premiums and accretion of
discount, net 311 200
Losses on disposal of fixed assets 10 ---
(Gains) Losses on sales and calls of securities
available for sale, net (183) 27
(Gains) Losses on calls of securities held to maturity
188 (118)
Losses and writedowns on other real estate owned 107 111
(Increase) decrease in:
Mortgage loans held for sale 807 157
Accrued interest receivable (275) (543)
Other assets (1,417) 4,567
Increase (decrease) in:
Accrued interest payable 147 (6)
Other liabilities 453 438
----------------- -----------------
Net cash provided by operating
activities $11,497 $16,255
---------------- -----------------
Cash flows from investing activities
Net decrease in interest-bearing deposits $6,627 $30,694
Proceeds from calls, principal payments, sales and maturities of
securities available for sale 13,924 19,982
Proceeds from calls, principal payments and maturities of
securities held to maturity 7,943 6,933
Proceeds from sale of securities held to maturity 3,312 ---
Purchases of securities available for sale (21,442) (20,221)
Purchases of securities held to maturity (18,405) (14,288)
Purchases of loan participations (5,463) (1,114)
Collections of loan participations 2,149 941
Net (increase) in loans to customers (9,750) (26,269)
Acquisitions, net of cash received 13,178 (13,602)
Proceeds from disposal of other real estate owned 510 970
Recoveries on loans charged off 146 174
Purchase of bank premises and equipment (1,352) (687)
Proceeds from disposal of bank premises and equipment 76 2
---------------- -----------------
Net cash (used in) investing
activities $(8,547) $(16,485)
---------------- -----------------
10
Cash flows from financing activities
Net increase (decrease) in other deposits $(2,379) $7,510
Net increase (decrease) in time deposits 6,615 (2,576)
Net increase in other borrowed funds 326 2,079
Stock options exercised 106 123
Cash dividends (2,464) (2,216)
Stock Repurchased (533) (217)
---------------- ----------------
Net cash provided by financing
activities 1,671 4,703
---------------- ----------------
Net increase in cash and due from banks 4,621 4,473
Cash and due from banks at beginning of period 12,493 11,733
---------------- ----------------
Cash and due from banks at end of period $17,114 $16,206
================ ================
Supplemental disclosure of cash flow information
Cash paid for interest $9,938 $8,168
================ ================
Cash paid for income taxes $3,165 $2,576
================ ================
Loans charged to the allowance for loan losses $812 $1,091
================ ================
Loans transferred to other real estate owned $151 $327
================ ================
Unrealized (losses) on securities available for sale ($1,117) $(265)
================ ================
Transactions related to acquisition of branches in 2005 and CNB in 2004
Increase in assets and liabilities:
Investments --- $10,052
Loans $8,831 $40,371
Deposits $22,009 $59,979
See accompanying notes to consolidated financial statements.
11
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 2005
(Unaudited)
($ In thousands, except share and per share data)
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 nine months ended September 30, 2005 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 in
this Form 10-Q should be read in conjunction with the notes to consolidated
financial statements included in the Company's 2004 Form 10-K. The Company posts
all reports required to be filed under the Securities and Exchange Act of 1934
on its web site at www.nationalbankshares.com.
Note (2) Stock-Based Compensation
At September 30, 2005, the Company had a stock-based employee
compensation plan, which is described more fully in the Company's Form 10-K
dated December 31, 2004. 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.
Nine months ended Three months ended
September 30, September 30,
-------------- ------------- ------------- ------------
($ In thousands, except per share data) 2005 2004 2005 2004
-------------- ------------- ------------- ------------
Net income, as reported $9,199 $9,111 $3,054 $3,215
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards (110) (76) (37) (25)
-------------- ------------- ------------- ------------
Pro forma net income $9,089 $9,035 $3,017 $3,190
-------------- ------------- ------------- ------------
Earnings per share:
Basic - as reported $2.62 $2.59 $0.87 $0.91
-------------- ------------- ------------- ------------
Basic - pro forma $2.59 $2.57 $0.86 $0.91
-------------- ------------- ------------- ------------
Diluted - as reported $2.60 $2.57 $0.86 $0.91
-------------- ------------- ------------- ------------
Diluted - pro forma $2.57 $2.55 $0.85 $0.90
-------------- ------------- ------------- ------------
During the nine months ended September 30, 2005, there were no stock
options granted and 1,250 stock options were forfeited.
For the nine months ended September 30, 2005 and 2004, 24,000 shares and
11,000 shares, respectively, were excluded from the diluted earnings per share
calculation, as their impact would have been anti-dilutive. For the three months
ended September 30, 2005 and 2004, 36,000 shares and 16,500 shares were
excluded.
12
Note (3) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended
September 30, December 31,
------------- ------------
2005 2004 2004
-------------- -------------- -----------------
($ In thousands, except % data)
Balance at beginning of period $5,729 $5,369 $5,369
Provision for loan losses 557 885 1,189
Loans charged off (812) (1,091) (1,550)
Recoveries 146 174 223
Acquisition of bank - CNB --- 498 498
-------------- -------------- --------------
Balance at the end of period $5,620 $5,835 $5,729
============== ============== ==============
Ratio of allowance for loan losses to the end
of period loans, net of unearned income and
deferred fees 1.13% 1.24% 1.20%
============== ============== ==============
Ratio of net charge-offs to average loans, net
of unearned income and deferred fees(1) 0.18% 0.28% 0.30%
============== ============== ===============
Ratio of allowance for loan losses to
nonperforming loans(2) 2,239.04% 1,220.71% 1,454.06%
============== ============== ===============
(1) Net charge-offs are on an annualized basis.
(2) The Company defines nonperforming loans as total nonaccrual and
restructured loans. Loans 90 days past due and still accruing are
excluded.
September 30, December 31,
------------- ------------
2005 2004 2004
------------- ------------ --------------
($ In thousands, except % data)
Nonperforming Assets:
Nonaccrual loans $251 $478 $394
Restructured loans --- --- ---
------------- ------------ --------------
Total nonperforming loans 251 478 394
Foreclosed property 429 1,010 895
------------- ------------ --------------
Total nonperforming assets $680 $1,488 $1,289
============= ============ ==============
Ratio of nonperforming assets to loans, net of
unearned income and deferred fees, plus other real
estate owned 0.14% 0.31% 0.27%
============= ============ ==============
13
September 30, December 31,
------------- ------------
2005 2004 2004
------------- ------------ ---------------
Loans Past due 90 days or more and
still accruing $563 $1,121 $754
============= ============ =============
Ratio of loans past due 90 days or
more and still accruing to loans, net of
unearned income and deferred fees 0.11% 0.24% 0.16%
============= ============ =============
Impaired loans
Total impaired loans $247 $478 $354
============= ============ =============
Impaired loans with a
valuation allowance --- $64 $79
Valuation allowance --- (64) (55)
------------- ------------ -------------
Impaired loans, net of allowance --- --- $24
============= ============ =============
Impaired loans with no
valuation allowance $247 $414 $275
============= ============ =============
Average recorded investment
in impaired loans $299 $663 $601
============= ============ =============
Income recognized on impaired
loans $1 --- ---
============= ============ =============
Amount of income recognized
on a cash basis $1 --- ---
============= ============ =============
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 at
September 30, 2005 were $5.
14
Note (4) Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for the sale by major security type as of
September 30, 2005 are as follows:
September 30, 2005
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ----------------
Available for sale:
U.S. Treasury $4,037 $8 $66 $3,979
U.S. Government
Agencies and
Corporations 14,773 22 59 14,736
State and political
subdivisions 73,997 1,677 455 75,219
Mortgage-backed
securities 22,794 123 147 22,770
Corporate debt
securities 31,564 218 764 31,018
Federal Reserve Bank stock-
restricted 208 --- --- 208
Federal Home Loan
Bank stock-restricted 1,613 --- --- 1,613
Other securities 1,973 169 --- 2,142
------------- ----------------- ----------------- ----------------
Total securities
available for sale $150,959 $2,217 $1,491 $151,685
============= ================= ================= ================
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of
September 30, 2005 are as follows:
September 30, 2005
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
--------------- -------------- -------------- ---------------
Held to Maturity:
U.S. Government
Agencies and
Corporations $25,600 $13 $244 $25,369
State and political
subdivisions 58,128 1,518 67 59,579
Mortgage-backed
securities 4,305 67 4 4,368
Corporate securities 24,225 471 344 24,352
--------------- -------------- -------------- ---------------
Total securities
held to maturity $112,258 $2,069 $659 $113,668
=============== ============== ============== ===============
15
Information pertaining to securities with gross unrealized losses and
length of time that individual securities have been in a continuous loss
position follows:
Less Than 12 Months 12 Months or More
- --------------------------- ------------------- --------------------- --------------------- ---------------------
Fair Value Unrealized Loss Fair Value Unrealized Loss
- --------------------------- ------------------- --------------------- --------------------- ---------------------
December 31, 2004 $60,623 $885 $17,950 $748
- --------------------------- ------------------- --------------------- --------------------- ---------------------
September 30, 2005 $74,085 $650 $44,274 $1,500
- --------------------------- ------------------- --------------------- --------------------- ---------------------
Losses shown above are attributable to interest rate movements. The
Company continuously monitors the credit quality of the securities portfolio.
Since the Company has the ability and intent to hold the securities, the losses
associated with those securities are considered temporary.
Note (5) Recent Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 154, "Accounting Changes
and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement
No. 3." The new standard changes the requirements for the accounting for and
reporting of a change in accounting principle. Among other changes, SFAS No. 154
requires that a voluntary change in accounting principle be applied
retrospectively with all prior period financial statements presented based on
the new accounting principle, unless it is impracticable to do so. SFAS No. 154
also provides that (1) a change in method of depreciating or amortizing a
long-lived nonfinancial asset be accounted for as a change in estimate
(prospectively) that was effected by a change in accounting principle, and (2)
correction of errors in previously issued financial statements should be termed
a "restatement." The new standard is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005.
The Corporation does not anticipate this revision will have a material effect on
its financial statements.
On December 16, 2004, FASB issued SFAS No. 123R (revised 2004),
"Share-Based Payment," that addresses the accounting for share-based payment
transactions in which a company receives employee services in exchange for
either equity instruments of the company or liabilities that are based on the
fair value of the company's equity instruments or that may be settled by the
issuance of such equity instruments. SFAS No. 123R eliminates the ability to
account for share-based compensation transactions using the intrinsic method and
requires that such transactions be accounted for using a fair-value-based method
and recognized as expense in the statement of income. The effective date of SFAS
No. 123R (as amended by the SEC) is for annual periods beginning after June 15,
2005. The provisions of SFAS No. 123R do not have an impact on the Corporation's
results of operations at the present time.
In March 2005, the SEC issued Staff Accounting Bulleting No. 107 (SAB
107). SAB 107 expresses the views of the SEC staff regarding the interaction of
FAS 123R and certain SEC rules and regulations and provides the SEC staff's view
regarding the valuation of share-based payment arrangements for public
companies. SAB 107 does not impact the Corporation's results of operations at
the present time.
In November 2004, the Emerging Issues Task Force (EITF) published Issue
03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments." The Task Force discussed the meaning of
other-than-temporary impairment and its application to certain investments
carried at cost. The Task Force requested that the FASB staff consider other
impairment models within U.S. Generally Accepted Accounting Principles (GAAP)
when developing its views. The Task Force also requested that the scope of the
impairment issue be expanded to include equity investments and investments
subject to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," and that the issue be addressed by the Task Force as a separate
EITF issue. At the EITF meeting, the Task Force reached a consensus on one issue
that certain quantitative and qualitative disclosures should be required for
securities accounted for under SFAS No. 115 that are impaired at the balance
sheet date but for which an other-than-temporary impairment has not been
recognized. The Board ratified the consensus on that one issue at its November
25, 2004 meeting. In September 2004, FASB directed its staff to issue two
proposed FASB Staff Positions (FSP): Proposed FSP EITF Issue 03-1-a, which
provides guidance for the application of paragraph 16 of EITF Issue 03-1 to debt
securities that are impaired because of interest rate and/or sector spread
increases, and Proposed FSP EITF Issue 03-1-b, which delays the effective date
of Issue 03-1 for debt securities that are impaired because of interest rate
and/or sector spread increases. In June 2005, the FASB reached a decision
whereby they declined to provide additional guidance on the meaning of
other-than-temporary impairment. The Board directed the FASB staff to issue EITF
03-1a as final and to draft a new FSP that will replace EITF 03-01. The final
FSP (retitled FAS 115-1, "The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments"), would be effective for
other-than-temporary impairment analysis conducted in periods beginning after
September 15, 2005. The Corporation does not anticipate this revision will have
a material effect on its financial statements.
16
Note (6) Defined Benefit Plan
Components of Net Periodic Benefit Cost
Pension Benefits
Nine Months Ended Three Months Ended
September 30, September 30,
--------------------- -----------------------
($ in Thousands)
2005 2004 2005 2004
---- ---- ---- ----
Service cost $ 420 $ 372 $ 140 $ 124
Interest cost 459 402 153 134
Expected return on plan assets (435) (375) (145) (125)
Amortization of prior service cost 6 6 2 2
Recognized net actuarial loss 138 90 46 30
Amortization of transition cost (9) (9) (3) (3)
---------- ---------- ----------- -----------
Net periodic benefit cost $ 579 $ 486 $ 193 $ 162
========== ========== =========== ===========
Employer Contributions
Bankshares previously disclosed in its financial statements for the year
ended December 31, 2004, an estimated quarterly minimum contribution of $124 to
its pension plan in 2005. That estimate has since been revised and Bankshares
now expects to contribute a total of $610, paid in quarterly installments, to
the pension plan for 2005. As of September 30, 2005, the Company has contributed
$317. Bankshares anticipates making all required contributions prior to the end
of 2005.
Note (7) Acquisitions
In February of 2005, the Company acquired two branches from Planters
Bank and Trust Company of Virginia. The transaction added approximately $8,831
in loans and approximately $22,009 in deposits. A deposit intangible of
approximately $1,304 arose as a result of the transaction. This intangible will
amortize over twelve years. Approximately $311 in fixed assets was also
acquired.
17
National Bankshares, Inc. and Subsidiaries
(In thousands, except per share data)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations for the Nine Months Ended September 30, 2005
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. Refer to the financial statements and other information included in
this report as well as the 2004 Annual Report on Form 10-K for an understanding
of the following discussion and analysis.
This Quarterly Report on Form 10-Q contains forward-looking statements
as described in 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 when earning income,
recognizing an expense, recovering an asset or relieving a liability. We use
historical loss factors as one element 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 estimable 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 actual
events occur. The formula allowance uses a historical loss view and certain
qualitative factors 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. 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
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.
18
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 $9,958 and $10,912
at December 31, 2003 and 2002, respectively, did not constitute the acquisition
of a business, and therefore will continue to be amortized.
Overview
National Bankshares, Inc. (NBI) is a financial holding company located in
Southwest Virginia. It conducts operations primarily through two full-service
banking affiliates, the National Bank of Blacksburg and Bank of Tazewell County.
It also has one nonbanking affiliate, National Bankshares Financial Services,
Inc., which offers investment and insurance products. Net income derived from
the nonbanking affiliate is not significant at this time or in the foreseeable
future. NBI is a community bank operation.
Performance Summary
The following table shows NBI's key performance ratios for the period ended
September 30, 2005 and December 31, 2004 and 2003:
September 30, December 31, December 31,
2005 2004 2003
- -------------------------------------------- ------------------- ---------------------- --------------------
Return on average assets 1.51% 1.62% 1.64%
- -------------------------------------------- ------------------- ---------------------- --------------------
Return on average equity 13.69% 14.48% 14.77%
- -------------------------------------------- ------------------- ---------------------- --------------------
Net interest margin (1) 4.53% 4.69% 4.82%
- -------------------------------------------- ------------------- ---------------------- --------------------
Noninterest margin (2) 1.82% 1.77% 1.81%
- -------------------------------------------- ------------------- ---------------------- --------------------
Basic net earnings per share $2.62 $3.48 $3.26
- -------------------------------------------- ------------------- ---------------------- --------------------
Fully diluted net earnings per share $2.60 $3.46 $3.24
- -------------------------------------------- ------------------- ---------------------- --------------------
(1) Net Interest Margin: Year-to-date tax-equivalent net interest income
divided by year-to-date average earning assets using a tax rate of 35%.
(2) Noninterest Margin: Noninterest income (including securities gains and
losses) less noninterest expense (excluding the provision for bad debts
and income taxes) divided by average year-to-date assets.
19
The Company undertook three acquisitions during the period from the second
quarter of 2004 through the first quarter of 2005. These acquisitions resulted
in substantial growth, but did not have a material effect on the net interest
margin. However, as interest rates have risen in the financial markets, there
has been a compression in the net interest margin. The cost of funds has
increased more rapidly than interest income and has impacted the level of net
interest income. Net interest income at September 30, 2005 was $23,701, a 5.4%
increase when compared to the prior year.
Noninterest income for the nine month period ending September 30, 2005 was
$5,587. This represents an increase of $302, or 5.7%, over the same period in
2004. An increase in credit card fees of $263 accounted for approximately 87.1%
of the total change. Trust income declined by $43 when the two periods are
compared.
Growth
The following table shows NBI's key growth indicators:
September 30, 2005 December 31, 2004 December 31, 2003
- ------------------- ---------------------------- --------------------- ----------------------
Securities $263,943 $250,708 $230,154
- ------------------- ---------------------------- --------------------- ----------------------
Loans, net 493,240 472,199 401,428
- ------------------- ---------------------------- --------------------- ----------------------
Deposits 732,177 705,932 625,378
- ------------------- ---------------------------- --------------------- ----------------------
Total assets 828,907 796,154 708,560
- ------------------- ---------------------------- --------------------- ----------------------
At September 30, 2005 total assets were $828,907, an increase of $32,753
from December 31, 2004.
Reflected in the totals for the first nine months of 2005, is approximately
$22,009 in deposits and $8,831 in loans that the Company acquired from Planters
Bank and Trust Company of Virginia during the first quarter. This transaction
accounted for the majority of the deposit growth and approximately 42% of the
growth observed in loans. Surplus funds acquired in the transaction also
contributed to growth in the investment portfolio.
Asset Quality
Key asset quality indicators are shown below:
September 30, 2005 December 31,2004 December 31, 2003
- --------------------------------------------- ----------------------- --------------------- ----------------------
Nonperforming loans $ 251 $ 394 $ 354
- --------------------------------------------- ----------------------- --------------------- ----------------------
Loans past due over 90 days 563 754 931
- --------------------------------------------- ----------------------- --------------------- ----------------------
Other real estate owned 429 895 1,663
- --------------------------------------------- ----------------------- --------------------- ----------------------
Allowance for loan losses to loans 1.13% 1.20% 1.32%
- --------------------------------------------- ----------------------- --------------------- ----------------------
Net charge-off ratio 0.18% 0.30% 0.34%
- --------------------------------------------- ----------------------- --------------------- ----------------------
This data indicates that the level of nonperforming loans has declined,
as has the level of loans past due 90 days or more. Other real estate owned
continues to decline as properties foreclosed upon are sold. Asset quality
remains excellent at one of the Company's subsidiary banks, and it continues to
improve at the Company's other banking affiliate.
Net Interest Income
Net interest income for the nine-month period ended September 30, 2005
was $23,701, an increase of $1,208, or 5.4%, over the same period in 2004. As
previously mentioned, the Company has experienced a period of substantial growth
largely through acquisitions, and this growth is the source of the increase in
net interest income.
Overall, the net interest margin has responded well to the acquisitions
completed over the past year. However, the margin has narrowed as interest rates
have increased.
At September 30, 2005 the net interest margin was 4.53%, and it was 4.73%
at September 30, 2004.
With the assets from the past year's acquisitions, some fluctuation in the
net interest margin was expected. It was also expected that the acquired assets
and liabilities would not be optimal from an asset and liability management
perspective, and that, going forward, some adjustments would be required.
20
Net Interest Income - Trends and Future Expectations
During 2004, the Federal Reserve Board initiated a series of interest
rate increases. These increases were designed to restore interest rates to
historically more typical levels and to prevent inflation. Rate increases have
occurred at regular intervals, each at 25 basis points to date.
Management believes that interest rates will continue to rise for the
foreseeable future.
Rising energy costs coupled with high levels of government spending are
viewed as inflationary. Government expenditures are expected to remain high as
a result of natural disasters, conflict in the Middle East and new spending
programs such as the prescription drug benefit for senior citizens. It is
expected that the Federal Reserve Bank will continue to raise interest rates to
combat inflationary pressures.
The general impact of a rising interest rate scenario on the Company's
balance sheet is described on page 15 of the Company's 2004 Form 10K, which is
incorporated by reference in this report.
Interest Expense
Interest expense for the nine months ended September 30, 2005 was
$10,085, an increase of $1,923, or 23.6%, from the same period the prior year.
As previously discussed, the Company has experienced a period of growth which
has contributed to the interest expense increase, as have rising interest rates.
During periods of rising interest rates, interest-bearing demand
deposits, and to a lesser degree savings deposits, migrate to higher rate,
longer-term time deposits. Generally, as rates climb, more migration occurs.
Given their re-pricing characteristics, interest-bearing demand deposits readily
respond to any interest rate movement. In other words, increases or decreases in
interest expense can occur quite quickly.
With a definite bias towards higher interest rates in the future, it is
expected that the net interest margin will continue to decline, at least
temporarily, in response to rising interest rates. The ultimate impact of rising
interest rates is dependent upon the number of rate increases, the amount of
these rate increases and the level to which interest rates ultimately rise.
Provision and Allowance for Loan Losses
The provision for loan losses for the nine-month period ended September
30, 2005 was $557, a $328 decrease from the same period ended September 30,
2004. The ratio of the allowance for loan losses to total loans at the end of
the first nine months of 2005 was 1.13%, which compares to 1.24% at the same
period last year. The net charge-off ratio at September 30, 2005 was 0.18%, and
it was 0.28% at September 30, 2004.
The Company regularly reviews asset quality and re-evaluates the
allowance for loan losses. Reviews are conducted for each of the two bank
subsidiaries, and an appropriate provision and allowance for loan losses is
established for each bank, depending upon factors that are unique to that bank
and the quality of its loan portfolio. As noted above, the ratio of the
allowance for loan losses to total loans is lower than at the end of the third
quarter in 2004. The ratio has declined as total loans have grown from $478,809
at December 31, 2004 to $499,787 at September 30, 2005, while the level of the
allowance has remained stable. Because of the continued excellent overall
quality of the loan portfolio at one subsidiary bank and the improving quality
of the loan portfolio at the second bank, it is management's judgment that the
decrease in the provision for loan losses is justified and the allowance is
appropriate and adequate. (See "Allowance for Loan Losses" under "Critical
Accounting Policies".)
21
Noninterest Income
September 30, 2005 September 30, 2004 September 30, 2003
- ----------------------------------- ----------------------- ------------------------ ------------------------
Service charges on deposits $2,273 $2,234 $1,877
- ----------------------------------- ----------------------- ------------------------ ------------------------
Other service charges and fees 224 182 206
- ----------------------------------- ----------------------- ------------------------ ------------------------
Credit card fees 1,625 1,362 1,210
- ----------------------------------- ----------------------- ------------------------ ------------------------
Trust fees 1,062 1,105 757
- ----------------------------------- ----------------------- ------------------------ ------------------------
Other income 408 311 342
- ----------------------------------- ----------------------- ------------------------ ------------------------
Realized securities gains (losses) (5) 91 3
- ----------------------------------- ----------------------- ------------------------ ------------------------
Noninterest income is made up of several categories. Following is a
description of each, as well as the factors that influence each.
"Service charges on deposit accounts" consist of a variety of charges
imposed on demand deposits, interest-bearing deposits and savings deposit
accounts. These include, but are not limited to, the following:
o Demand deposit monthly activity fees
o Service charges for checks for which there are non-sufficient funds or
overdraft charges
o ATM transaction fees
The principal factors affecting current or future levels of income from
this category are:
o Internally generated growth
o Acquisitions of other banks/branches or de novo branches
o Adjustments to service charge structures
As the above table demonstrates, there was a 1.7% increase in service
charges and deposit accounts between 2004 and 2005. Additional volume from
acquisitions was the primary cause for the increase, as there have been no
significant changes to service charge structures.
"Other service charges and fees" consist of several categories. The
primary categories are listed below.
o Fees for the issuance of official checks
o Safe deposit box rent
o Income from the sale of customer checks
o Income from the sale of credit life and accident and health insurance
Levels of income derived from other service charges and fees vary. Fees
for the issuance of official checks and customer check sales tend to grow as
the existing franchise grows and as new offices are added. Fee schedules, while
subject to change, generally do not by themselves yield a significant increase
in income when they change. The most significant growth in safe deposit box
rent also comes with an expansion of offices. Safe deposit box fee schedules,
which are already at competitive levels, are occasionally adjusted. Income
derived from the sale of credit life insurance and accident and health
insurance varies with loan volume. The increase in this category is also
largely the result of increased volume from acquisitions.
"Credit card fees" consist of three types of revenues.
o Credit card transaction fees
o Debit card transaction fees
o Merchant fees
In all three cases volume is critical to growth in income. For debit and
credit cards the number of accounts, whether obtained from internal growth or
by acquisition, is the key factor. Merchant fees also depend on the number of
merchants in the Company's program, as well as the type of business and the
level of transaction discounts associated with them. Recent acquisitions have
had a positive impact on this category.
22
"Trust income" is somewhat dependent upon market conditions and the
number of estate accounts being handled at any given point in time. Financial
market conditions, which affect the value of trust assets managed, can vary,
leading to fluctuations in the related income. Over the past few years and into
2005, the financial markets have experienced a degree of volatility. Income
from estates is also unpredictable, as the number of estates is impossible to
predict.
Trust income for the period ended September 30, 2005 was $1,062, down
$43 from the same period in 2004. This decrease was caused by a decrease in
estate income.
"Other income" is used for types of income that cannot be classified
with other categories of noninterest income. The category includes such things
as:
o Net gains on the sale of fixed assets
o Rent on foreclosed property
o Income from cash value life insurance
o Other infrequent or minor forms of income
o Revenue from investment and insurance sales
Given the nature of the items included in this category, trends or patterns
are not discernable.
Realized net losses on securities were $(5). The net loss was due to
write-downs in certain investments in limited liability companies (LLC's) of
which the Company is part owner, as well as sales, maturities and calls of
securities.
Noninterest Expense
September 30, 2005 September 30, 2004 September 30, 2003
- ----------------------------- --------------------------- -------------------------- ---------------------------
Salaries and employee
benefits $8,534 $7,815 $7,161
- ----------------------------- --------------------------- -------------------------- ---------------------------
Occupancy and furniture and
fixtures 1,450 1,337 1,248
- ----------------------------- --------------------------- -------------------------- ---------------------------
Data processing and ATM 1,172 913 851
- ----------------------------- --------------------------- -------------------------- ---------------------------
Credit card processing 1,270 1,100 949
- ----------------------------- --------------------------- -------------------------- ---------------------------
Intangibles and goodwill
amortization 832 699 715
- ----------------------------- --------------------------- -------------------------- ---------------------------
Net costs of other real
estate owned 244 149 38
- ----------------------------- --------------------------- -------------------------- ---------------------------
Other operating expenses 3,157 2,997 2,878
- ----------------------------- --------------------------- -------------------------- ---------------------------
Noninterest expense includes several categories. Following is a brief
description of the factors that affect each.
In addition to employee salaries, the salaries and benefits expense
category includes the costs of employment taxes and employee fringe benefits.
Certain of these are:
o Health insurance
o Employee life insurance
o Dental insurance
o Executive compensation plans (1)
o Pension plans (1)
o Employer FICA
o Unemployment taxes
23
(1) See the 2004 Form 10-K and the Proxy Statement for the 2005 Annual
Stockholders meeting for further information
For the first nine months of 2005, salary and benefits expense was
$8,534, an increase of $719. A greater number of employees because of
acquisitions, routine salary increases, pensions and health insurance cost
increases contributed to the increase.
At September 30, 2005 the Company employed 272 full time equivalent
employees, and there were 242 full time equivalent employees at September 30,
2004.
Occupancy costs include such items as depreciation expense, maintenance
of the properties, repairs and real estate taxes.
This category is most affected by new property acquisitions resulting
from mergers, branch purchases or construction of new branch facilities.
Conversely, expense can be lowered by branch office consolidations or closures,
which though infrequent, have occurred. Occasionally, but not frequently,
repairs and other expense items may be significant. Included in the increase is
depreciation of costs related to a new phone system and for fixed assets
purchased in acquisitions.
The Company maintains its own data processing facility and has ATM's at
twenty-one of the branch offices of its subsidiary banks and at four off-site
locations. Costs to operate ATM's are reflected in this category and include
depreciation, maintenance, communication lines and certain supplies.
For the period ended September 30, 2005, data processing and ATM
expenses were up $259 when compared to the same period in 2004. A significant
percentage of this increase is attributable to acquisitions. One-time conversion
expenses were approximately $152. In addition, out-sourced data processing fees
for Community National Bank (CNB) continued from the date of its purchase in the
second quarter of 2004 until its computer systems were combined with NBB's in
the first quarter of 2005. These fees totaled $47. Also included in the
increased data processing expenses were the costs related to the operation of
five additional ATM's.
Credit card processing includes costs associated with the processing of
credit cards, debit cards and merchant transactions. These expenses are related
to credit card income previously discussed in "Noninterest Income", and the
comments in that section are applicable.
Intangibles offset by intangible amortization and goodwill increased by
$133 due to acquisition activity.
At September 30, 2005 the net cost of other real estate owned was $244,
which consists of losses on disposal, write-downs and other foreclosure costs.
As the Company's bank subsidiaries generally hold one or more parcels of
foreclosed real estate, more losses are possible. The September 30, 2005 costs
are not necessarily indicative of the full year for 2005. Other real estate
owned at September 30, 2005 was $429, which compares to $895 at December 31,
2004.
Other operating expenses include all other forms of expense not
classified elsewhere in the Company's statement of income. Included in this
category are such items as stationery and supplies, franchise taxes,
contributions, telephone, postage and other operating costs.
Many of the expenses included in this category are relatively stable or
increase moderately with inflation from year-to-year. However, there are some
items included in the category, such as other losses and charge-offs and
repossession expense, which can vary from time to time.
Overall costs for this category increased by 5.4%, when the periods
ended September 30, 2005 and September 30, 2004 are compared.
Included in this category is postage, which rose approximately $22 when
the periods ended September 30, 2005 and 2004 are compared. Increased mailings
due to a larger deposit base and two computer conversions, which required
additional mailings, contributed to the increase.
24
Stationery and supplies, which are also affected by the acquisitions,
were up $13 when the two periods are compared.
Franchise taxes, which banks pay in lieu of state income taxes, were up
by $69. This tax is based on the banks' capital, and capital increased because
of earnings retained.
Balance Sheet
Year-to-date daily averages for the major balance sheet categories are as
follows:
Assets September 30, 2005 December 31, 2004
- ------------------------------------------------ -------------------------- ----------------------
Federal funds sold $ 72 $ 276
Interest-bearing deposits 12,592 16,224
Securities available for sale 151,260 143,021
Securities held to maturity 109,773 107,284
Mortgage loans held for sale 690 626
Real estate construction loans 26,878 23,041
Real estate mortgage loans 118,000 107,189
Commercial and industrial loans 258,717 228,897
Loans to individuals 89,313 86,083
Total Assets $ 814,827 $ 753,730
Liabilities and stockholders equity
- ------------------------------------------------
Noninterest-bearing demand deposits $ 114,086 $93,320
Interest-bearing demand deposits 201,510 186,106
Savings deposits 58,863 58,899
Time deposits 345,338 327,302
Other borrowings 967 531
Shareholders' equity $89,819 $84,479
Securities
The Company sold approximately $3,312 in securities held to maturity
during the first nine months of 2005. These sales were prompted by reductions in
credit quality ratings, and therefore were not a violation of FAS 115.
Loans
During the first nine months of 2005, the Company completed an
acquisition of two branches from Planters Bank and Trust Company of Virginia.
The purchase of approximately $8,831 in loans was included in the transaction.
The volume of mortgage loans held for sale is directly related to
interest rate levels. Activity generally peaks during periods of low interest
rates, declining as interest rates rise. Period-end balances are not indicative
of volume, as loans are constantly being originated and sold. The balance shown
at period-end reflects only loans held by NBB for which there are purchase
commitments from investors, but which have not yet been funded. At September 30,
2005 there was approximately $3,487 in outstanding commitments to extend
mortgage loans.
Construction loans were $27,639 at September 30, 2005 and $25,009 at
December 31, 2004, an increase of $2,630. This category tends to fluctuate
because of demand and with the seasons. Demand also may vary because of economic
conditions. Completion of construction projects generally occurs within one
year, at which time permanent financing through one of the Company's banking
affiliates or another lender is obtained. Loans for which the Company retains
permanent financing move into the commercial and industrial loan or mortgage
loan categories.
Real estate loans at September 30, 2005 were $120,240, which represents
an increase of $4,852 from December 31, 2004. Loans in this category are for
one-to-four family housing and are loans the banking affiliates elected to
retain rather than to sell on the secondary market.
25
Commercial and industrial loans were $263,729 at September 30, 2005, an
increase of $15,206 from December 31, 2004. Included in this category are loans
for working capital, equipment, commercial real estate and other loans for
business needs. See Note 15 of the Company's 2004 Form 10-K for information
related to "Concentrations of Credit".
Loans to individuals decreased by $1,710 when September 30, 2005 is
compared to December 31, 2004. For further comments on trends related to loans
to individuals see "Loans" on page 15 in the Company's 2004 Form 10-K.
Total deposits at September 30, 2005 increased by $26,245 from December
31, 2004. Noninterest-bearing demand deposits increased by $8,985 when September
30, 2005 is compared to December 31, 2004. During the same period,
interest-bearing demand deposits increased by $10,210, and time deposits
increased by $14,182. The majority of the growth in deposits came from the
acquisition of the two Planters Bank and Trust branches in the first quarter of
2005.
Liquidity and Capital Resources
Net cash provided by operating activities was $11,497 for the period
ended September 30, 2005, which compares to $16,255 for the same period the
previous year.
Net cash used in investing activities was $8,547 for the period ended
September 30, 2005, and $16,485 used for the period ended September 30, 2004.
Net cash provided by financing activities was $1,671 for the period ending
September 30, 2005.
Management is unaware of any commitment that would have a material and
adverse effect on liquidity at September 30, 2005.
Total shareholders' equity grew by $5,582 from December 31, 2004 to
September 30, 2005. Earnings and the changes in unrealized gains and losses for
securities available for sale accounted for the net increase. During the first
three quarters of 2005, the Company repurchased 11,400 shares of its own stock
for approximately $533 at an average price of $46.70 (excluding broker
commission). During the second quarter, the Company declared a $0.70 per share
dividend. The Tier I and Tier II risk-based capital ratios at September 30, 2005
were 13.12% and 14.11%, respectively. The Company's leverage capital ratio was
9.35%
Interest Rate Sensitivity
Following is a table showing repricing and maturity data for the
Company's interest-earning assets and interest-bearing liabilities:
September 30, 2005
-----------------------------------------------
Assets <1 Year 1-5 Years > 5 Years
- ------------------------------------------- -------------- ---------------- ---------------
Federal funds sold --- --- ---
Interest-bearing deposits 15,836 --- ---
Securities available for sale 20,978 66,326 64,381
Securities held to maturity 15,718 44,834 51,706
Mortgage loans held for sale 196 --- ---
Loans, net of unearned income
and deferred fees 156,997 276,023 65,840
-------------- ---------------- ---------------
Total assets repricing/maturing 209,725 387,183 181,927
============== ================ ===============
Cumulative 209,725 596,908 778,835
============== ================ ===============
Liabilities
Interest-bearing demand deposits 209,107 --- ---
Savings deposits 55,685 --- ---
Time deposits 179,118 171,505 588
Other borrowings 623 --- ---
-------------- ---------------- ---------------
Total liabilities/maturing 444,533 172,505 588
============== ================ ===============
Gap (234,808) 214,678 181,339
============== ================ ===============
Cumulative repricing gap (234,808) (20,130) 161,209
============== ================ ===============
Cumulative gap ratio 0.47 0.97 1.26
============== ================ ===============
26
As is noted under "Net Interest Income", the Company is liability-sensitive,
as its deposits will re-price at a faster rate than its interest earning assets.
In a period of rising interest rates, this can have a negative effect until
assets can re-price higher.
Management's Discussion and Analysis of Financial Condition
and Results of Operations for the Three Months Ended
September 30, 2005.
The following table shows NBI's key performance ratios for the three
months ended September 30, 2005 and 2004.
Three months ended
September 30, September 30,
2005 2004
---- ----
Return on average assets 1.47% 1.63%
Return on average equity 13.30% 15.24%
Net interest margin 4.31% 4.70%
Basic net earnings per share $0.87 $0.91
Fully diluted net earnings per share $0.86 $0.91
The return on average assets for the three months ended September 30, 2005
was 1.47%, a sixteen basis point decrease from the same period in 2004. The
return on average equity also declined.
The decline in the net interest margin was caused to a large extent by
increased cost of funds. In addition, the third quarter of 2005 reflects the
full effects of two acquisitions, one of which occurred in late June 2004 and
another in February of 2005.
Net Interest Income
The following table shows information related to NBI's net interest margin
for the three months ended September 30, 2005 and 2004.
Three months ended
September 30, September 30, % change
2005 2004
Interest income $11,483 $10,841 5.92%
Interest expense 3,816 2,904 31.40%
----- ----- ------
Net interest income $7,667 $7,937 (3.40)%
====== ====== =======
September 30, September 30,
2005 2004
Yield on earning assets 6.26% 6.27%
Cost to fund earning assets 1.95% 1.57%
Net interest margin 4.31% 4.70%
When the two periods are compared, the yield on interest earning assets
remained essentially the same. However, the cost to fund the earning assets rose
by 38 basis points. This reflects the steady increase in interest rates
affecting the Company and the entire banking industry.
Forecasts suggest that the Federal Reserve will continue to increase
interest rates in the near future. Considered as a whole, the Company is
liability-sensitive, which means its deposit base will upwardly reprice at a
faster rate than its interest earning assets. This will have a negative effect,
at least in the short term, until the slower-responding asset side reprices
upward.
27
Provision for Loan Losses
The provision for loan losses for the three months ended September 30,
2005 was $169. This compares to $293 for the three months ended September 30,
2004 and represents a $124 decrease. Comments made in the year-to-date
discussion for the "Provision and Allowance for Loan Losses" apply. Because
asset quality directly impacts the level of the provision for loan losses, see
also the "Asset Quality" section.
Noninterest Income
The following table compares NBI's noninterest income categories for the
three months ended September 30, 2005 and 2004.
Three months ended
September 30, 2005 September 30, 2004 % change
Service charges on deposits $797 $824 (3.28)%
Other service charges and fees 68 52 30.77%
Credit card fees 553 480 15.21%
Trust fees 326 274 18.98%
Other income 149 131 13.74%
Realized securities gains/losses (1) 104 (100.96)%
Service charges on deposits for the third quarter of 2005 were $797,
down 3.3% over the same quarter in 2004. There have been no material changes in
the service charge structure.
Credit card fees increased $73 when the third quarter of 2005 and 2004
are compared. These fees are almost exclusively driven by volume. Growth from
acquisitions was again the major cause of the increase.
Other income for the third quarter of 2005 was $149, up $18 from the
third quarter of 2004. Comments in the year-to-date discussion apply.
Noninterest Expenses
The following table compares NBI's noninterest expense categories for
the three months ended September 30, 2005 and 2004.
Three months ended
September 30, September 30,
2005 2004 % change
---- ---- --------
Salaries and employee benefits $2,822 $2,723 3.64%
Occupancy and furniture and fixtures 491 473 3.81%
Data processing and ATM 270 349 (22.64)%
Credit card processing 431 398 8.29%
Intangible assets and goodwill amortization 283 233 21.46%
Net costs of other real estate owned 63 37 70.27%
Other operating expenses 1,019 1,062 (4.05)%
Salaries and employee benefits for the three month period ending
September 30, 2005 were $2,822, up $99 or 3.6%. In late June 2004, NBB acquired
the Community National Bank of Pulaski, Virginia and substantially all of its
employees became employees of that bank. In February of 2005, BTC completed an
acquisition of certain branches. These acquisitions account for the majority of
the increase in this category. Comments in the year-to-date discussion also
apply.
Occupancy and furniture and fixtures expense increased $18 when the
third quarter of 2005 and 2004 expense are compared. Impacting this area was the
acquisition of a new Company-wide phone system, as well as the previously
mentioned acquisitions late in June 2004 and in the first quarter of 2005.
Data processing and ATM expenses were $270 for the three month period
ended September 30, 2005, compared to $349 for the same period in 2004. A large
portion of the decrease is attributable to the termination in early 2005 of a
contract for previously outsourced computer services at Community National Bank.
Expenses related to the amortization of intangibles increased $50 when
the third quarter of 2005 and 2004 are compared. Acquisitions accounted for this
increase. There have been no write-downs due to impairment.
The $63 in costs associated with other real estate is the result of
efforts to liquidate foreclosed properties. The amount of foreclosed property
has declined from $895 at December 31, 2004 to $429 at September 30, 2005.
28
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 September 30, 2005 was approximately $1,008. Amortized cost
for these securities was approximately $1,003.
The Company's banking affiliates extend lines of credit to their
customers in the normal course of business. Amounts drawn upon these lines vary
at any given time depending on the business needs of the customers.
Standby letters of credit are also issued to the banks' customers. There
are two types of standby letters of credit. The first is a guarantee of payment
to facilitate customer purchases. The second type is a performance letter of
credit that guarantees a payment if the customer fails to perform a specific
obligation.
While it would be possible for customers to draw in full on approved
lines of credit and letters of credit, historically this has not occurred. In
the event of a sudden and substantial draw on these lines, the Company has its
own lines of credit on which it could draw funds. Sale of the loans would also
be an option.
The Company also sells mortgages on the secondary market for which there
are recourse agreements should the borrower default.
During the first nine months of 2005, there have been no significant or
unusual changes in this area.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
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, 2004 in the Company's Form 10-K. (See
"Interest Rate Sensitivity" above.)
Item 4. Controls and Procedures
Under the supervision and with the participation of management,
including the Company's principal executive officer and principal financial
officer, the Company has conducted an evaluation of the effectiveness of the
design and operation of its disclosure controls and procedures as of September
30, 2005. Based on that evaluation, the Company's principal executive officer
and principal financial officer have concluded that these controls and
procedures are effective to give reasonable assurance in alerting them in a
timely fashion to material information relating to the Company that is required
to be included in the reports the Company files under the Act. There were no
changes in the Company's internal controls over financial reporting during the
period covered by this report that have materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting.
Disclosure controls and procedures are the Company's controls and
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports it files or submits under the Exchange Act is
accumulated and communicated to allow timely decisions regarding its required
disclosure. The Company believes that a controls system, no matter how well
designed and operated, cannot provide absolute assurance that all control issues
have been detected.
29
Part II
Other Information
Item 1. Legal Proceedings
There were no material legal proceedings for the three months
ended September 30, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On May 12, 2004, the Board of Directors approved the repurchase
of up to $1 million of the Company's common stock in a stock
repurchase program that was set to expire on May 31, 2005. On May
11, 2005, the Board of Directors approved the renewal of the
stock repurchase program and authorized the open market
repurchase of up to $1 million in common stock between June 1,
2005 and May 31, 2006. At September 30, 2005, approximately
$797,788 may yet be purchased under the new plan. No shares were
purchased during the quarter ended September 30, 2005.
Item 3. Defaults upon Senior Securities
None for the three months ended September 30, 2005.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
See Index of Exhibits.
30
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, National
Bankshares, Inc. has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DATE: November 8, 2005 NATIONAL BANKSHARES, INC.
/s/ JAMES G. RAKES
-------------------------
James G. Rakes
Chief Executive Officer
/s/ J. ROBERT BUCHANAN
-------------------------
J. Robert Buchanan
Chief Financial Officer
(1) Index of Exhibits
Page No. in
Exhibit No. Description Sequential System
----------- ----------- -----------------
3(i) Articles of Incorporation, as amended, of National (incorporated herein by
Bankshares, Inc. reference to Exhibit 3(a)
of the Annual Report on
Form 10-K for fiscal year
ended December 31, 1993)
3(i) Articles of Amendment to Articles of Incorporation (incorporated herein by
of National Bankshares, Inc.,dated April 8, 2003. reference to exhibit 3(i) of
The Annual Report on Form 10-K
for the fiscal year ended
December 31, 2003)
4(i) Specimen copy of certificate for National (incorporated herein by
Bankshares, Inc. common stock, $2.50 par value reference to Exhibit 4(a) of
the Annual Report on Form 10-K
for fiscal year ended December
31, 1993)
4(i) Article Four of the Articles of Incorporation of (incorporated herein by
National Bankshares, Inc. included in Exhibit No. reference to Exhibit 4(b)
3(a) of the Annual Report on
Form 10-K for fiscal year
ended December 31, 1993)
10(ii)(B) Computer software license agreement dated June 18, (incorporated herein by
1990, by and between Information Technology, Inc. reference to Exhibit 10(e)
and The National Bank of Blacksburg of the Annual Report on
Form 10-K for fiscal year
ended December 31, 1992)
*10(iii)(A) National Bankshares, Inc. 1999 Stock Option Plan (incorporated herein by
reference to Exhibit 4.3 of
the Form S-8, filed as
Registration No. 333-79979
with the Commission on June 4,
1999)
31
*10(iii)(A) Employment Agreement dated January 2002 between (incorporated herein by
National Bankshares, Inc. and James G. Rakes reference to Exhibit 10(iii)(A)
of Form 10-Q for the period
ended June 30, 2002)
*10(iii)(A) Employment Lease Agreement dated August 14, 2002, (incorporated herein by
between National Bankshares, Inc. and The National reference to Exhibit 10(iii)(A)
Bank of Blacksburg of form 10-Q for the period ended
September 30, 2002)
*10(iii)(A) Change in Control Agreement dated January 5, 2003, (incorporated herein by
between National Bankshares, Inc. and Marilyn B. reference to Exhibit 10 iii
Buhyoff (A) of Form 10-K for the
period ended December 31, 2002)
*10(iii)(A) Change in Control Agreement dated January 8, 2003, (incorporated herein by
between National Bankshares, Inc. and F. Brad reference to Exhibit 10 iii (A)
Denardo of Form 10-K for the period ended
December 31, 2002)
31(i) Section 302 Certification of Chief Executive Officer Page 33
31(ii) Section 302 Certification of Chief Financial Officer Page 34
32(i) 18 U.S.C. Section 1350 Certification of Chief
Executive Officer Page 35
32(ii) 18 U.S.C. Section 1350 Certification of Chief
Financial Officer Page 35
* Indicates a management contract or compensatory plan required to be filed
herein.
32
Exhibit No. 31(i)
CERTIFICATIONS UNDER SECTION 906 OF THE SARBANES OXLEY ACT OF 2002
I, James G. Rakes, Chairman, President and Chief Executive Officer of
National Bankshares, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of National Bankshares,
Inc.;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a - 15 (e) and 15d - 15 (e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a - 15(f) and 15d -
15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, 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 report is being prepared;
(b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluations; and
(d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: November 8, 2005
/s/ JAMES G. RAKES
-------------------------
James G. Rakes
Chairman
President and Chief Executive Officer
(Principal Executive Officer)
33
Exhibit 31(ii)
I, J. Robert Buchanan, Treasurer (Chief Financial Officer) of National
Bankshares, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of National
Bankshares, Inc.;
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a - 15 (e) and 15d - 15 (e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a - 15(f) and 15d -
15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, 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 report is being prepared; and
(b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purpose in accordance
with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluations; and
(d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: November 8, 2005
/s/ J. ROBERT BUCHANAN
------------------------
J. Robert Buchanan
Treasurer
(Principal Financial Officer)
34
Exhibit 32 (i)
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
In connection with the Form 10-Q of National Bankshares, Inc. for the
quarter ended September 30, 2005, I, James G. Rakes, President and Chief
Executive Officer of National Bankshares, Inc. (Principal Executive Officer),
hereby certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my knowledge and
belief, that:
(1) such Form 10-Q for the quarter ended September 30, 2005, fully complies with
the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of
1934; and
(2)the information contained in such Form 10-Q for the quarter ended
September 30, 2005, fairly presents, in all material respects, the financial
condition and results of operations of National Bankshares, Inc.
/s/ JAMES G. RAKES
- --------------------
James G. Rakes
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 32 (ii)
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
In connection with the Form 10-Q of National Bankshares, Inc. for the
quarter ended September 30, 2005, I, J. Robert Buchanan, Treasurer (Principal
Financial Officer) of National Bankshares, Inc., hereby certify pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, to the best of my knowledge and belief, that:
(1) such Form 10-Q for the quarter ended September 30, 2005, fully complies with
the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of
1934; and
(2)the information contained in such Form 10-Q for the quarter ended
September 30, 2005, fairly presents, in all material respects, the financial
condition and results of operations of National Bankshares, Inc.
/s/ J. ROBERT BUCHANAN
- ------------------------
J. Robert Buchanan
Treasurer
(Principal Financial Officer)
35