National Bankshares
1997 Annual Report
$ In thousands, except per share data.
Financial Highlights 1997 1996 1995
------ ------ ------
Net income per share $ 1.73 1.61 1.46
Cash dividends declared per share 0.68 0.62 0.57
Book value per share 14.73 13.56 12.70
Loans, net $214,552 193,598 163,193
Total securities 149,974 171,244 187,635
Total assets 402,907 388,850 380,915
Total deposits 344,867 334,584 330,313
Stockholders' equity 54,029 49,801 48,154
Contents
Community Caring 2
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To Our Stockholders 4
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Selected Consolidated
Financial Data 5
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Management's Discussion and
Analysis 6
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Independent Auditors' Report 15
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Consolidated Financial
Statements 16
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Notes to Consolidated
Financial Statements 20
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Corporate Information 44
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Community
Caring
National Bankshares, Inc. "Picture of Community Breakfast"
strives to be an exceptional (Lara Ramsey - Community
community bank holding Oranizations and Businesses)
company dedicated to
providing shareholder value "Picture of Main Street Moments"
by offering financial services (Carl Gillespie - Board Member and
to customers through Sandra Viney - Head Teller)
subsidiary financial
institutions and affiliated "Picture of Boo Party"
companies in an efficient, (Halloween Party hosted by BTC
friendly, personalized and for the area pre-school and
cost-effective manner. We head start students)
recognize that to do this, our
financial institutions must
retain the ability to make
decisions locally and must "Picture of Primeline Social"
actively participate in the (Customers with Primeline Account)
communities they serve. We
are committed to offering
competitive and fair
employment opportunities
and to maintaining the highest
standards in all aspects of
our business.
NBB
The National Bank
BTC Bank of Tazewell County
2
"Picture of Crystal Artis"
(COE Student - Cooperative
Office Education)
"Picture of Wilderness Trail Festival"
(Phyllis Duncan - North Main Branch Manager)
"Picture of Main Street Moments"
(Anthony Dawson, T. C. Bowen and
Connie Stallard)
"Picture of Rich Creek Branch Opening"
(Betty Johnson - Branch Manager)
3
National Bankshares
"Picture of James G. Rakes"
To Our Stockholders: technology and employee computer
training. Late in the year, the
It is always pleasant to report Board of Directors of Bank of
positive financial results to you, Tazewell County determined that
and there are a number of highlights during 1998 BTC will combine its
in National Bankshares' performance data processing with that of NBB.
for 1997. Net income reached a Consolidation will allow the
record $6.56 million, up from the Tazewell bank to take advantage of
$6.12 million earned in 1996, which NBB's updated equipment, and it will
was itself a record total. permit both banks to realize some
Stockholders shared in this success, economies of scale.
with annual dividends in 1997 that
were 9.68% higher than in 1996. In April 1997, The National Bank
During the past year, the asset size opened its eighth branch office in
of Bankshares and its bank Rich Creek, Virginia, the third
subsidiaries topped the $400 million office in Giles County. At the end
mark for the first time, and the of the year, NBB agreed to purchase
Company ended 1997 with nearly $403 the Galax, Virginia office of First
million in total assets. American Federal Savings Bank. We
hope to complete that transaction
Several areas that contributed to very soon, and to begin offering our
1997's final results deserve special style of personalized banking in a
mention. A positive 10.82% increase new, but nearby, market area.
in net loans accomplished two
important things. First, funds were The year just past proved to be
shifted from the securities profitable for our banks and our
portfolio into higher yielding customers. We worked to attain our
loans. Second, thousands of loans goal of being an exceptional
were made to individuals and community bank holding company
businesses throughout Southwest dedicated to providing value to our
Virginia, keeping the deposits stockholders. We are firmly
generated in our region at work in committed to the belief that there
our localities. Reflecting the is a bright future for community
strong economy, the quality of the banks, and therefore a great
loan portfolio remained high and the opportunity for a progressive and
level of total nonperforming assets competitive company like ours. I
dropped significantly, from $1.1 would be remiss if I did not thank
million in 1996 to $0.5 million in our directors, officers and
1997. The Company's already good employees for their contributions to
capital level increased during the our success in 1997, and I also
year, and at year end Bankshares and thank you for your continued
subsidiaries had over $54 million in investment and confidence in
stockholders' equity. A healthy National Bankshares.
capital base is a positive indicator
of the strength of our subsidiary
banks, and, in addition, it allows
us to actively consider new business James G. Rakes
opportunities. President and
Chief Executive Officer
While enjoying the prosperity of
1997, we planned for the future.
During the year, The National Bank
made a significant investment in
upgraded information processing
4
National Bankshares, Inc. and Subsidiaries
Selected Consolidated Financial Data
$ In thousands, except per share data. Years ended December 31,
----------------------------------------------------------------
1997 1996 1995 1994 1993
------ ------ ------ ------ ------
Selected Interest income $ 29,797 28,647 28,094 26,062 25,827
Income Interest expense 13,106 13,036 12,703 10,684 10,752
Statement Net interest income 16,691 15,611 15,391 15,378 15,075
Data: Provision for loan
losses 435 331 282 553 953
Noninterest income 2,834 2,693 2,382 2,047 2,399
Noninterest expense 10,031 9,515 10,033 9,725 9,002
Income taxes 2,499 2,341 1,933 1,844 1,903
Net income 6,560 6,117 5,525 5,303 5,644
Per Share Net income $ 1.73 1.61 1.46 1.40 1.49
Data: Cash dividends
declared 0.68 0.62 0.57 0.52 0.45
Book value per
share(1) 14.73 13.56 12.70 11.25 10.81
Selected Loans, net $214,552 193,598 163,193 156,289 150,156
Balance Total securities 149,974 171,244 187,635 184,231 174,964
Sheet Total assets 402,907 388,850 380,915 373,132 357,773
Data at Total deposits 344,867 334,584 330,313 327,686 314,001
End Stockholders'
of Year: equity 54,029 49,801 48,154 42,658 40,951
Selected Loans, net $204,540 177,419 160,643 152,976 149,027
Balance Total securities 157,179 177,403 183,994 185,365 154,740
Sheet Total assets 395,932 388,045 378,406 369,962 349,747
Daily Total deposits 339,439 335,938 330,261 325,167 307,645
Averages: Stockholders'
equity(1) 53,712 49,459 45,726 42,402 39,435
Selected Return on average
Ratios: assets 1.66 1.58 1.46 1.43 1.61
Return on average
equity(1) 12.21 12.37 12.08 12.51 14.31
Dividend payout
ratio 39.31 37.55 37.32 37.13 32.18
Average equity to
average assets(1) 13.57 12.75 12.08 11.46 11.28
(1) Includes amount related to common stock subject to ESOP put
option excluded from stockholders' equity on the Consolidated
Balance Sheets.
(Dollars) (Dollars)
Book Value Per Share Graph Cash Dividends Per Share Graph
1993 1994 1995 1996 1997 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
$10.81 11.25 12.70 13.56 14.73 $0.45 0.52 0.57 0.62 0.68
5
Management's Discussion and Analysis
($ In thousands, except per share data.)
Net Income Graph
($ In millions)
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
$5.6 5.3 5.5 6.1 6.6
Average Equity to Average Assets Graph
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
11.28% 11.46% 12.08% 12.75% 13.57%
PERFORMANCE SUMMARY
Net income in 1997 for National Bankshares, Inc. (Bankshares) and its
wholly-owned subsidiaries, The National Bank of Blacksburg (NBB) and Bank of
Tazewell County (BTC), (the Company), was $6,560, an increase of $443 or
7.24%. This produced a return on average assets and a return on average
equity of 1.66% and 12.21%, respectively.
Net income for the Company for 1996 was $6,117, an increase of $592 or
10.71% over 1995. The return on average assets and return on average equity
for 1996 were 1.58% and 12.37%, respectively.
The Company's net income for 1995 was $5,525 which produced a return on
average assets of 1.46% and a return on average equity of 12.08%.
Earnings per share increased steadily over the three year period rising
from $1.46 per share in 1995, to $1.61 in 1996 and $1.73 in 1997.
The Company continues to enjoy good profitability as indicated by the
return on average assets and steadily increasing earnings per share. The
decline in the return on average equity in 1997 was due to a net increase in
the Company's capital resulting from continued good earnings offset by
dividends paid to the Company's stockholders. The dividend payout ratio for
1997 was 39.31%, which compares to 37.55% in 1996 and 37.32% in 1995.
NET INTEREST INCOME
Net interest income for 1997 was $16,691, an increase of $1,080 or 6.92%
over 1996. In 1996, net interest income was $15,611, up $220 or 1.43% from
1995 net interest income of $15,391.
The net yield on earnings assets for 1997 was 4.75%. In 1996 and 1995,
the net yields on earning assets were 4.59% and 4.63%, respectively.
Throughout the three year period, management's strategy was to fund
increases in the loan portfolio through liquidity generated principally from
the securities portfolio. In 1997, overall loan growth remained strong,
particularly in commercial loans and loans to individuals.
In 1996, a substantial amount of loan growth took place in the highly
rate-competitive commercial loan area. This limited the effect of the loan
growth on net interest income.
6
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 and
fair market values to adverse movement in interest rates. Interest rate
sensitivity analyses indicate repricing opportunities, and interest rate
shock simulations indicate potential economic loss due to future interest
rate changes. Management realizes certain risks are inherent and minimizes
these by adjusting asset/liability management responses to changing economic
conditions.
The Company reduces the volatility of its net interest income by
managing the relationship of interest-rate sensitive assets to interest-rate
sensitive liabilities. The Company would be impacted by rising interest rate
changes, as it is liability sensitive for the time period up to one year.
Beyond one year, the cumulative interest rate position is asset sensitive,
indicating that the effect of rising rates would dissipate in the one to five
year time period.
The impact of rate fluctuations is dependent, however, upon the
magnitude, the length of the rising or falling rate trend and the period of
time rates remain stable at a given level. Based on the information and
assumptions in effect at December 31, 1997, management believes that an
immediate 200 basis point rate shock, up or down, over a twelve month period
could significantly affect the Company's annualized net interest income or
net economic value if not countered by management's pricing strategies.
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.
Loan loss and other industry indicators related to asset quality are
presented in the Loan Loss Data table.
7
Management's Discussion and Analysis
Loan Loss Data
($ In thousands) 1997 1996 1995
------ ------ ------
Provision for loan losses $ 435 331 282
Net charge-offs to average
net loans 0.28% 0.21% 0.13%
Allowance for loan losses to
loans, net of unearned
interest and deferred fees 1.12% 1.31% 1.58%
Allowance for loan losses to
nonperforming loans 2,802.30% 418.02% 365.60%
Allowance for loan losses to
nonperforming assets 479.92% 236.24% 177.37%
Nonperforming assets to loans,
net of unearned income
and deferred fees, plus
other real estate owned 0.23% 0.55% 0.89%
Nonaccrual loans $ 87 616 718
Other real estate owned, net 421 474 762
--------- ------ ------
Total nonperforming assets $ 508 1,090 1,480
========= ====== ======
Accruing loans past due 90 days
or more $ 672 458 574
Nonperforming loans include nonaccrual loans and do not include accruing
loans past due 90 days or more. Nonperforming assets for 1997 have decreased
$582 or 53.39% from 1996 and represent the continuation of a declining trend.
Nonperforming assets for 1996 decreased by $390 or 26.35% from the 1995 total
of $1,480.
Net charge-offs to average net loans for 1997 were .28%, up .07% when
compared to 1996. Allocations for these net charge-offs were made in
previous periods. In 1997, overall asset quality continued to improve and
general economic conditions were favorable. While the provision for loan
loss increased by $104 or 31.42%, the previously mentioned loan charge-offs
and the level of loan growth resulted in a lower ratio of the allowance to
loans.
Net charge-offs to average net loans for 1996 were .21%, up from 1995
when that ratio was .13%. While the Company did experience an increase in
net charge-offs, there was an overall trend of improving asset quality. The
provision for loan losses, which was up $49 in 1996 or 17.38% over 1995's
provision of $282, was increased to cover 1996's net charge-offs. See note 5
of Notes to Consolidated Financial Statements for additional information
relating to nonperforming assets, past due loans, impaired loans and
allowance for loan losses.
8
National Bankshares, Inc. and Subsidiaries
While past efforts directed at improving asset quality have been largely
successful, management is unable to estimate when and under what exact terms
problem credits will be resolved. With the information available, management
does not anticipate any significant deterioration in asset quality. However,
changing economic conditions, the timing and extent of changes and the
ultimate impact on the Company's asset quality is not within management's
ability to predict with any degree of precision.
NONINTEREST INCOME
Noninterest income for 1997 was $2,834, an increase of $141 or 5.24%
over 1996. Noninterest income for 1996 was $2,693, up $311 or 13.06% from
1995.
Service charges on deposits for 1997 totalled $1,131, a decrease of $52
or 4.40% from 1996. Service charges on deposit accounts in 1996 were up $190
or 19.13% from the previous year. The level of these charges is driven by
demand deposit volume, types of accounts opened, service charge rates in
effect, the level of charges such as overdraft fees and the waiver policy
concerning these fees. The decrease for 1997 and the increase for 1996 were
largely attributable to fluctuations in overdraft volumes.
Other service charges and fees are composed of safe deposit box rent,
charges associated with letters of credit and other miscellaneous items. In
1997, these charges were $250, a decrease of $19 or 7.06% from 1996. For
1996, these charges totalled $269, an increase of $41 or 17.98% over 1995.
Trust income for 1997 was $738 which represents an increase of $135 or
22.39% over 1996. In 1996, trust income was $603, an increase of $123 or
25.63% over 1995. Factors affecting the growth in trust income include an
increase in the number of accounts managed, an increase in the average value
of the accounts managed and an increase in both the number and value of
estates settled. Due to its nature, estate business volume and the related
income is not within management's ability to predict.
Credit card income is composed of several types of fees and charges,
including transaction or interchange fees, merchant discount fees and
overlimit charges. In 1997, credit card income totalled $606, an increase of
$95 or 18.59% over 1996. Credit card income for 1996 was $511, up $61 or
13.56% over 1995. Credit card income increased in 1997 largely because of a
higher volume of interchange transactions, created in part by the
introduction of a debit card product. The increase in credit card income was
offset somewhat by the discontinuation early in 1997 of annual membership
fees charged to customers. Given the highly competitive market which limits
the amount of charges set, revenue increases result from growth in the number
of merchant accounts processed and increases in the number of customer credit
and debit card accounts that result in higher transaction volume.
Net securities gains were $37 in 1997, down $60 or 61.86% from 1996. In
1996, net securities gains were $97, down 46.70% from 1995. Gains and losses
can occur as a result of portfolio restructuring, called securities and
certain market adjustments. The majority of the gains for 1996 consisted of
market adjustments to an allowance set up to cover potential losses on
certain bonds held by BTC. These bonds were disposed of in 1997 and a gain
of approximately $10 was recognized.
NONINTEREST EXPENSE
Noninterest expense in 1997 totalled $10,031, up $516 or 5.42% from
1996. In 1996, noninterest expense was $9,515, a decrease of $518 or 5.16%
from 1995.
9
Management's Discussion and Analysis
Salaries and benefits increased $120 or 2.27% from 1996. The increase
resulted from the addition of staff in connection with NBB's opening of a new
branch office early in 1997 and from salary adjustments, promotions and other
normal compensation related items, offset by a $119 decrease in net pension
cost.
In 1996, salaries and benefits expense totalled $5,278, up $244 or 4.85%
from 1995. This was largely due to a $177 increase in net pension cost and
other normal compensation related items.
Occupancy and furniture and fixtures expense increased $74 or 8.37% for
1997 when compared to 1996. This increase was due to higher costs associated
with the new branch office constructed and opened by NBB and also to regular
planned maintenance of facilities. Management anticipates occupancy and
furniture and fixtures expense to continue to increase. NBB expects to
purchase a branch office in Galax, Virginia in early 1998 and will also start
construction of a new office building during the year. The expected increase
in occupancy and furniture and fixtures expense will be somewhat moderated by
a future reduction in expenses for leased premises. Occupancy and furniture
and fixtures expense experienced a slight decrease in 1996 of 3.91% over
1995.
Data processing and ATM expense was $578 for 1997, an increase over 1996
of $81 or 16.30%. This increase was due to costs associated with the upgrade
of information system hardware and software and costs related to an expanded
microcomputer network. Data processing and ATM expense is also likely to
increase in 1998, as BTC completes a planned upgrade of its information
system hardware and software and an expansion of its microcomputer network.
In 1996, data processing and ATM expense was $497, an increase of $35 or
7.58% over 1995. The expansion of a microcomputer network and increased
costs of maintenance on older equipment were the primary causes of the
increase.
The cost of Federal Deposit Insurance increased in 1997 by $39 over
1996. While the banks' base premiums remain at the minimum required by law,
legislation enacted in late 1996 levied an assessment on banks for the
purpose of financing certain costs associated with the resolution of the
savings and loan crisis. This additional levy is expected to remain in
effect until 2018-2019. In 1996, the Company's affiliates paid the base
premium of $4, the minimum payment required by law, which was a 98.94%
decrease from 1995's assessment.
Credit card processing expense for 1997 was $551, an increase of $85 or
18.24% over 1996. This increase reflects additional expense due to the
introduction of a debit card product, higher merchant processing costs and an
overall increase in business activity. In 1996, credit card processing
expense increased by $55 or 13.38%, which was primarily the result of
increased business activity.
Net costs of other real estate owned for 1997 were $8, a decrease of $3
or 60.00% from 1996. Other real estate owned net of valuation allowance
decreased in 1997 by $53. Efforts to market existing properties continue,
however, the exact timing, terms and conditions of the sale of the properties
remain unknown. In 1996, net costs of other real estate owned decreased by
$190 or 97.44% from 1995, primarily due to a $119 reduction in the valuation
allowance for other real estate in 1996.
Other operating expenses were $2,465 in 1997, up $114 or 4.85% from
1996. The other operating expense category in 1996 decreased by $251 or
9.65% from 1995 and was due primarily to a $111 reduction in merger expenses,
from $268 in 1995 to $157 in 1996. Other operating expenses in 1995 included
a contribution to a community development corporation which was not incurred
in 1996.
10
National Bankshares, Inc. and Subsidiaries
INCOME TAXES
Higher pre-tax income in 1997 resulted in a $158 increase in income tax
expense when compared to 1996. Tax exempt interest income continues to be
the primary difference between the "expected" and reported income tax
expense. The Company's effective tax rates for 1997, 1996 and 1995 were
27.59%, 27.68% and 25.92%, respectively. The increase in the effective tax
rate for 1996 was due primarily to the level of tax exempt interest income
being comparable to 1995.
See note 9 of Notes to Consolidated Financial Statements for additional
information relating to income taxes.
EFFECTS OF INFLATION
The Company's consolidated statements of income generally reflect the
effects of inflation. Since interest rates, loan demand and deposit levels
are related to inflation, the resulting changes are included in net income.
The most significant item which does not reflect the effects of inflation is
depreciation expense, because historical dollar values used to determine this
expense do not reflect the effect of inflation on the market value of
depreciable assets after their acquisition.
BALANCE SHEET
Total assets at year end 1997 were $402,907 which represents an increase
of $14,057 or 3.62% over the previous year. The Company's primary methods of
achieving growth are to seek to increase deposits at its bank subsidiaries
and to grow through corporate acquisitions and mergers. In both 1997 and
1996, the Company experienced excess liquidity, and because management
stressed profitability over growth, management's strategy was to utilize
those funds before aggressively pursuing new deposits. In 1997 and 1996,
total average deposits grew by $3,501 and $5,677, respectively, which
represents growth rates of 1.04% and 1.72%, respectively.
Total Assets Graph
(Millions)
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
$357.8 373.1 380.9 388.9 402.9
LOANS
Loans, net of unearned income and deferred fees, grew by $20,817 or
10.61% in 1997. Commercial loans grew by $13,860 or 15.84% with loans to
individuals increasing by $5,644 or 9.25%.
In 1996, loans, net of unearned income and deferred fees, grew by
$30,355 or 18.31%. Commercial loans, which grew by $27,910 or 46.82%,
accounted for the largest portion of the increase.
The Company engages in the origination and sale of mortgage loans in the
secondary market. In 1997 and 1996, the Company originated $19,120 and
$17,907, respectively, and sold $19,231 and $18,271 in 1997 and 1996,
respectively, of mortgage loans.
SECURITIES
In 1997, bank-owned securities declined by $21,270 or 12.42% compared to
1996. The decrease took place in the held to maturity portfolio which
declined by $24,318 or 22.37%. Securities available for sale increased
$3,048 or 4.87% offsetting a portion of that decline. In 1996, total bank-
11
Management's Discussion and Analysis
owned securities were $171,244, a decrease of $16,391 or 8.74% from 1995. In
1997 and 1996, cash flows resulting from the reduction in the securities
portfolio were used to fund loan growth.
The Company's investment policy stresses safety with a program of
purchasing high quality securities such as U.S. Treasury and U.S. Government
agency issues, state, county, and municipal bonds, corporate bonds, mortgage-
backed securities and other bank qualified investments. The Company has
classified all of its investment securities as either held to maturity or
available for sale, as the Company does not engage in trading activities.
Investment strategies are adjusted in response to market conditions and
available investment vehicles.
At December 31, 1997 and 1996, the Company had no investment
concentrations in any single issues (excluding U.S. Government) that exceeded
ten percent of capital.
DEPOSITS
At year end 1997, total deposits were $344,867 which represent a $10,283
or a 3.07% increase over 1996. At December 31 1996, total deposits were
$334,584, an increase of 1.29% over 1995.
Average noninterest-bearing deposits of $44,193 grew by $2,196 or 5.23%
in 1997, $3,164 or 8.15% in 1996 and $2,109 or 5.74% in 1995. Average
interest-bearing deposits were $295,246 in 1997, an increase of $1,305 over
1996. In 1996, average interest-bearing deposits of $293,941 increased
$2,513 from the 1995 total of $291,428.
DERIVATIVES AND MARKET RISK EXPOSURES
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. See note 13 of Notes to Consolidated Financial Statements for
additional information relating to financial instruments with off-balance
sheet risk. Management does not plan any future involvement in high risk
derivative products. The Company has investments in mortgage-backed
securities, collateralized mortgage obligations, structured notes and other
similar instruments which are included in securities available for sale and
securities held to maturity. The fair value of these investments at December
31, 1997 approximated $11,144. See note 3 of Notes to Consolidated Financial
Statements for additional information relating to securities.
The Company's securities and loans are subject to credit and interest
rate risk and its deposits are subject to interest rate risk. Management
considers its credit risk when a loan is granted and monitors its credit risk
after the loan is granted. The Company maintains an allowance for loan
losses to absorb losses in the collection of its loans. See note 5 of Notes
to Consolidated Financial Statements for information relating to
nonperforming assets, past due loans, impaired loans and allowance for loan
losses. See note 14 of Notes to Consolidated Financial Statements for
information relating to concentrations of credit risk. The Company has an
asset/liability program to manage its interest rate risk. This program
provides management with information related to the rate sensitivity of
certain assets and liabilities and the effect of changing rates on
profitability and capital accounts. While this planning process is designed
to protect the Company over the long term, it does not provide near term
protection from interest rate shocks, as interest rate sensitive assets and
liabilities do not, by their nature, move up or down in tandem in response to
12
National Bankshares, Inc. and Subsidiaries
changes in the overall rate environment. The Company's profitability in the
near term may temporarily be affected, either positively by a falling
interest rate scenario or negatively by a period of rising rates. See note
15 of Notes to Consolidated Financial Statements for information relating to
fair value of financial instruments.
LIQUIDITY
Liquidity is the ability to provide sufficient cash flow to meet
financial commitments and to fund additional loan demand or withdrawal of
existing deposits. Sources of liquidity include deposits, loan principal and
interest repayments, sales, calls and maturities of securities and short-term
borrowings. The Company maintained an adequate liquidity level during 1997
and 1996. Management is not aware of any trends, commitments or events that
will result in or that are reasonably likely to result in a material increase
or decrease in liquidity.
Net cash from operating activities of $7,573 in 1997 decreased $395 from
1996 due primarily to the increase in net income offset by the change in
other liabilities. Net cash flows provided by operating activities,
securities and financing activities for 1997 of $7,573, $21,966 and $7,562,
respectively, were used to fund the net increases in federal funds sold,
interest-bearing deposits, loans made to customers and purchases of loan
participations of $2,390, $9,637, $17,400 and $6,189, respectively.
Net cash from operating activities of $7,968 in 1996 increased $1,604
from 1995 and was primarily attributable to the increase in net income and
the change in the mortgage loans held for sale category which fluctuates
based upon loan demand and the timing of loan sales in the secondary market.
Cash flows from investing activities in 1996 continued to reflect the
shifting of securities to the loan portfolio and from securities held to
maturity to available for sale. Net cash flows provided by operating
activities, federal funds sold, securities and financing activities for 1996
of $7,968, $5,815, $15,542 and $1,930, respectively, were used principally to
fund the net increase in loans of $31,633.
A pending acquisition by NBB of the Galax branch of First American
Federal Savings Bank, which is expected to close in early 1998, is not
anticipated to have a material impact on the Company's liquidity. See
"Future Management Considerations."
CAPITAL RESOURCES
Total stockholders' equity increased $4,228 from 1996 to 1997 and $1,647
from 1995 to 1996. Net income, less cash dividends on common stock of $2,579
in 1997 and $2,297 in 1996, accounted primarily for the increase. Net
unrealized gains (losses) on securities available for sale, net of deferred
income taxes, were $194 at December 31, 1997, $(248) at December 31, 1996 and
$282 at December 31, 1995. These unrealized net gains and losses are
recorded as a separate component of stockholders' equity and will continue to
be subject to change in future years due to fluctuations in fair values,
sales, purchases, maturities and calls of securities classified as available
for sale.
The Company has operated from a consistently strong capital position.
The ratio of total stockholders' equity to total assets was 13.41% at year
end 1997 compared to 12.81% at year end 1996 and 12.64% at year end 1995.
Banks are required to apply percentages to various assets, including off-
balance sheet assets, to reflect their perceived risk. Regulatory defined
capital is divided by risk weighted assets in determining the bank's risk-
based capital ratio. No regulatory authorities have advised National
Bankshares, Inc., The National Bank of Blacksburg or Bank of Tazewell County
13
Management's Discussion and Analysis
of any specific leverage ratios applicable to them. National Bankshares,
Inc., The National Bank of Blacksburg and Bank of Tazewell County's capital
adequacy ratios exceed regulatory requirements and provide added flexibility
to take advantage of business opportunities as they arise. See note 10 of
Notes to Consolidated Financial Statements for additional information.
Stockholders' Equity Graph
(Millions)
1993 1994 1995 1996 1997
---- ---- ---- ---- ----
$41.0 42.7 48.2 49.8 54.0
RECENT ACCOUNTING PRONOUNCEMENTS
See notes 1 and 17 of Notes to Consolidated Financial Statements for
information relating to recent accounting pronouncements.
MERGER
On June 1, 1996, Bankshares issued 1,888,209 shares of its common stock
in a one-for-one exchange for all the outstanding common stock of Bank of
Tazewell County, Tazewell, Virginia. This business combination has been
accounted for as a pooling-of-interests and, accordingly, the consolidated
financial statements for the periods prior to the combination have been
restated to include the accounts and results of operations of Bank of
Tazewell County. There were no adjustments of a material amount resulting
from Bank of Tazewell County's adoption of Bankshares' accounting policies.
In May 1996, Bankshares declared a stock split of .11129 per share
effected in the form of a stock dividend to the holders of Bankshares common
stock just prior to the merger effective date to facilitate the one-for-one
common stock exchange ratio. All stockholders' equity accounts, share and
per share data have been adjusted retroactively to reflect the stock split.
Bank of Tazewell County is well capitalized with excess liquidity, and
provides the Company with an expanded market place.
FUTURE MANAGEMENT CONSIDERATIONS
Year 2000
The Company is cognizant of the risks and challenges presented by the
impact of the century date change on information processing and other
computer controlled systems. The Year 2000 presents two related but distinct
issues for financial institutions. The Company's internal information
processing and computer controlled systems must be Year 2000 compliant, and
the subsidiary banks' compliance efforts are subject to regulatory review.
In addition, banks face credit risk should their commercial loan customers
suffer significant business disruptions as a result of the impact of computer
failures in their own operations or in those of their suppliers or customers.
As a normal part of business operations, the Company's subsidiaries are
currently in the process of upgrading information processing systems which
will include the acquisition of new information processing hardware and
software. The primary goal of this project is to provide a shared
information processing system for affiliates, additional capacity and the
ability to use the most advanced software available from vendors.
14
National Bankshares, Inc. and Subsidiaries
While the overall costs associated with the upgrade are substantial, it
is not anticipated that the Year 2000 component of this upgrade will have a
material effect on the Company's consolidated financial statements.
Pending Acquisition
On December 26, 1997, NBB entered into an agreement to purchase the
assets, including real estate and improvements, and assume the liabilities of
the Galax, Virginia, branch office of First American Federal Savings Bank.
The transaction, which is subject to regulatory approval, is expected to
close in early 1998.
COMMON STOCK INFORMATION AND DIVIDENDS
National Bankshares, Inc.'s common stock is traded on a limited basis in
the over-the-counter market and is not listed on any exchange or quoted on
NASDAQ. Some trades in the Company's stock are reported on the OTC Bulletin
Board under the trading symbol NKSH. Local brokerage firms are familiar with
and active in trading in the common stock of National Bankshares, Inc. As of
December 31, 1997, there were 1,163 stockholders of Bankshares common stock.
The following is a summary of the market price per share and cash dividend
per share of the common stock of National Bankshares, Inc. for 1997 and 1996.
Prices do not necessarily reflect the prices which would have prevailed had
there been an active trading market, nor do they reflect unreported trades,
which may have been at lower or higher prices.
Common Stock Market Prices
Dividends
1997 1996 Per Share
----------- ---------- -----------
High Low High Low 1997 1996
---- --- ---- --- ---- ----
First Quarter $26.25 25.00 $26.50 24.00 --- ---
Second Quarter 25.87 23.50 26.25 24.50 .33 .30
Third Quarter 25.75 23.81 27.00 24.50 --- ---
Fourth Quarter 26.50 23.50 26.50 25.00 .35 .32
Bankshares' primary source of funds for dividend payments is dividends
from its subsidiaries, The National Bank of Blacksburg and Bank of Tazewell
County. Bank regulatory agencies restrict dividend payments of the
subsidiaries as more fully disclosed in note 10 of Notes to Consolidated
Financial Statements.
15
Independent Auditors' Report
The Board of Directors and Stockholders
National Bankshares, Inc.:
We have audited the accompanying consolidated balance sheets of National
Bankshares, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of income, changes in stockholders' equity,
and cash flows for each of the years in the three-year period ended December
31, 1997. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits. We did not
audit the 1995 financial statements of Bank of Tazewell County, a wholly-
owned subsidiary, which statements reflect total assets constituting 47
percent and total interest income constituting 43 percent of the related 1995
consolidated totals. Those statements were audited by other auditors whose
report has been furnished to us, and our opinion, insofar as it relates to
the amounts included for Bank of Tazewell County for 1995, is based solely on
the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits and the report
of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of National
Bankshares, Inc. and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997 in conformity with generally
accepted accounting principles.
KPMG Peat Marwick LLP
Roanoke, Virginia
February 6, 1998
16
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
$ In thousands except share and per share data.
December 31, 1997 and 1996 1997 1996
------ ------
Assets Cash and due from banks (notes 2 and 15) $ 12,435 9,989
Interest-bearing deposits (note 15) 9,728 91
Federal funds sold (note 15) 4,300 1,910
Securities available for sale (notes 3 and 15) 65,582 62,534
Securities held to maturity (fair value
$85,005 in 1997 and $108,755 in 1996) 84,392 108,710
Mortgage loans held for sale (notes 13, 14 and 15) 405 516
Loans (notes 4, 5, 14 and 15):
Real estate construction loans 8,510 6,295
Real estate mortgage loans 42,969 43,917
Commercial and industrial loans 101,379 87,519
Loans to individuals 66,635 60,991
-------- -------
Total loans 219,493 198,722
Less unearned income and deferred fees (2,503) (2,549)
-------- -------
Loans, net of unearned income and
deferred fees 216,990 196,173
Less allowance for loan losses (note 5) (2,438) (2,575)
-------- -------
Loans, net 214,552 193,598
-------- -------
Bank premises and equipment, net (note 6) 5,739 5,037
Accrued interest receivable 3,445 3,510
Other real estate owned, net (note 5) 421 474
Other assets (note 9) 1,908 2,481
-------- -------
Total assets $402,907 388,850
======== =======
Liabilities Noninterest-bearing demand deposits $ 45,093 44,096
and Interest-bearing demand deposits 77,863 73,804
Stockholders'Savings deposits 46,773 48,164
Equity Time deposits (note 7) 175,138 168,520
-------- -------
Total deposits (note 15) 344,867 334,584
-------- -------
17
Other borrowed funds (note 15) 485 627
Accrued interest payable 722 700
Other liabilities (note 8) 966 1,495
-------- -------
Total liabilities 347,040 337,406
-------- -------
Common stock subject to ESOP put option (note 8) 1,838 1,643
-------- -------
Stockholders' equity (notes 9, 10 and 16):
Preferred stock of no par value. Authorized
5,000,000 shares; none issued and
outstanding --- ---
Common stock of $2.50 par value. Authorized
5,000,000 shares; issued and outstanding
3,792,833 shares 9,482 9,482
Retained earnings 46,191 42,210
Net unrealized gains (losses) on securities
available for sale 194 (248)
Common stock subject to ESOP put option
(72,783 shares at $25.25 per share in 1997
and 64,796 shares at $25.35 per share in
1996) (note 8) (1,838) (1,643)
-------- -------
Total stockholders' equity 54,029 49,801
Commitments and contingent liabilities (notes 6,
8, 13 and 16)
-------- -------
Total liabilities and stockholders'
equity $402,907 388,850
======== =======
See accompanying notes to consolidated financial statements.
18
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
$ In thousands, except per share data. Years ended
December 31, 1997, 1996 and 1995 1997 1996 1995
------ ------ ------
Interest Interest and fees on loans $19,553 17,232 15,761
Income Interest on federal funds sold 451 476 704
Interest on interest-bearing deposits 230 91 ---
Interest on securities - taxable 7,776 8,877 9,723
Interest on securities - nontaxable 1,787 1,971 1,906
------- ------- -------
Total interest income 29,797 28,647 28,094
------- ------- -------
Interest Interest on time deposits of $100,000
Expense or more 2,335 2,070 1,898
Interest on other deposits 10,754 10,939 10,770
Interest on borrowed funds 17 27 35
------- ------- -------
Total interest expense 13,106 13,036 12,703
------- ------- -------
Net interest income 16,691 15,611 15,391
Provision for loan losses (note 5) 435 331 282
------- ------- -------
Net interest income after
provision for loan losses 16,256 15,280 15,109
------- ------- -------
Noninterest Service charges on deposit accounts 1,131 1,183 993
Income Other service charges and fees 250 269 228
Credit card fees 606 511 450
Trust income 738 603 480
Other income 72 30 49
Realized securities gains, net
(note 3) 37 97 182
------- ------- -------
Total noninterest income 2,834 2,693 2,382
------- ------- -------
Noninterest Salaries and employee benefits (note 8) 5,398 5,278 5,034
Expense Occupancy and furniture and fixtures 958 884 920
Data processing and ATM 578 497 462
FDIC assessment 43 4 379
Credit card processing 551 466 411
Goodwill amortization 30 30 30
Net costs of other real estate owned 8 5 195
Other operating expense 2,465 2,351 2,602
------- ------- -------
Total noninterest expense 10,031 9,515 10,033
------- ------- -------
19
Income before income tax expense 9,059 8,458 7,458
Income tax expense (note 9) 2,499 2,341 1,933
------- ------- -------
Net income $ 6,560 6,117 5,525
======= ======= =======
Net income per share (note 1) $ 1.73 1.61 1.46
======= ======= =======
See accompanying notes to consolidated financial statements.
20
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Net
Unrealized Common
Gains Stock
(Losses) on Subject
$ In thousands, except per share Securities to ESOP
data. Years ended December 31, Common Retained Available Put
1997, 1996 and 1995. Stock Earnings For Sale Option Total
------- -------- ----------- ------- -------
Balances, December 31, 1994 $ 9,482 34,927 (1,751) --- 42,658
Net income --- 5,525 --- --- 5,525
Cash dividends ($.57 per share) --- (1,080) --- --- (1,080)
Cash dividends of BTC declared
prior to merger --- (982) --- --- (982)
Change in net unrealized gains
(losses) on securities available
for sale, net of income tax
expense of $1,047 --- --- 2,033 --- 2,033
------- ------ ------ ------ ------
Balances, December 31, 1995 9,482 38,390 282 --- 48,154
Net income --- 6,117 --- --- 6,117
Cash dividends ($.62 per share) --- (1,787) --- --- (1,787)
Cash dividends of BTC declared
prior to merger --- (510) --- --- (510)
Change in net unrealized gains
(losses) on securities available
for sale, net of income tax
benefit of $273 --- --- (530) --- (530)
Common stock subject to ESOP put
option --- --- --- (1,643) (1,643)
------- ------ ------ ------ ------
Balances, December 31, 1996 9,482 42,210 (248) (1,643) 49,801
Net income --- 6,560 --- --- 6,560
Cash dividends ($.68 per share) --- (2,579) --- --- (2,579)
Change in net unrealized gains
(losses) on securities available
for sale, net of income tax
expense of $228 --- --- 442 --- 442
Change in common stock subject to
ESOP put option --- --- --- (195) (195)
------- ------ ------ ------ ------
Balances, December 31, 1997 $ 9,482 46,191 194 (1,838) 54,029
======= ====== ====== ====== ======
See accompanying notes to consolidated financial statements.
21
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
$ In thousands. Years ended December 31, 1997, 1996 and 1995 1997 1996 1995
------ ------ ------
Cash Flows Net income $ 6,560 6,117 5,525
from Adjustments to reconcile net income to net cash
Operating provided by operating activities:
Activities Provision for loan losses 435 331 282
(Note 12) Recovery of bond losses (10) (89) ---
Provision for deferred income taxes 300 (4) (120)
Depreciation of bank premises and equipment 586 517 535
Amortization of intangibles 121 121 145
Amortization of premiums and accretion of
discounts, net 11 52 (32)
(Gains) losses on bank premises and
equipment disposals 8 7 (9)
Gains on sales and calls of
securities available for sale, net (5) (3) (2)
Gains on calls of securities held to
maturity, net (22) (5) (180)
(Gains) losses and write-downs on other
real estate owned (4) (9) 168
(Increase) decrease in:
Mortgage loans held for sale 111 364 (488)
Accrued interest receivable 65 111 88
Other assets (76) 40 129
Increase (decrease) in:
Accrued interest payable 22 (44) 170
Other liabilities (529) 462 153
------- ------- -------
Net cash provided by operating
activities 7,573 7,968 6,364
------- ------- -------
Cash Flows Net (increase) decrease in federal funds sold (2,390) 5,815 (100)
from Net increase in interest-bearing deposits (9,637) (91) ---
Investing Proceeds from sales of securities available for
Activities sale --- 1,000 1,867
(Note 12)
22
Proceeds from calls and maturities of
securities available for sale 9,839 21,938 8,134
Proceeds from calls and maturities of
securities held to maturity 35,673 35,569 28,592
Purchases of securities available for sale (12,201) (10,397) (16,432)
Purchases of securities held to maturity (11,345) (32,477) (22,271)
Purchases of loan participations (6,189) (1,704) ---
Collection of loan participations 1,934 2,448 1,928
Net increase in loans made to customers (17,400) (31,633) (9,197)
Proceeds from disposal of other real estate owned 216 325 220
Recoveries on loans charged off 107 125 83
Bank premises and equipment expenditures (1,304) (882) (492)
Proceeds from sale of bank premises and equipment 8 --- 9
------- ------- -------
Net cash used in investing
activities (12,689) (9,964) (7,659)
------- ------- -------
Cash Flows Net increase in time deposits 6,618 1,672 18,179
from Net increase (decrease) in other deposits 3,665 2,599 (15,552)
Financing Net increase (decrease) in other borrowed funds (142) 466 (630)
Activities Cash dividends paid (2,579) (2,807) (2,056)
(Note 12) ------- ------- -------
Net cash provided by (used in)
financing activities 7,562 1,930 (59)
------- ------- -------
Net increase (decrease) in cash and due from banks 2,446 (66) (1,354)
Cash and due from banks at beginning of year 9,989 10,055 11,409
------- ------- -------
Cash and due from banks at end of year $12,435 9,989 10,055
======= ======= =======
<FN>
See accompanying notes to consolidated financial statements.
23
Notes to Consolidated Financial Statements
$ In thousands, except share and per share data.
December 31, 1997, 1996 and 1995
Note 1: Summary of Significant Accounting Policies
The accounting and reporting policies of National Bankshares, Inc.
(Bankshares) and its wholly-owned subsidiaries, The National Bank of
Blacksburg (NBB) and Bank of Tazewell County (BTC), conform to generally
accepted accounting principles and general practices within the banking
industry (see note 16 for merger with BTC).
The following is a summary of the more significant accounting policies.
(A) Consolidation
The consolidated financial statements include the accounts of
National Bankshares, Inc. and its wholly-owned subsidiaries (the
Company). All significant intercompany balances and transactions have
been eliminated.
(B) Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents
include cash on hand and due from banks.
(C) Securities
Securities available for sale are reported at fair value, with
unrealized gains and losses excluded from net income and reported, net of
income taxes, in a separate component of stockholders' equity.
Securities held to maturity are stated at cost, adjusted for amortization
of premiums and accretion of discounts on a basis which approximates the
level yield method. The Company does not engage in securities trading.
Gains and losses on securities are accounted for on the completed
transaction basis by the specific identification method.
A decline in the fair value of any available for sale or held to
maturity security below cost that is deemed other than temporary is
charged to income resulting in the establishment of a new cost basis for
the security.
(D) Loans
Loans are stated at the amount of funds disbursed plus the
applicable amount, if any, of unearned income and deferred fees less
payments received. Income on installment loans, including impaired
installment loans that have not been placed in nonaccrual status, is
recognized on methods which approximate the level yield method. Interest
on all other loans, including impaired other loans that have not been
placed in nonaccrual status, is accrued based on the balance outstanding
times the applicable interest rate.
Interest is recognized on the cash basis for all loans carried in
nonaccrual status. Loans generally are placed in nonaccrual status when
the collection of principal or interest is 90 days or more past due,
unless the obligation is both well-secured and in the process of
collection.
Loan origination and commitment fees and certain direct costs are
being deferred, and the net amount amortized as an adjustment to the
related loan's yield. These amounts are being amortized over the
contractual life of the related loans.
Effective January 1, 1995, the Company adopted the provisions of
Statement of Financial Accounting Standards (Statement) No. 114,
"Accounting by Creditors for Impairment of a Loan," as amended by
Statement 118, "Accounting by Creditors for Impairment of a Loan - Income
24
National Bankshares, Inc. and Subsidiaries
Recognition and Disclosures." Statement 114, as amended by Statement
118, requires that impaired loans within the scope of the Statements be
presented in the financial statements at the present value of expected
future cash flows or at the fair value of the loan's collateral if the
loan is deemed "collateral dependent." A valuation allowance is required
to the extent that the measure of the impaired loans is less than the
recorded investment. Statement 114 does not apply to large groups of
small-balance homogeneous loans such as residential real estate mortgage,
consumer installment, home equity and bank card loans, which are
collectively evaluated for impairment. Statement 118 allows a creditor
to use existing methods for recognizing interest income on an impaired
loan. Adoption of this Statement did not have a material impact on the
Company's financial position, result of operations or liquidity.
Mortgage loans held for sale are carried at the lower of cost or
fair value on an individual loan basis.
(E) Allowance for Loan Losses
The allowance for loan losses is a valuation allowance consisting
of the cumulative effect of the provision for loan losses, plus any
amounts recovered on loans previously charged off, minus loans charged
off. The provision for loan losses charged to expense is the amount
necessary in management's judgement to maintain the allowance for loan
losses at a level it believes adequate to absorb losses in the collection
of its loans.
(F) Bank Premises and Equipment
Bank premises and equipment are stated at cost, net of accumulated
depreciation. Depreciation is charged to expense over the estimated
useful lives of the assets on the straight-line basis. Depreciable lives
include 40 years for premises, 3-10 years for furniture and equipment,
and 5 years for computer software. Costs of maintenance and repairs are
charged to expense as incurred and improvements are capitalized.
(G) Other Real Estate Owned
Other real estate, acquired through foreclosure or deed in lieu of
foreclosure, is carried at the lower of the recorded investment or its
fair value, less estimated costs to sell (net realizable value). When
the property is acquired, any excess of the loan balance over net
realizable value is charged to the allowance for loan losses. Increases
or decreases in the net realizable value of such properties are credited
or charged to income by adjusting the valuation allowance for other real
estate owned. Net costs of maintaining or operating foreclosed
properties are expensed as incurred.
(H) Intangible Assets
Included in other assets are deposit intangibles of $575 and $666
at December 31, 1997 and 1996, respectively, and goodwill of $337 and
$367 at December 31, 1997 and 1996, respectively. Deposit intangibles
are being amortized on a straight-line basis over a ten-year period and
goodwill is being amortized on a straight-line basis over a fifteen-year
period.
25
Notes to Consolidated Financial Statements
(I) Pension Plans
The Company sponsors two separate defined benefit pension plans
which cover substantially all full-time officers and employees. The
benefits are based upon length of service and a percentage of the
employee's compensation during the final years of employment. Pension
costs are computed based upon the provisions of Statement 87. The
Company contributes to the pension plans amounts deductible for federal
income tax purposes.
(J) Income Taxes
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases and operating loss and tax credit carryforwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on
deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
(K) Trust Assets and Income
Assets (other than cash deposits) held by the Trust Departments in
a fiduciary or agency capacity for customers are not included in the
consolidated financial statements since such items are not assets of the
Company. Trust income is recognized on the accrual basis.
(L) Net Income Per Share
Net income per share is based upon the weighted average number of
common shares outstanding (3,792,833 shares in 1997, 1996 and 1995).
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings per
Share." Statement 128 establishes new standards for computing and
presenting earnings per share (EPS) and applies to entities with publicly
held common stock or potential common stock. It replaces the
presentation of primary EPS with a presentation of basic EPS. It also
requires dual presentation of basic and diluted EPS on the face of the
income statement for all entities with complex capital structures and
requires a reconciliation of the numerator and denominator of the basic
EPS computation to the numerator and denominator of the diluted EPS
computation.
Basic EPS excludes dilution and is computed by dividing income
available to common stockholders by the weighted-average number of common
shares outstanding for the period. Diluted EPS reflects the potential
dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the
entity.
Statement 128 was adopted by the Company at December 31, 1997. The
Statement requires restatement of prior years EPS data previously
presented. Adoption of this Statement did not have any effect on current
or prior years' EPS data presented due to the Company's simple capital
structure.
26
National Bankshares, Inc. and Subsidiaries
(M) Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company has entered into
off-balance sheet financial instruments consisting of commitments to
extend credit and standby letters of credit. Such financial instruments
are recorded in the financial statements when they become payable.
(N) Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the
fair value of each class of financial instrument for which it is
practicable to estimate that value:
(1) Cash and Due from Banks, Interest-Bearing Deposits and Federal
Funds Sold
The carrying amounts are a reasonable estimate of fair
value.
(2) Securities
The fair values of securities are determined by quoted
market prices or dealer quotes. The fair value of certain
state and municipal securities is not readily available
through market sources other than dealer quotations, so fair
value estimates are based on quoted market prices of similar
instruments, adjusted for differences between the quoted
instruments and the instruments being valued.
(3) Loans
Fair values are estimated for portfolios of loans with
similar financial characteristics. Loans are segregated by
type such as mortgage loans held for sale, commercial, real
estate - commercial, real estate - construction, real estate -
mortgage, credit card and other consumer loans. Each loan
category is further segmented into fixed and adjustable rate
interest terms and by performing and nonperforming categories.
The fair value of performing loans is calculated by
discounting scheduled cash flows through the estimated
maturity using estimated market discount rates that reflect
the credit and interest rate risk inherent in the loan, as
well as estimates for prepayments. The estimate of maturity
is based on the Company's historical experience with
repayments for each loan classification, modified, as
required, by an estimate of the effect of current economic and
lending conditions.
Fair value for significant nonperforming loans is based
on estimated cash flows which are discounted using a rate
commensurate with the risk associated with the estimated cash
flows. Assumptions regarding credit risk, cash flows and
discount rates are judgmentally determined using available
market information and specific borrower information.
(4) Deposits
The fair value of demand and savings deposits is the
amount payable on demand. The fair value of fixed maturity
time deposits and certificates of deposit is estimated using
the rates currently offered for deposits with similar
remaining maturities.
27
Notes to Consolidated Financial Statements
(5) Other Borrowed Funds
Other borrowed funds represents treasury tax and loan
deposits. The carrying amount is a reasonable estimate of
fair value because the deposits are generally repaid within 1
to 120 days from the transaction date.
(6) Commitments to Extend Credit and Standby Letters of Credit
The only amounts recorded for commitments to extend
credit, standby letters of credit and financial guarantees
written are the deferred fees arising from these unrecognized
financial instruments. These deferred fees are not deemed
significant at December 31, 1997 and 1996, and as such, the
related fair values have not been estimated.
(O) Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of
The Company adopted the provisions of Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," on January 1, 1996. This Statement requires
that long-lived assets and certain identifiable intangibles be reviewed
for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability
of assets to be held and used is measured by a comparison of the carrying
amount of an asset to future net cash flows expected to be generated by
the asset. If such assets are considered to be impaired, the impairment
to be recognized is measured by the amount by which the carrying amount
of the assets exceed the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less
costs to sell. Adoption of this Statement did not have a material impact
on the Company's financial position, results of operations or liquidity.
(P) Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities
The Company adopted the provisions of Statement No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," on January 1, 1997. This Statement
provides accounting and reporting standards for transfers and servicing
of financial assets and extinguishments of liabilities based on
consistent application of a financial-components approach that focuses on
control. Under that approach, after a transfer of financial assets, an
entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control
has been surrendered, and derecognizes liabilities when extinguished.
This Statement provides consistent standards for distinguishing transfers
of financial assets that are sales from transfers that are secured
borrowings. This Statement also provides implementation guidance for
assessing isolation of transferred assets and for accounting for
transfers of partial interests, servicing of financial assets,
securitizations, transfers of sales-type and direct financing lease
receivables, securities lending transactions, repurchase agreements
including "dollar rolls," "wash sales," loan syndications and
participations, risk participations in banker's acceptances, factoring
arrangements, transfers of receivables with recourse, and extinguishments
of liabilities. Statement No. 127, "Deferral of the Effective Date of
Certain Provisions of Statement 125," issued in December 1996, deferred
until January 1, 1998 the effective date (a) of paragraph 15 of Statement
125 and (b) for repurchase agreement, dollar-roll, securities lending,
28
National Bankshares, Inc. and Subsidiaries
and similar transactions, of paragraphs 9-12 and 237(b) of Statement 125.
Statement 125 was required to be adopted on a prospective basis and its
adoption did not have a material impact on the Company's financial
position, results of operations or liquidity.
(Q) Use of Estimates
In preparing the consolidated financial statements, management is
required to make certain estimates, assumptions and loan evaluations that
affect its consolidated financial statements for the period. Actual
results could vary significantly from those estimates.
Changing economic conditions, adverse economic prospects for
borrowers, as well as regulatory agency action as a result of an
examination, could cause NBB and BTC to recognize additions to the
allowance for loan losses and may also affect the valuation of real
estate acquired in connection with foreclosures or in satisfaction of
loans.
(R) Reclassifications
Certain reclassifications have been made to prior years'
consolidated financial statements to place them on a basis comparable
with the 1997 consolidated financial statements.
Note 2: Restrictions on Cash
To comply with Federal Reserve regulations, the Company is required to
maintain certain average reserve balances. The daily average reserve
requirements were $3,699 and $2,914 for the weeks including December 31, 1997
and 1996, respectively.
Note 3: Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for sale by major security type as of
December 31, 1997 and 1996 are as follows:
December 31, 1997
----------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
--------- ---------- ---------- --------
Available for sale:
U.S. Treasury $ 6,742 131 (11) 6,862
U.S. Government agencies
and corporations 36,252 141 (117) 36,276
States and political
subdivisions 9,540 101 (2) 9,639
Mortgage-backed securities 4,172 34 (87) 4,119
Other securities 8,582 121 (17) 8,686
-------- ----- ------ ------
Total securities
available for sale $ 65,288 528 (234) 65,582
======== ===== ====== ======
29
Notes to Consolidated Financial Statements
December 31, 1996
----------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
--------- ---------- ---------- --------
Available for sale:
U.S. Treasury $ 8,740 116 (66) 8,790
U.S. Government agencies
and corporations 33,840 149 (349) 33,640
States and political
subdivisions 8,688 86 (155) 8,619
Mortgage-backed securities 4,568 12 (128) 4,452
Other securities 7,074 25 (66) 7,033
-------- ---- ----- ------
Total securities
available for sale $ 62,910 388 (764) 62,534
======== ==== ===== ======
The amortized costs and fair values of single maturity securities
available for sale at December 31, 1997, by contractual maturity, are shown
below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties. Mortgage-backed securities included in these
totals are allocated based upon estimated cash flows at December 31, 1997.
December 31, 1997
------------------
Amortized Fair
($ In thousands) Costs Values
--------- --------
Due in one year or less $ 8,952 8,926
Due after one year through five years 25,758 25,894
Due after five years through ten years 21,950 22,099
Due after ten years 7,826 7,801
No maturity 802 862
-------- ------
$ 65,288 65,582
======== ======
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of
December 31, 1997 and 1996 are as follows:
December 31, 1997
----------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
--------- ---------- ---------- --------
Held to maturity:
U.S. Treasury $ 7,527 27 (41) 7,513
U.S. Government agencies
and corporations 36,853 167 (362) 36,658
States and political
subdivisions 32,949 696 (32) 33,613
Mortgage-backed securities 630 28 --- 658
Other securities 6,433 131 (1) 6,563
------- ----- ---- ------
Total securities held
to maturity $84,392 1,049 (436) 85,005
======= ===== ==== ======
30
National Bankshares, Inc. and Subsidiaries
December 31, 1996
----------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
--------- ---------- ---------- --------
Held to maturity:
U.S. Treasury $ 11,547 36 (148) 11,435
U.S. Government agencies
and corporations 54,804 215 (604) 54,415
States and political
subdivisions 34,144 530 (105) 34,569
Mortgage-backed securities 767 29 --- 796
Other securities 7,448 103 (11) 7,540
-------- ----- ----- -------
Total securities held
to maturity $108,710 913 (868) 108,755
======== ===== ===== =======
The amortized costs and fair values of single maturity securities held to
maturity at December 31, 1997, by contractual maturity, are shown below.
Expected maturities may differ from contractual maturities because borrowers
may have the right to call or prepay obligations with or without call or
prepayment penalties. Mortgage-backed securities included in these totals
are allocated based upon estimated cash flows at December 31, 1997.
December 31, 1997
-------------------
Amortized Fair
($ In thousands) Costs Values
--------- --------
Due in one year or less $ 18,150 18,128
Due after one year through five years 44,924 45,225
Due after five years through ten years 17,074 17,308
Due after ten years 4,244 4,344
-------- ------
$ 84,392 85,005
======== ======
There were no sales of securities held to maturity during 1997, 1996 or
1995.
The carrying value of securities pledged to secure public and trust
deposits, and for other purposes as required or permitted by law, was $21,257
at December 31, 1997 and $18,446 at December 31, 1996.
Note 4: Loans to Officers and Directors
In the normal course of business, loans have been made to executive
officers and directors of Bankshares and its subsidiaries. As of December
31, 1997 and 1996, there were direct loans to executive officers and
directors of $1,351 and $2,567, respectively. In addition, there were loans
of $3,566 and $2,145 at December 31, 1997 and 1996, respectively, which were
endorsed by directors and/or executive officers or had been made to companies
in which directors and/or executive officers had an equity interest.
The following schedule summarizes amounts receivable from executive
officers and directors of Bankshares and its subsidiaries, and their
immediate families or associates:
31
Notes to Consolidated Financial Statements
Year ended
December 31,
($ In thousands) 1997
------
Aggregate balance, beginning of year $ 4,712
Additions 4,852
Collections (4,647)
-------
Aggregate balance, end of year $ 4,917
=======
Note 5: Nonperforming Assets, Past Due Loans, Impaired Loans and Allowance
for Loan Losses
Nonperforming assets consist of the following:
December 31,
----------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Nonaccrual loans $ 87 616 718
Other real estate owned, net 421 474 762
-------- ------ ------
Total nonperforming assets $ 508 1,090 1,480
======== ====== ======
Accruing loans past due 90 days or
more $ 672 458 574
There were no material commitments to lend additional funds to customers
whose loans were classified as nonperforming at December 31, 1997.
The following table shows the interest that would have been earned on
nonaccrual loans if they had been current in accordance with their original
terms and the recorded interest that was earned and included in income on
these loans:
Years ended December 31,
----------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Scheduled interest:
Nonaccrual loans $ 8 68 59
======== ======= ======
Recorded interest:
Nonaccrual loans $ 1 24 5
======== ======= ======
Changes in the valuation allowance for other real estate owned are as
follows:
32
National Bankshares, Inc. and Subsidiaries
Years ended December 31,
---------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Balances, beginning of year $ 96 91 49
Provision for other real estate owned --- 5 124
Write-offs (28) --- (82)
-------- ----- ----
Balances, end of year $ 68 96 91
======== ===== ====
At December 31, 1997, the recorded investment in loans which have been
identified as impaired loans, in accordance with Statement 114, totaled $177.
Of this amount, $124 related to loans with no valuation allowance and $53
related to loans with a corresponding valuation allowance of $53. At
December 31, 1996, the recorded investment in loans which have been
identified as impaired loans totaled $725. Of this amount, $354 related to
loans with no valuation allowance and $371 related to loans with a
corresponding valuation allowance of $290.
For the year ended December 31, 1997, the average recorded investment in
impaired loans was approximately $458, and the total interest income
recognized on impaired loans was $23 of which $12 was recognized on a cash
basis. For the year ended December 31, 1996, the average recorded investment
in impaired loans was approximately $800, and the total interest income
recognized on impaired loans was $33 of which $23 was recognized on a cash
basis.
Changes in the allowance for loan losses are as follows:
Years ended December 31,
----------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Balances, beginning of year $ 2,575 2,625 2,551
Provision for loan losses 435 331 282
Recoveries 107 125 83
Loans charged off (679) (506) (291)
------- ------ ------
Balances, end of year $ 2,438 2,575 2,625
======= ====== ======
Note 6: Bank Premises and Equipment
Bank premises and equipment stated at cost, less accumulated
depreciation, are as follows:
December 31,
--------------------
($ In thousands) 1997 1996
------ ------
Premises $ 6,148 5,787
Furniture and equipment 4,458 3,936
Construction-in-progress 33 249
-------- ------
10,639 9,972
Less accumulated depreciation (4,900) (4,935)
-------- ------
Total bank premises and equipment $ 5,739 5,037
======== ======
33
Notes to Consolidated Financial Statements
The Company leases a branch facility as well as certain other office
space under noncancellable operating leases that expire over the next six
years. The future minimum lease payments under these leases (with initial or
remaining lease terms in excess of one year) as of December 31, 1997 are as
follows: $78 in 1998, $38 in 1999, $13 in years 2000, 2001 and 2002 and $10
in 2003.
Note 7: Time Deposits
Included in time deposits are certificates of deposit and other time
deposits of $100 or more in the aggregate amounts of $42,547 at December 31,
1997 and $37,414 at December 31, 1996. At December 31, 1997, the scheduled
maturities of time deposits are as follows: $128,929 in 1998, $19,451 in
1999, $19,338 in 2000, $3,419 in 2001 and $4,001 in 2002.
Note 8: Employee Benefit Plans
NBB has a Retirement Accumulation Plan qualifying under IRS Code Section
401(k). Eligible participants in the plan can contribute up to 10% of their
total annual compensation to the plan. Employee contributions are matched by
NBB based on a percentage of an employee's total annual compensation
contributed to the plan. For the years ended December 31, 1997, 1996 and
1995, NBB contributed $87, $83 and $78, respectively, to the plan.
Bankshares has a nonleveraged Employee Stock Ownership Plan (ESOP) which
enables employees of the sole participating employer, NBB, who have one year
of service and who have attained the age of 21 prior to the plan's January 1
and July 1 enrollment dates to own Bankshares common stock. Contributions to
the ESOP are determined annually by the Board of Directors. Contribution
expense amounted to $219, $200 and $163 for the years ended December 31,
1997, 1996 and 1995, respectively. Dividends on ESOP shares are charged to
retained earnings. As of December 31, 1997, the number of allocated shares
held by the ESOP was 50,615 and the number of unallocated shares was 22,168.
All shares held by the ESOP are treated as outstanding in computing the
Company's net income per share. Bankshares or the ESOP has the right of
first refusal for any shares distributed to a participant in the event the
participant elects to sell the shares. Upon reaching age 55 with ten years
of plan participation, a vested participant has the right to diversify 50% of
his or her allocated ESOP shares and Bankshares or the ESOP, with the
agreement of the Trustee, would be obligated to purchase those shares. The
ESOP contains a put option which allows a withdrawing participant to require
Bankshares or the ESOP, if the plan administrator agrees, to purchase his or
her allocated shares if the shares are not readily tradeable on an
established market at the time of its distribution. Since the shares are not
readily tradeable, at December 31, 1997, 72,783 shares of stock held by the
ESOP, at their estimated fair value, which is based on the most recent
available independent valuation, is recorded outside of stockholders' equity.
Bankshares does not anticipate any material cash requirements in each of the
next five years relating to the purchase of shares held by the ESOP
participants.
The Company also sponsors two separate noncontributory defined benefit
pension plans which cover substantially all of its employees. The pension
plans' benefit formulas generally base payments to retired employees upon
their length of service and a percentage of qualifying compensation during
their final years of employment. The NBB pension plan's assets are invested
principally in U.S. Government agency obligations (47%), mutual funds (25%)
and equity securities (28%). BTC's pension plan's assets are invested
principally in BTC certificates of deposit (22%), U.S. Government agency
obligations (36%), U.S. Treasury securities (11%), money market funds (24%)
and equity securities (7%).
34
National Bankshares, Inc. and Subsidiaries
The plans' funded status at December 31, 1997 and 1996 is as follows:
December 31,
----------------
($ In thousands) 1997 1996
------ ------
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including
vested benefits of $3,027 in 1997 and $3,148
in 1996 $ 3,150 3,252
======= =======
Projected benefit obligation for service
rendered to date (4,967) (5,160)
Plan assets at fair value 4,337 3,950
------- -------
Projected benefit obligation in excess of
plan assets (630) (1,210)
Unrecognized net transition asset (205) (228)
Unrecognized net loss from past experience
different from that assumed 459 989
Prior service cost not yet recognized in net
pension cost 231 246
------- -------
Net accrued pension cost (includes accrued
pension cost of $352 in 1997 and $346 in
1996 included in other liabilities, and
prepaid pension cost of $207 in 1997 and
$143 in 1996 included in other assets) $ (145) (203)
======= =======
Net pension cost includes the following (income) expense components:
Years ended December 31,
--------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Service cost-benefits earned during
the year $ 281 327 223
Interest cost on projected benefit
obligation 367 353 288
Actual return on plan assets (327) (185) (304)
Net amortization and deferral (37) (92) 19
------ ------ -----
Net pension cost $ 284 403 226
====== ====== =====
35
Notes to Consolidated Financial Statements
Assumptions used in accounting for the pension plans as of December 31,
1997, 1996 and 1995 are as follows:
NBB BTC
----------------------- ----------------------
1997 1996 1995 1997 1996 1995
------ ------ ------ ------ ------ ------
Weighted average
discount rate 7.50% 7.75% 7.00% 7.50% 7.00% 7.00%
Expected long-term
rate of return 9.00% 9.00% 9.00% 9.00% 9.00% 7.50%
Rate of increase in
future compensation 5.00% 5.00% 5.00% 5.00% 5.00% 5.00%
Note 9: Income Taxes
Total income taxes were allocated as follows:
Years ended December 31,
--------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Income $ 2,499 2,341 1,933
Stockholders' equity, for net
unrealized gains (losses) on
securities available for sale
recognized for financial reporting
purposes 228 (273) 1,047
------- ------ -----
Total income taxes $ 2,727 2,068 2,980
======= ====== =====
The components of federal income tax expense attributable to income
before income tax expense are as follows:
Years ended December 31,
--------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Current $ 2,199 2,345 2,053
Deferred 300 (4) (120)
------- ------ ------
Total income tax expense $ 2,499 2,341 1,933
======= ====== ======
Taxes resulting from securities transactions amounted to a tax expense of
$13 for the year ended December 31, 1997, $33 for the year ended December 31,
1996 and $62 for the year ended December 31, 1995.
The following is a reconciliation of the "expected" income tax expense,
computed by applying the U.S. Federal income tax rate of 34% to income before
income tax expense, with the reported income tax expense:
36
National Bankshares, Inc. and Subsidiaries
Years ended December 31,
--------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Expected income tax expense (34%) $ 3,080 2,876 2,536
Tax-exempt interest income (700) (756) (744)
Nondeductible interest expense 90 99 88
Other, net 29 122 53
------- ------ ------
Reported income tax expense $ 2,499 2,341 1,933
======= ====== ======
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December
31, 1997 and 1996 are presented below:
December 31,
---------------
($ In thousands) 1997 1996
------ ------
Deferred tax assets:
Loans, principally due to allowance for loan
losses and unearned fee income $ 344 545
Other real estate owned, principally due to
valuation allowance 23 33
Deferred compensation and other liabilities,
due to accrual for financial reporting
purpose 114 138
Deposit intangibles and goodwill 42 35
Nonaccrual interest on loans --- 23
Community development corporation related tax
credit 26 30
Net unrealized losses on securities available
for sale --- 128
------- -------
Total gross deferred tax assets 549 932
Less valuation allowance --- ---
------- -------
Net deferred tax assets 549 932
------- -------
Deferred tax liabilities:
Bank premises and equipment, principally due
to differences in depreciation (16) (12)
Securities, due to differences in discount
accretion (77) (43)
Other assets (62) (55)
Net unrealized gains on securities available
for sale (100) ---
------- -------
Total gross deferred liabilities (255) (110)
------- -------
Net deferred tax asset included in
other assets $ 294 822
======= =======
37
Notes to Consolidated Financial Statements
The Company has determined that a valuation allowance for the gross
deferred tax assets is not necessary at December 31, 1997 and 1996 due to the
fact that the realization of the entire gross deferred tax assets can be
supported by the amount of taxes paid during the carryback period available
under current tax laws.
Note 10: Restrictions on Payments of Dividends and Capital Requirements
Bankshares' principal source of funds for dividend payments is dividends
received from its subsidiary banks. For the years ended December 31, 1997,
1996 and 1995, dividends received from subsidiary banks were $2,712, $1,901
and $1,055, respectively.
Substantially all of Bankshares' retained earnings are undistributed
earnings of its banking subsidiaries, which are restricted by various
regulations administered by federal and state bank regulatory agencies. Bank
regulatory agencies restrict, without prior approval, the total dividend
payments of a bank in any calendar year to the bank's retained net income of
that year to date, as defined, combined with its retained net income of the
preceding two years, less any required transfers to surplus. At December 31,
1997, retained net income which was free of such restriction amounted to
approximately $7,828.
Bankshares and its subsidiaries are subject to various regulatory capital
requirements administered by the bank regulatory agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could
have a direct material effect on the Company's consolidated financial
statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, Bankshares and its subsidiaries must meet
specific capital guidelines that involve quantitative measures of their
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices. Bankshares' and its subsidiaries' capital
amounts and classification are also subject to qualitative judgments by
regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require Bankshares and its subsidiaries to maintain minimum amounts
and ratios (set forth in the table below) of total and Tier I capital (as
defined in the regulations) to risk weighted assets (as defined), and of Tier
I capital (as defined) to average assets (as defined). Management believes,
as of December 31, 1997, that Bankshares and its subsidiaries meet all
capital adequacy requirements to which they are subject.
Bankshares' and its subsidiaries' actual regulatory capital amounts and
ratios are also presented in the following tables.
38
National Bankshares, Inc. and Subsidiaries
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
------------- ------------- -------------
($ In thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 1997
Total capital (to risk
weighted assets)
Bankshares consolidated $57,198 23.3% 19,652 8.0% N/A N/A
NBB 28,825 17.4% 13,232 8.0% 16,540 10.0%
BTC 28,313 34.7% 6,527 8.0% 8,159 10.0%
Tier I capital (to risk
weighted assets)
Bankshares consolidated $54,760 22.3% 9,826 4.0% N/A N/A
NBB 27,084 16.4% 6,616 4.0% 9,924 6.0%
BTC 27,616 33.9% 3,264 4.0% 4,895 6.0%
Tier I capital (to
average assets)
Bankshares consolidated $54,760 13.7% 15,988 4.0% N/A N/A
NBB 27,084 12.1% 8,985 4.0% 11,231 5.0%
BTC 27,616 15.8% 7,003 4.0% 8,754 5.0%
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
------------- ------------- -------------
($ In thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 1996
Total capital (to risk
weighted assets)
Bankshares consolidated $53,193 23.0% 18,497 8.0% N/A N/A
NBB 26,175 16.3% 12,855 8.0% 16,069 10.0%
BTC 27,007 38.3% 5,642 8.0% 7,052 10.0%
Tier I capital (to risk
weighted assets)
Bankshares consolidated $50,618 21.9% 9,249 4.0% N/A N/A
NBB 24,171 15.0% 6,428 4.0% 9,641 6.0%
BTC 26,436 37.5% 2,821 4.0% 4,231 6.0%
Tier I capital (to
average assets)
Bankshares consolidated $50,618 13.0% 15,620 4.0% N/A N/A
NBB 24,171 11.2% 8,636 4.0% 10,795 5.0%
BTC 26,436 15.1% 6,984 4.0% 8,730 5.0%
As of December 31, 1997, the most recent notifications from the
appropriate regulatory authorities categorized Bankshares and its
subsidiaries as adequately capitalized under the regulatory framework for
prompt corrective action. To be categorized as adequately capitalized,
Bankshares and its subsidiaries must maintain minimum total risk-based, Tier
39
Notes to Consolidated Financial Statements
I risk-based, and Tier I leverage ratios as set forth in the table. There
are no conditions or events since those notifications that management
believes have changed Bankshares' and its subsidiaries' category.
Note 11: Parent Company Financial Information
Condensed financial information of National Bankshares, Inc. (Parent) is
presented below:
Condensed Balance Sheets
December 31,
-----------------
($ In thousands, except share and
per share data) 1997 1996
------ ------
Assets Cash due from subsidiaries $ 69 20
Investment in subsidiaries, at
equity 55,807 51,434
Refundable income taxes due
from subsidiaries 22 25
-------- -------
Total assets $ 55,898 51,479
======== =======
Liabilities Other liabilities $ 31 35
and -------- -------
Stockholders' Common stock subject to ESOP
Equity put option (note 8) 1,838 1,643
-------- -------
Stockholders' equity (notes 9,
10 and 16):
Preferred stock of no par
value. Authorized
5,000,000 shares; none
issued and outstanding --- ---
Common stock of $2.50 par
value. Authorized
5,000,000 shares; issued
and outstanding 3,792,833
shares 9,482 9,482
Retained earnings 46,191 42,210
Net unrealized gains
(losses) on securities
available for sale 194 (248)
Common stock subject to ESOP
put option (72,783 shares at
$25.25 per share in 1997 and
64,796 shares at $25.35 per
share in 1996) (note 8) (1,838) (1,643)
-------- -------
Total stockholders' equity 54,029 49,801
Commitments and contingent
liabilities (notes 6, 8,
13 and 16)
-------- -------
Total liabilities and
stockholders' equity $ 55,898 51,479
======== =======
40
National Bankshares, Inc. and Subsidiaries
Condensed Statements of Income
Years ended December 31,
----------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Income Dividends from subsidiaries
(note 10) $2,712 1,901 1,055
Expenses Other expenses 125 232 285
------ ------ ------
Income before income tax
benefit and equity in
undistributed net income
of subsidiaries 2,587 1,669 770
Applicable income tax
benefit 42 41 97
------ ------ ------
Income before equity in
undistributed net income
of subsidiaries 2,629 1,710 867
Equity in undistributed net
income of subsidiaries 3,931 4,407 4,658
------ ------ ------
Net income $6,560 6,117 5,525
====== ====== ======
41
Notes to Consolidated Financial Statements
Condensed Statements of Cash Flows
Years ended December 31,
----------------------------
($ In thousands) 1997 1996 1995
------ ------ ------
Cash Flows Net income $ 6,560 6,117 5,525
from Adjustments to reconcile
Operating net income to net cash
Activities provided by operating
activities:
Equity in undistributed
net income of
subsidiaries (3,931) (4,407) (4,658)
Decrease in other assets --- --- 3
Decrease in refundable
income taxes due from
subsidiaries 3 88 162
Decrease in other
liabilities (4) (5) (9)
------- ------ ------
Net cash provided by
operating activities 2,628 1,793 1,023
------- ------ ------
Cash Flows Cash dividends paid (2,579) (1,787) (1,080)
from ------- ------ ------
Financing
Activities Net cash used in
financing activities (2,579) (1,787) (1,080)
------- ------ ------
Net increase (decrease) in
cash 49 6 (57)
Cash due from subsidiary
at beginning of year 20 14 71
------- ------ ------
Cash due from subsidiary
at end of year $ 69 20 14
======= ====== ======
Note 12: Supplemental Cash Flow Information
The Company paid $13,084, $13,080 and $12,533 for interest and $2,719,
$1,839 and $1,942 for income taxes, net of refunds, in 1997, 1996 and 1995,
respectively. Noncash investing activities consisted of $679, $506 and $291
of loans charged against the allowance for loan losses in 1997, 1996 and
1995, respectively. Noncash investing activities also included $159 in 1997
and $28 in 1996 of loans transferred to other real estate owned. In
addition, for the years ended December 31, 1997, 1996 and 1995, noncash
investing activities included changes in net unrealized gains (losses) on
securities available for sale of $670, ($803) and $3,080, respectively,
changes in deferred tax assets included in other assets of ($228), $273 and
($1,047), respectively, and changes in net unrealized gains (losses) on
securities available for sale included in stockholders' equity of $442,
($530) and $2,033, respectively. Securities, classified as held to maturity,
totaling approximately $30,200, were transferred to securities available for
sale in 1995. This was in accordance with the one-time reassessment of the
classification of securities allowed by the Financial Accounting Standards
Board.
42
National Bankshares, Inc. and Subsidiaries
Note 13: Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business to meet the financing needs of its
customers. These financial instruments include commitments to extend credit
and standby letters of credit. Those instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the
consolidated balance sheets. The contract amounts of those instruments
reflect the extent of involvement the Company has in particular classes of
financial instruments.
The Company's exposure to credit loss, in the event of nonperformance by
the other party to the financial instrument for commitments to extend credit
and standby letters of credit, is represented by the contractual amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance sheet
instruments.
The Company may require collateral or other security to support the
following financial instruments with credit risk:
December 31,
--------------------
($ In thousands) 1997 1996
------ ------
Financial instruments whose contract
amounts represent credit risk:
Commitments to extend credit $37,700 32,087
======= ======
Standby letters of credit $ 1,949 1,380
======= ======
Mortgage loans sold with potential
recourse $19,231 18,271
======= ======
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Company evaluates
each customer's creditworthiness on a case-by-case basis. The amount of
collateral obtained, if required by the Company upon extension of credit, is
based on management's credit evaluation of the customer. Collateral held
varies but may include accounts receivable, inventory, property, plant and
equipment and income-producing commercial properties. Extensions of credit
arising from these commitments are predominantly variable rate in nature; the
principal exception being construction loans which are at fixed rates, but
have terms generally less than one year.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance of a customer to a third party. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loans to customers. Collateral held varies but
may include accounts receivable, inventory, property, plant and equipment and
income-producing commercial properties.
The Company originates mortgage loans for sale to secondary market
investors subject to contractually specified and limited recourse provisions.
In 1997, the Company originated $19,120 and sold $19,231 to investors,
43
Notes to Consolidated Financial Statements
compared to $17,907 originated and $18,271 sold in 1996. Every contract with
each investor contains certain recourse language. In general, the Company
may be required to repurchase a previously sold mortgage loan if there is
major noncompliance with defined loan origination or documentation standards,
including fraud, negligence or material misstatement in the loan documents.
Repurchase may also be required if necessary governmental loan guarantees are
canceled or never issued, or if an investor is forced to buy back a loan
after it has been resold as a part of a loan pool. In addition, the Company
may have an obligation to repurchase a loan if the mortgagor has defaulted
early in the loan term. This potential default period is approximately
twelve months after sale of a loan to the investor.
Note 14: Concentrations of Credit Risk
The Company does a general banking business, serving the commercial,
agricultural and personal banking needs of its customers. NBB's trade
territory, commonly referred to as the New River Valley, consists of
Montgomery and Giles Counties, Virginia and portions of adjacent counties.
NBB's operating results are closely correlated with the economic trends
within this area which are, in turn, influenced by the area's three largest
employers, Virginia Polytechnic Institute and State University, Montgomery
County Schools and Celanese. Other industries include a wide variety of
manufacturing, retail and service concerns. Most of BTC's business
originates from the communities of Tazewell and Bluefield and other
communities in Tazewell County, Virginia and in Mercer County, West Virginia.
BTC's service area has largely depended on the coal mining industry and
farming for its economic base. In recent years, coal companies have
mechanized and reduced the number of persons engaged in the production of
coal. There are still a number of support industries for the coal mining
business that continue to provide employment in the area. Additionally,
several new businesses have been established in the area and Bluefield, West
Virginia has begun to emerge as a regional medical center. The ultimate
collectibility of the loan portfolios and the recovery of the carrying
amounts of repossessed property are susceptible to changes in the market
conditions of these areas.
At December 31, 1997 and 1996, approximately $80,000 and $71,000,
respectively, of the loan portfolio were concentrated in commercial real
estate. This represents approximately 37% and 36% of the loan portfolio at
December 31, 1997 and 1996, respectively. Included in commercial real estate
at December 31, 1997 and 1996 was approximately $50,000 and $49,000,
respectively, in loans for college housing and professional office buildings.
Loans secured by residential real estate were approximately $65,000 and
$60,000 at December 31, 1997 and 1996, respectively. This represents
approximately 30% and 31% of the loan portfolio at December 31, 1997 and
1996, respectively. Loans secured by automobiles were approximately $34,000
and $29,000 at December 31, 1997 and 1996, respectively. This represents
approximately 16% of the loan portfolio at December 31, 1997 and 15% at
December 31, 1996.
The Company has established operating policies relating to the credit
process and collateral in loan originations. Loans to purchase real and
personal property are generally collateralized by the related property and
with loan amounts established based on certain percentage limitations of the
property's total stated or appraised value. Credit approval is primarily a
function of collateral and the evaluation of the creditworthiness of the
individual borrower or project based on available financial information.
Interest-bearing deposits with banks represent deposits with the Federal Home
Loan Bank of Atlanta. Management considers the concentration of credit risk
to be minimal.
44
National Bankshares, Inc. and Subsidiaries
Note 15: Fair Value of Financial Instruments
The estimated fair values of the Company's financial instruments at
December 31, 1997 and 1996 are as follows:
December 31,
------------------------------------------
1997 1996
-------------------- --------------------
($ In thousands) Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
Financial assets:
Cash and due from banks $ 12,435 12,435 9,989 9,989
Interest-bearing
deposits 9,728 9,728 91 91
Federal funds sold 4,300 4,300 1,910 1,910
Securities 149,974 150,587 171,244 171,289
Mortgage loans held for
sale 405 405 516 516
Loans, net 214,552 215,285 193,598 192,201
-------- ------- ------- -------
Total financial assets $391,394 392,740 377,348 375,996
======== ======= ======= =======
Financial liabilities:
Deposits 344,867 344,589 334,584 331,758
Other borrowed funds 485 485 627 627
-------- ------- ------- -------
Total financial
liabilities $345,352 345,074 335,211 332,385
======== ======= ======= =======
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial instrument.
These estimates do not reflect any premium or discount that could result from
offering for sale at one time the Company's entire holdings of a particular
financial instrument. Because no market exists for a significant portion of
the Company's financial instruments, fair value estimates are based on
judgements regarding future expected loss experience, current economic
conditions, risk characteristics of various financial instruments and other
factors. These estimates are subjective in nature and involve uncertainties
and matters of significant judgement and therefore cannot be determined with
precision. Changes in assumptions could significantly affect these estimates.
Fair value estimates are based on existing on-and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not
considered financial instruments. Significant assets that are not considered
financial assets include deferred tax assets and the bank premises and
equipment. In addition, the tax ramifications related to the realization of
the unrealized gains and losses can have a significant effect on fair value
estimates and have not been considered in the estimates.
Note 16: Business Combination and Pending Acquisition
On June 1, 1996, Bankshares issued 1,888,209 shares of its common stock
in a one-for-one exchange for all the outstanding common stock of Bank of
Tazewell County, Tazewell, Virginia. This business combination has been
45
Notes to Consolidated Financial Statements
accounted for as a pooling-of-interests and, accordingly, the consolidated
financial statements for the periods prior to the combination have been
restated to include the accounts and results of operations of Bank of
Tazewell County. There were no adjustments of a material amount resulting
from Bank of Tazewell County's adoption of Bankshares' accounting policies.
In May 1996, Bankshares declared a stock split of .11129 per share
effected in the form of a stock dividend to the holders of Bankshares common
stock just prior to the merger effective date to facilitate the one-for-one
common stock exchange ratio. All stockholders' equity accounts, share and
per share data have been adjusted retroactively to reflect the stock split.
The results of operations previously reported by the separate
enterprises and the combined amounts presented in the accompanying financial
statements are summarized below:
Six months Year ended
ended June 30, December 31,
($ In thousands) 1996 1995
------ ------
Revenues:
National Bankshares, Inc. $ 9,286 17,848
Bank of Tazewell County 6,166 12,628
------- -------
Combined $15,452 30,476
======= =======
Net Income:
National Bankshares, Inc. $ 1,883 3,256
Bank of Tazewell County 1,106 2,269
------- -------
Combined $ 2,989 5,525
======= =======
On December 26, 1997, NBB entered into an agreement to purchase the
assets, including real estate and improvements, and assume the liabilities of
the Galax, Virginia, branch office of First American Federal Savings Bank.
The transaction, which is subject to regulatory approval, is expected to
close in early 1998 and is not expected to have a material impact on the
Company's results of operations or liquidity.
Note 17: Future Accounting Considerations
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income." Statement 130 establishes standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains and
losses) in a full set of general purpose financial statements. Statement 130
was issued to address concerns over the practice of reporting elements of
comprehensive income directly in equity.
This Statement requires all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed in equal prominence with the other
financial statements. It does not require a specific format for that
financial statement but requires that an enterprise display an amount
representing total comprehensive income for the period in that financial
statement. Enterprises are required to classify items of "other
46
National Bankshares, Inc. and Subsidiaries
comprehensive income" by their nature in the financial statement and display
the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in-capital in the equity section of a
statement of financial position. It does not require per share amounts of
comprehensive income to be disclosed.
Statement 130 is effective for fiscal years beginning after December 15,
1997. Earlier application is permitted. Comparative financial statements
provided for earlier periods are required to be reclassified to reflect the
provisions of this statement. Publicly traded enterprises that issue
condensed financial statements for interim periods are required to report a
total for comprehensive income in those financial statements.
Adoption of Statement 130 on January 1, 1998 will not have any effect on
the Company's consolidated financial position, results of operation or
liquidity. However, Statement 130 will have an effect on future financial
statement displays presented by the Company since the Company has net
unrealized gains (losses) on securities available for sale, an item of other
comprehensive income, which is included in the consolidated statements of
changes in stockholders' equity.
In June 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information." Statement 131
establishes standards for the way public business enterprises are to report
information about operating segments in annual financial statements and
requires those enterprises to report selected information about operating
segments in interim financial reports issued to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. Statement 131 is effective for
financial statements for periods beginning after December 15, 1997. It is
not anticipated that Statement 131 will have any material effect on current
or prior period disclosures presented by the Company.
In February 1998, the FASB issued Statement No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits." This
Statement standardizes the disclosure requirements for pensions and other
postretirement benefits, requires additional information on changes in the
benefit obligations and fair values of assets and eliminates certain existing
disclosure requirements. Statement 132 is effective for fiscal years
beginning after December 15, 1997 and will impact future disclosures of the
Company's defined benefit pension plans.
47
National Bankshares, Inc. Board of Directors
(Picture of National Bankshares, Inc. Board of Directors)
Paul A. Duncan, Holiday Motor Corp., President;
Alonzo A. Crouse, Bank of Tazewell County, Executive
Vice President, Secretary and Cashier; R.E. Dodson,
Bank of Tazewell County, President and Chief
Executive Officer; Charles L. Boatwright, Vice
Chairman of the Board, Physician; James G. Rakes,
National Bankshares, Inc., The National Bank,
President and Chief Executive Officer; William T.
Peery, Cargo Oil Co., Inc., President; Robert E.
Christopher, Jr., Chairman of the Board, Retired;
Jeffrey R. Stewart, Educational Consultant; T.C.
Bowen, Jr., Attorney
48
The National Bank and Bank of Tazewell County Boards of Directors
(Picture of The James G. Rakes, National Bankshares, Inc., The National
National Bank Bank, President and Chief Executive Officer; Charles
Board of Directors) L. Boatwright, Vice Chairman of the Board, Physician;
Robert E. Christopher, Jr., Chairman of the Board,
Retired; L. Allen Bowman, Litton Poly-Scientific, Retired
President; Jeffrey R. Stewart, Educational Consultant;
Paul A. Duncan, Holiday Motor Corp., President; James
M. Shuler, Companion Animal Clinic, Inc., President,
Virginia House of Delegates, Delegate; Paul P. Wisman,
Grundy National Bank, Vice President of Investments,
Nicewonder Investments, Manager of Assets; J. Lewis
Webb, Jr., Dentist
(Picture of Bank Alonzo A. Crouse, Bank of Tazewell County, Executive Vice
of Tazewell County President, Secretary and Cashier; James G. Rakes,
Board of Directors) National Bankshares, Inc., The National Bank, President
and Chief Executive Officer; William T. Peery, Cargo Oil
Co., Inc. President; R. E. Dodson, Bank of Tazewell
County, President and Chief Executive Officer; James S.
Gillespie, Jr., Jim Sam Gillespie Farm, President; T.C.
Bowen, Jr., Chairman of the Board, Attorney; James A.
Deskins, Deskins Super Market, Inc., President; Carl C.
Gillespie, Honorary Chairman of the Board, Attorney;
Jack H. Harry, Harry's Enterprises, Inc., President; J.M.
Pope, Retired, Charles E. Green, III, Registered
Representative, The Equitable Life Assurance Society of
the United States; E.P.Greever, Retired; William H.
VanDyke, Candlewax Smokeless Fuel Co., Vice President
The National Bank Advisory Boards
Montgomery County Advisory Board Dan A. Dodson, W. Clinton Graves, James J.
Owen, Arlene A. Saari, James C. Stewart, T. Cooper Via
Giles Advisory Board Paul B. Collins, John H. Givens, Jr., Ross E. Martin,
Kenneth L. Rakes, Scarlet B. Ratcliffe, H.M. Scanland, Jr., Buford Steele
49
Corporate Information
National Bankshares, Inc. Officers
James G. Rakes Joan C. Nelson
President and Chief Executive Officer Corporate Officer
J. Robert Buchanan Shelby M. Evans
Treasurer Corporate Compliance Officer
Marilyn B. Buhyoff David K. Skeens
Secretary and Counsel Corporate Auditor
F. Brad Denardo
Corporate Officer
Annual Meeting
The Annual Meeting of Stockholders will be held on Tuesday, April 14, 1998 at
3:00 p.m. at the Best Western Red Lion Inn, 900 Plantation Road, Blacksburg,
Virginia.
Corporate Stock
The common stock of National Bankshares, Inc. is traded over the counter, and
certain trades are reported on the OTC Bulletin Board under the symbol
"NKSH."
Financial Information
Investors and analysts seeking financial information about National
Bankshares, Inc. should contact:
James G. Rakes or J. Robert Buchanan
President and Chief Executive Officer Treasurer
(540)552-2011 or (540)552-2011 or
(800)552-4123 (800)552-4123
Written requests may be directed to: National Bankshares, Inc., P.O. Box
90002, Blacksburg, VA 24062-9002.
Stockholder Services and Stock Transfer Agent
Stockholders seeking information about National Bankshares, Inc. stock
accounts should contact:
Marilyn B. Buhyoff
Secretary and Counsel
(540)552-2011 or (800)552-4123
The National Bank of Blacksburg serves as transfer agent for National
Bankshares, Inc. stock.
Written requests and requests for stock transfers may be directed to:
National Bankshares, Inc., P.O. Box 90002, Blacksburg, VA 24062-9002.
A copy of National Bankshares, Inc.'s annual report to the Securities and
Exchange Commission on Form 10-K will be furnished without charge to any
stockholder upon written request.
Corporate Office National Bankshares, Inc.
100 South Main Street
Blacksburg, VA 24060
P.O. Box 90002
Blacksburg, VA 24062-9002
50