United States
Securities and Exchange Commission
Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File Number:
September 30, 1998 0-15204
National Bankshares, Inc.
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Virginia 54-1375874
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 South Main Street
P.O. Box 90002
Blacksburg, Virginia 24062-9002
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code) (540)552-2011
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at October 31, 1998
- ------------------------------- ---------------------------------
Common Stock, $2.50 Par Value 3,792,833
(This report contains 27 pages)
National Bankshares, Inc. and Subsidiaries
Form 10-Q
Index
Page
----
PART I FINANCIAL INFORMATION
- --------------------------------
Item 1 - Financial Statements
Consolidated Balance Sheets, September 30, 1998
and December 31, 1997 4-5
Consolidated Statements of Income and
Comprehensive Income, Three Months Ended
September 30, 1998 and 1997 6-7
Consolidated Statements of Income and
Comprehensive Income, Nine Months Ended
September 30, 1998 and 1997 8-9
Consolidated Statements of Changes in
Stockholders' Equity, Nine Months Ended
September 30, 1998 and 1997 10
Consolidated Statements of Cash Flows,
Nine Months Ended September 30, 1998 and 1997 11-12
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 13-24
Item 3 - Quantitative and Qualitative Disclosures About
Market Risk 25
PART II OTHER INFORMATION
- ----------------------------
Items 1 - 3 - Legal Proceedings; Changes in
Securities; Defaults Upon Senior Securities 26
Item 4 - Submission of Matters to a Vote of
Security Holders 26
Item 5 - Other Information 26
Item 6 - Exhibits and Reports on Form 8-K 26
SIGNATURES 27
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2
National Bankshares, Inc. and Subsidiaries
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
The consolidated financial statements of National Bankshares, Inc.
(Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg
(NBB) and Bank of Tazewell County (BTC), (the Company), conform to generally
accepted accounting principles and to general practices within the banking
industry. The accompanying interim period consolidated financial statements are
unaudited; however, in the opinion of management, all adjustments consisting of
normal recurring adjustments which are necessary for a fair presentation of the
consolidated financial statements have been included. The results of operations
for the nine months ended September 30, 1998 are not necessarily indicative of
results of operations for the full year or any other interim period. The
interim period consolidated financial statements and financial information
included herein should be read in conjunction with the notes to consolidated
financial statements included in the Company's 1997 Annual Report to
Stockholders and additional information supplied in the 1997 Form 10-K.
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 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 the balance sheet. It does not require per
share amounts of comprehensive income to be disclosed. The Company adopted
Statement 130 on January 1, 1998.
Other comprehensive income at present arises from unrealized gains (losses)
on securities available for sale. The following table shows other comprehensive
income arising from unrealized gains (losses) on securities available for sale
and the related income tax effects:
Nine Months Ended
September 30,
($000's) 1998 1997
---- ----
Before tax amount $1,164 398
Tax expense at 34% (396) (135)
------- ---
Other comprehensive income, net of
taxes $ 768 263
====== ===
3
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 1998 and December 31, 1997
(Unaudited)
September 30, December 31,
($000's, except share and per share data) 1998 1997
============= ============
Assets
Cash and due from banks $ 9,720 12,435
Interest-bearing deposits 16,132 9,728
Federal funds sold 4,230 4,300
Securities available for sale 100,978 65,582
Securities held to maturity (fair value
$57,158 in 1998 and $85,005 in 1997) 55,975 84,392
Mortgage loans held for sale 532 405
Loans:
Real estate construction loans 10,025 8,510
Real estate mortgage loans 46,638 42,969
Commercial and industrial loans 110,704 101,379
Loans to individuals 68,282 66,635
-------- -------
Total loans 235,649 219,493
Less unearned income and deferred fees (2,420) (2,503)
-------- -------
Loans, net of unearned income and
deferred fees 233,229 216,990
Less allowance for loan losses (2,659) (2,438)
-------- -------
Loans, net 230,570 214,552
-------- -------
Bank premises and equipment, net 6,094 5,739
Accrued interest receivable 3,643 3,445
Other real estate owned, net 286 421
Other assets 2,471 1,908
-------- -------
Total assets $430,631 402,907
======== =======
Liabilities and Stockholders' Equity
Noninterest-bearing demand deposits $ 52,993 45,093
Interest-bearing demand deposits 76,918 77,863
Savings deposits 47,693 46,773
Time deposits 190,298 175,138
-------- -------
Total deposits 367,902 344,867
-------- -------
Other borrowed funds 188 485
Accrued interest payable 725 722
Other liabilities 1,565 966
-------- -------
Total liabilities 370,380 347,040
-------- -------
Common stock subject to ESOP put option 1,835 1,838
-------- -------
4
Stockholders' equity:
Preferred stock of no par value.
Authorized 5,000,000 shares; none issued
and outstanding --- ---
Common stock of $2.50 par value. Authorized
5,000,000 shares; issued and outstanding
3,792,833 shares 9,482 9,482
Retained earnings 49,807 46,191
Accumulated other comprehensive income 962 194
Common stock subject to ESOP put option (1,835) (1,838)
-------- -------
Total stockholders' equity
Commitments and contingent liabilities 58,416 54,029
-------- -------
Total liabilities and
stockholders' equity $430,631 402,907
======== =======
5
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
Three Months Ended September 30, 1998 and 1997
(Unaudited)
September September
($000's, except per share data) 30, 1998 30, 1997
========== =========
Interest Income
Interest and fees on loans $ 5,532 4,996
Interest on interest-bearing deposits 207 55
Interest on federal funds sold 99 92
Interest on securities - taxable 1,820 1,939
Interest on securities - nontaxable 492 435
------- ------
Total interest income 8,150 7,517
------- ------
Interest Expense
Interest on time deposits of $100,000 or more 625 612
Interest on other deposits 2,961 2,707
Interest on borrowed funds 4 1
------- ------
Total interest expense 3,590 3,320
------- ------
Net interest income 4,560 4,197
Provision for loan losses 225 94
------- ------
Net interest income after provision
for loan losses 4,335 4,103
------- ------
Noninterest Income
Service charges on deposit accounts 295 240
Other service charges and fees 54 69
Credit card fees 170 161
Trust income 212 179
Other income 9 41
Realized securities gains, net 14 11
------- ------
Total noninterest income 754 701
------- ------
Noninterest Expense
Salaries and employee benefits 1,460 1,386
Occupancy and furniture and fixtures 250 228
Data processing and ATM 197 145
FDIC assessment 17 15
Credit card processing 155 152
Goodwill amortization 9 7
Net costs of other real estate owned --- 7
Other operating expense 692 635
------- ------
Total noninterest expense 2,780 2,575
------- ------
Income before income tax expense 2,309 2,229
Income tax expense 638 612
------- ------
Net income 1,671 1,617
------- ------
6
Other comprehensive income, net of taxes:
Unrealized gains on securities
available for sale 691 239
------- ------
Comprehensive income $ 2,362 1,856
======= ======
Net income per share $ 0.44 0.43
======= ======
7
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
Nine Months Ended September 30, 1998 and 1997
(Unaudited)
September September
($000's, except per share data) 30, 1998 30, 1997
========= =========
Interest Income
Interest and fees on loans $16,129 14,418
Interest on interest-bearing deposits 544 136
Interest on federal funds sold 277 323
Interest on securities - taxable 5,334 5,922
Interest on securities - nontaxable 1,360 1,353
------- ------
Total interest income 23,644 22,152
------- ------
Interest Expense
Interest on time deposits of $100,000 or more 1,813 1,715
Interest on other deposits 8,521 8,024
Interest on borrowed funds 10 32
------- ------
Total interest expense 10,344 9,771
------- ------
Net interest income 13,300 12,381
Provision for loan losses 319 303
------- ------
Net interest income after provision
for loan losses 12,981 12,078
------- ------
Noninterest Income
Service charges on deposit accounts 878 801
Other service charges and fees 153 204
Credit card fees 488 449
Trust income 565 559
Other income 63 53
Realized securities gains, net 99 25
------- ------
Total noninterest income 2,246 2,091
------- ------
Noninterest Expense
Salaries and employee benefits 4,318 4,088
Occupancy and furniture and fixtures 741 713
Data processing and ATM 603 398
FDIC assessment 32 29
Credit card processing 446 423
Goodwill amortization 26 22
Net costs of other real estate owned 26 9
Other operating expense 2,134 1,845
------- ------
Total noninterest expense 8,326 7,527
------- ------
Income before income tax expense 6,901 6,642
Income tax expense 1,920 1,824
------- ------
Net income 4,981 4,818
------- ------
8
Other comprehensive income, net of taxes:
Unrealized gains on securities
available for sale 768 263
-------- ------
Comprehensive income $ 5,749 5,081
======== ======
Net income per share $ 1.31 1.27
======== ======
9
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Nine Months Ended September 30, 1998 and 1997
(Unaudited)
Common
Stock
Accumulated Subject
Other To ESOP
($000's, except for per Common Retained Comprehensive Put
share data) Stock Earnings Income Option Total
======= ======== ============= ======= =====
Balances, December 31,
1996 $ 9,482 42,210 (248) (1,643) 49,801
Net income --- 4,818 --- --- 4,818
Unrealized gains
(losses) on securities
available for sale,
net of tax --- --- 263 --- 263
Dividend ($ .33 per
share) --- (1,251) --- --- (1,251)
Change in common stock
Subject to ESOP put
Option --- --- --- (140) (140)
------ ------ ----- ------ -----
Balances, September 30, $ 9,482 45,777 15 (1,783) 53,491
1997 ====== ====== ====== ====== ======
Balances, December 31,
1997 9,482 46,191 194 (1,838) 54,029
Net income --- 4,981 --- --- 4,981
Unrealized gains
(losses) on securities
available for sale,
net of tax --- --- 768 --- 768
Dividend ($ .36 per
share) --- (1,365) --- --- (1,365)
Change in common stock
Subject to ESOP put
Option --- --- --- 3 3
------ ------ ------ ------ -----
Balances, September 30, $ 9,482 49,807 962 (1,835) 58,416
1998 ====== ====== ====== ====== ======
10
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1998 and 1997
(Unaudited)
September September
($000's) 30, 1998 30, 1997
========= =========
Cash Flows from Operating Activities
Net Income $4,981 4,818
Adjustments to reconcile net income to net cash
Provided by operating activities:
Provision for loan losses 319 303
Provision for deferred income taxes (28) (127)
Depreciation of bank premises and equipment 593 408
Amortization of intangibles 106 22
Amortization of premiums and accretion of
discounts, net 47 3
Gains on bank premises and equipment
disposals (7) (2)
Gains on calls of securities held to
maturity, net (99) (25)
Net gains on other real estate owned (19) ---
(Increase) decrease in:
Mortgage loans held for sale (127) (46)
Accrued interest receivable (198) (73)
Other assets (678) 18
Increase (decrease) in:
Accrued interest payable 3 (19)
Other liabilities 599 (115)
------- ------
Net cash provided by operating
Activities 5,492 5,165
------- -------
Cash Flows from Investing Activities
Net (increase)decrease in federal funds sold 70 (2,675)
Net increase in interest-bearing deposits (6,404) (6,537)
Proceeds from calls, sales and maturities of
securities available for sale 23,000 6,795
Proceeds from calls and maturities of securities
held to maturity 30,472 25,425
Purchases of securities available for sale (57,235) (4,844)
Purchases of securities held to maturity (2,000) (8,012)
Purchases of loan participations (1,640) (1,515)
Collections of loan participations 4,074 1,365
Loans purchased, net of premium (3,811) ---
Net increase in loans made to customers (15,215) (18,293)
Proceeds from disposal of other real estate owned 194 83
Recoveries on loans charged off 215 71
Bank premises and equipment expenditures (948) (475)
Proceeds from sale of bank premises and equipment 7 9
------- -------
Net cash used in investing
Activities (29,221) (8,603)
------- -------
11
Cash Flows from Financing Activities
Deposits assumed, net of premium paid 6,827 ---
Net increase in time deposits 7,974 6,697
Net increase in other deposits 7,875 1,065
Net decrease in other borrowed funds (297) (143)
Cash dividends paid (1,365) (1,251)
------- -------
Net cash provided by
financing activities 21,014 6,368
------- -------
Net increase(decrease) in cash and due from banks (2,715) 2,930
Cash and due from banks at beginning of period 12,435 9,989
------- -------
Cash and due from banks at end of period $ 9,720 12,919
======= =======
Supplemental Disclosure of Cash Flow Information
Interest paid $10,341 9,790
======= =======
Cash paid for income taxes $ 2,052 2,276
======= =======
Loans charged to the allowance for loan losses $ 313 530
======= =======
Loans transferred to other real estate owned $ 40 25
======= =======
Investments charged to the allowance for $ --- 272
securities losses ======= =======
12
National Bankshares, Inc. and Subsidiaries
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The purpose of this discussion is to set forth information about the
financial condition and results of operations of National Bankshares, Inc. and
its wholly-owned subsidiaries (the Company), which are not otherwise apparent
from the consolidated financial statements and other information included in
this report. Refer to the financial statements and other information included
in this report as well as the 1997 Annual Report and Form 10-K for an
understanding of the following discussion and analysis.
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. The Company's actual results could
differ materially from those set forth in the forward-looking statements.
Results of Operations - for the nine months ended September 30,1998
- --------------------------------------------------------------------
Net income for the nine months ended September 30, 1998 was $4,981,000
which represents an increase of $163,000 or 3.38% over the first nine months of
1997. The return on average assets as of September 30, 1998 was 1.60% and 1.64%
as of September 30, 1997. The return on average equity was 11.58% as of
September 30, 1998 and 12.13% as of September 30, 1997.
Earnings per share at the end of the third quarter of 1998 were $1.31 per
share, an increase of $0.04 per share over the third quarter of 1997.
The following table provides selected consolidated data.
September 30, December 31,
($000's, except per share data) 1998 1997 1997
====== ====== ============
Interest income $23,644 22,152 29,797
Interest expense 10,344 9,771 13,106
Net interest income 13,300 12,381 16,691
Provision for loan losses 319 303 435
Noninterest income 2,246 2,091 2,834
Noninterest expense 8,326 7,527 10,031
Income taxes 1,920 1,824 2,499
Net income 4,981 4,818 6,560
Return on average assets 1.60% 1,64% 1.66%
Return on average equity (1) 11.58% 12.13% 12.21%
Net income per share $ 1.31 1.27 1.73
Book value per share (1) $ 15.88 14.57 14.73
(1) Includes amount related to common stock subject to ESOP put option excluded
from stockholders' equity on the Consolidated Balance Sheets.
13
Net Interest Income
- -------------------
Net interest income at the end of the first nine months of 1998 was
$13,300,000, an increase of $919,000 or 7.42% over the same period in 1997.
The net interest margin is one of the primary ratios used by banks to
measure net interest income. The net interest margin is composed of the yield
on earning assets on a fully tax equivalent basis less the cost to fund earning
assets. The funding cost factors in capital and demand deposits as well as
interest-bearing liabilities. The following table sets forth the Company's net
interest margin for the periods shown.
September 30, September 30, December 31,
1998 1997 1997
============= ============= ============
Yield on earning assets 8.32% 8.24% 8.24%
Cost to fund earning assets 3.52% 3.51% 3.50%
-------- ------- -------
Net interest margin 4.80% 4.73% 4.74%
======== ======= =======
A second measure of net interest income is the net interest spread. This
ratio consists of the yield on earning assets on a fully tax equivalent basis
less the cost of interest bearing liabilities. It does not reflect the benefit
received from "free funds" such demand deposits and capital. The following
table sets forth the Company's net interest spread for the periods shown.
September 30, September 30, December 31,
1998 1997 1997
============= ============= ============
Yield on earning assets 8.32% 8.24% 8.24%
Cost of interest-bearing
Liabilities 4.51% 4.43% 4.43%
-------- ------- -------
Net interest spread 3.81% 3.81% 3.81%
======== ======= =======
As shown in the previous tables, the net interest margin has increased by
seven basis points. The principal reason for the increase was an eight point
increase in the yield on earning assets, which was caused by continued strong
loan growth. The cost to fund earning assets increased only slightly to 3.52%.
The cost of interest-bearing liabilities increased eight basis points to 4.51%
at September 30, 1998. This ratio reflects the rising cost of interest-bearing
liabilities. It does not give consideration to the beneficial effects of
capital and noninterest-bearing deposits, which have also increased.
14
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 in an effort to 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. Precise loss predictions may be difficult to
determine due to the complex circumstances that often surround troubled debts.
Loan loss and other industry indicators related to asset quality are presented
in the following tables.
For the periods ended
($000's) September 30, September 30, December 31,
1998 1997 1997
============= ============ ============
Balance at beginning of period $ 2,438 2,575 2,575
Provision for loan losses 319 303 435
Loans charged off (313) (530) (679)
Recoveries 215 71 107
------- ------ -------
Balance at the end of period $ 2,659 2,419 2,438
======= ====== =======
Ratio of allowance for loan
losses to end of period loans,
net of unearned income and
deferred fees 1.14% 1.13% 1.12%
======= ====== =======
Ratio of net charge-offs to
average loans, net of unearned
income and deferred fees(1) .06% .30% .23%
======= ====== =======
Ratio of allowance for loan
losses to nonperforming loans (2) 6,647.50% 675.70% 2,802.30%
losses to nonperforming ======== ====== ========
(1) Net charge-offs are on an annualized basis.
(2) The Company defines nonperforming loans as total nonaccrual and
restructured loans. Loans 90 days past due and still accruing are
excluded.
15
September 30, September 30, December 31,
($000's) 1998 1997 1997
============= ============= ============
Nonperforming Assets
Nonaccrual loans $ 40 358 87
Restructured loans --- --- ---
------- ------- -------
Total nonperforming loans 40 358 87
------- ------- -------
Foreclosed property 286 417 421
------- ------- -------
Total nonperforming assets $ 326 775 508
======= ======= =======
Ratio of nonperforming assets to
loans, net of unearned income and
deferred fees and foreclosed
properties .14% .36% .23%
======= ======= =======
Accruing Loans Past Due 90 Days or
More
Past due 90 days or more and
still accruing $ 899 546 672
======= ======= =======
Ratio of loans past due 90 days or
more to loans, net of unearned
income and deferred fees .39% .26% .31%
======= ======= =======
Impaired Loans
Total impaired loans $ 600 424 177
======= ======= =======
Impaired loans with a
Valuation allowance 284 382 53
Valuation allowance (52) (140) (53)
------- ------- -------
Impaired loans net of allowance $ 232 242 ---
======= ======= =======
Impaired loans with no
Valuation allowance $ 316 42 124
======= ======= =======
Average recorded investment
in impaired loans $ 360 519 458
======= ======= =======
Income recognized on impaired loans $ 49 8 23
======= ======= =======
Amount of income recognized
on a cash basis $ --- 9 12
======= ======= =======
16
Noninterest Income
- ------------------
Noninterest income continues to be an important source of the Company's
income. This category is comprised service charges on deposit accounts, credit
card fees and trust income and safe deposit box rental. Net securities gains
and losses are also included in this category.
Noninterest income for the period ended September 30, 1998 was $2,246,000,
an increase of $155,000 or 7.41% over the same period in 1997.
Service charges on deposit accounts were $878,000 at September 30, 1998, an
increase of $77,000 or 9.61% over the same period in 1997. Demand deposit
growth was the principal cause of this growth.
Other service charges declined by $51,000 when September 30, 1998 and 1997
are compared. Income for 1997 includes interest on a tax refund of $27,000 that
did not occur in 1998.
Credit card fees grew by $39,000 or 8.69% when the first nine months of
1998 and 1997 are compared. In 1997, the Company introduced a debit card
program. This new service was not in effect for the entire year of 1997; thus,
1998 reflects a higher level of income from this new activity, as well as from
increases in overall business volume.
Trust income remained essentially stable, increasing 1.07%. Trust income
is dependent on market conditions as well as the types of accounts being handled
at any given point in time. The level of estate business, for example, cannot
be predicted with any degree of preciseness.
Other income, which is comprised of various miscellaneous types of income,
increased by $10,000 for the first nine months of 1998.
Net securities gains and losses increased $74,000 when 1998 and 1997 are
compared. The income in this category reflects securities purchased at a
discount that were called prior to maturity.
Noninterest Expense
- -------------------
Noninterest expenses for the first nine months of 1998 were $8,326,000,
an increase of $799,000 or 10.62% over the first nine months of 1997.
Salaries and fringe benefits was $4,318,000 at the end of the first nine
month of 1998. This represents an increase of $230,000 or 5.63% over the
first nine months of 1997. The increase included additional expense for
normal merit increases, personnel costs at the Galax branch acquired in the
second quarter of 1998, and for a limited number of new positions.
Occupancy expenses increased by $28,000 or 3.93% when the first nine
months of 1998 and 1997 are compared. The increase includes the additional
expense associated with the 1998 Galax branch acquisition.
Data processing expense increased by $205,000 or 51.51%. The increases
were largely associated with the installation of a new mainframe computer
system that began in the fourth quarter of 1997. The principal objective of
this upgrade was to provide the Company with a single system to meet its data
processing needs.
17
Credit card expense rose by 5.44% in the first nine months of 1998.
Increases in overall volume contributed to this increase, as well as
additional costs associated with the debit card program previously mentioned.
Other expenses at September 30, 1998 were $2,134,000, which represents an
increase of $289,000 or 15.66% over the same period in 1997. Other expenses
include various types of costs. Examples of expense accounts included are
telephone, franchise taxes, stationary and supplies, market expense,
correspondent changes and numerous others. Some expenses included in this
area represent accrued expense for anticipated expenditures, while others are
on a cash or pay as incurred basis. Some categories are within management's
ability to control while others can only be controlled to a degree.
Results of Operations - for the three months ended September 30,1998
- --------------------------------------------------------------------
Net income for the three months ended September 30, 1998 was $1,671,000 and
increase of $54,000 or 3.34% over the same period in 1997. Earnings per share
for the third quarter of 1998 was $0.44 compared to $0.43 for the third
quarter of 1997.
Net Interest Income
- -------------------
Net interest income for the third quarter of 1998 was $4,560,000, which
represents an increase of $363,000 or 8.65% over the same period in 1997.
Interest expense rose $270,000 and interest income rose by $633,000. The
increase in interest income was largely attributable to continued loan growth.
Provision for Loan Losses
- -------------------------
The provision for loan losses for the third quarter of 1998 was $225,000 an
increase of $131,000 when compared to the same period the previous year.
Further comments related to the provision for loan losses are included in the
year-to-date discussion.
Noninterest Income
- ------------------
Noninterest income for the third quarter of 1998 was $754,000 an increase
of $53,000 when compared to the third quarter of 1997.
Service charges or deposits increased $55,000 when the third quarter of
1998 and 1997 are compared. As previously mentioned in the year-to-date income
discussion, growth in demand deposits prompted this increase.
Trust income increased $33,000 for the quarter though an overall year-to-
date basis has not shown a substantial increase. Income in this area is greatly
influenced by market conditions and the type accounts being processed in the
period.
18
The other service charge and other income categories include various
miscellaneous items and are subject to fluctuations.
Noninterest Expense
- -------------------
Total noninterest expenses for the third quarter of 1998 was $2,780,000, a
$205,000 increase over the same period in 1997.
Salaries and fringe benefits increased by $74,000 or 5.34%. A substantial
portion of the current quarter's increase was due to the acquisition of the
Galax branch. The remainder was due to normal salary increases and other
expected increases.
Data processing expense increased by $52,000 in the third quarter of 1998.
In late 1997 the Company undertook a major upgrade of its data processing
system. Expense increases were largely associated with this project.
Other expenses increased $57,000 when the third quarter of 1998 and 1997
are compared. Many of the accounts included in the category are on cash basis
such as stationary and supplies, postage, and correspondent bank fees, etc. and
will vary from quarter to quarter. Franchise taxes, which increase with the
level of capital, are also included in this category. Costs associated with the
Galax branch such as additional supplies and core deposit expense also
contributed to the increase.
Balance Sheet
- -------------
The following table sets forth selected consolidated balance sheet data.
($000's) September 30, September 30, December 31,
1998 1997 1997
============= ============= ============
Selected Period-End Data
- ------------------------
Loans, net $ 230,570 211,642 214,552
Total securities 156,953 152,300 149,974
Total assets 430,631 400,165 402,907
Total deposits 367,902 342,346 344,867
Stockholders' equity 58,416 53,491 54,029
19
Selected Daily Averages Data
- ----------------------------
Loans, net $ 222,538 201,849 204,540
Total securities 149,606 159,121 157,179
Interest-earning assets 392,998 372,605 374,478
Total assets 415,109 393,909 395,932
Total deposits 354,830 337,740 339,439
Interest-bearing liabilities 306,855 295,175 295,565
Stockholders' equity 55,449 51,354 53,712
Total average assets at September 30, 1998 were $415,109,000, an increase
of $19,177,000 or 4.84% from December 31, 1997. The Company continues to
experience satisfactory growth in deposits. It is management's belief that
recent deposit growth is the result of current volatility in the financial
markets. It is believed that deposit growth will continue as long as those
conditions exist.
Liquidity
- ---------
Liquidity is the ability to provide sufficient cash levels to meet
financial commitments and to fund loan demand and deposit withdrawals. Net cash
provided by operating activities was $5,492,000 for the nine months ended
September 30, 1998. Net cash used in investing activities was $29,221,000 with
the majority of that cash invested in securities and loans. Net cash from
financing activities was $21,014,000. Net cash decreased $2,715,000 from
December 31, 1997.
The Company actively manages its liquidity position through its investing
activities. At September 30, 1998, overnight funds which includes Federal Funds
sold and funds on deposit with the Federal Home Loan Bank totaled $20,362,000.
In addition, securities with a remaining maturity of less than one year totaled
$20,666,000. Liquidity is also managed through the management of deposit
liabilities; in particular, volatile funds such as time deposits of $100,000 or
more. The amount of such deposits is largely dependent on the rate of interest
offered. The Company had approximately $33,600,000 in such deposits due within
twelve months. Other types of deposits such as interest bearing demand, savings
and time deposits less than $100,000 are less volatile and less rate dependent,
historically.
Short term liquidity needs can also be satisfied by way of credit
facilities established with correspondent banks, the Federal Home Loan Bank and
Federal Reserve. Longer term borrowings, if necessary, can be obtained through
the Federal Home Loan Bank.
Management is not aware of any trend, commitment or events that will result
in or that are reasonably likely to result in a decrease in liquidity that would
be adverse and to a degree that operations would be materially impaired.
20
Capital Resources
- -----------------
Total stockholders' equity increased $4,387,000 or 8.12% from December
31,1997. During the first nine months of 1998, retained earnings grew by
$3,616,000. Accumulated comprehensive income increased stockholders' equity by
$768,000. This category is comprised solely of changes in the net unrealized
gains (losses) on securities available for sale. Common stock subject to put
option decreased by $3,000. The common stock subject to put option is affected
by the current market price of Bankshares' common stock as well as the number of
shares outstanding.
The following table sets forth the various ratios by which bank capital is
measured. Bankshares and its subsidiaries continue to be well capitalized.
September December
30, 1998 31, 1997
========= ========
Consolidated Capital Ratios
---------------------------
Total capital (to risk
Weighted assets) 22.80% 23.30%
Tier 1 Capital (to risk
Weighted assets) 21.80% 22.30%
Tier 1 capital (to average
Assets, leverage ratio) 13.72% 13.70%
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. Settlement of
this purchase agreement occurred on April 3, 1998 and did not have a material
impact on the Company's results of operations or liquidity.
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 micro-chip
controlled systems. The Year 2000 (Y2K) involves several issues for financial
institutions. The Company's own internal information processing and microchip
controlled systems, as well as those of its major service vendors, must be Y2K
compliant. Banks face credit and earnings risk should commercial loan customers
or large depositors 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. Banks could encounter temporary liquidity problems if
customers withdraw unusually large sums of cash because they are unduly
concerned about the effects of Y2K. And, although management believes the level
of counterparties trading risk is low, there could be a temporary or permanent
effect on the investment portfolio resulting from the negative impact of Y2K on
the underlying entities.
Both of the Company's bank subsidiaries have established Y2K project
management teams that have developed Y2K plans with assessment, testing and
remediation phases. The internal audit department is conducting Y2K audits, and
both banks are subject to regular Y2K compliance examinations by their
respective federal and state regulators.
21
The assessment phase outlined in both NBB's and BTC's Y2K plans has been
completed. The banks have identified all internal mission critical information
technology and microchip controlled systems. Outside vendors that provide
mission critical service to the institutions have also been identified.
Because of their importance to daily business operations, attention has
been focused on the banks' own bank-specific information processing hardware and
software. In 1997, in the normal course of business, NBB purchased a new Unisys
host computer and peripherals and installed the latest version of Information
Technology, Inc.'s. bank processing software. BTC is currently converting from
its previous in-house information processing system. That bank will shortly
process its daily work on NBB's host computer and will also use the Information
Technology, Inc. software. Full scale Y2K testing of this hardware and software
is planned in the last quarter of 1998, once the BTC computer conversion is
complete.
Each bank has identified independent information technology systems in its
Trust Department as being mission critical. NBB has completed testing by proxy
and full testing of these systems is expected to be completed by year end, 1998.
Microchip controlled bank security systems are also mission critical. Testing
of these systems is finished. Some minor upgrades in the security systems were
required, and this work is complete.
Both NBB and BTC deal with outside vendors that provide mission critical
support for bank card processing and ATM servicing. The banks are working
closely with vendors to assure their Y2K readiness. The vendors have been asked
to certify Y2K compliance. However, because both banks have decided to convert
to a new ATM servicer in early 1999, testing of that application will be delayed
until the conversion is complete.
Each bank has developed and implemented programs to assess the level of Y2K
risk among their large loan customers. NBB's Credit Review department performs
a pre-credit analysis of all new large loans made by both banks. An assessment
of the potential effects of Y2K on the credit-worthiness of borrowers is now a
part of this analysis. BTC is asking new commercial borrowers to sign an
agreement to insure compliance with minimum standards with regard to Y2K issues.
That bank is also following up with these borrowers to insure that promised
deadlines are met. NBB has a larger portfolio of existing commercial loans than
BTC, and therefore has undertaken a more intensive campaign to evaluate the
level of credit risk posed by the millenium date change. NBB has identified all
current commercial loan customers with outstanding balances of more that
$100,000. Bank loan officers are in process of meeting with each of these
customers to assess the level of Y2K related credit risk. These assessments
were substantially completed at the end of the third quarter.
Both banks have undertaken initiatives designed to educate customers about
Y2K issues and to allay any unwarranted concerns about the safety and soundness
of the institutions. Leaflets discussing the topic have been sent to all
customers, and NBB has posted information on its Web site. NBB also hosted a
public forum about Y2K which was directed at small business customers, but was
widely advertised to the general public. Employee training and awareness
campaigns have also been implemented.
Once the testing phases of the banks' Y2K plans are substantially complete
at year end 1998, both banks will focus more heavily on completing remediation
and business resumption contingency planning. NBB has drafted contingency plans
to 1) identify alternatives should mission critical applications not meet the
bank's readiness plan, and 2) develop a course of action to assure business
continuity in the event there are systems failures on critical dates. NBB will
refine its contingency plans utilizing the knowledge gained from testing.
Because of the major computer conversion project and the fact that a large part
of its mission critical applications will be supplied by NBB, BTC will need to
substantially revise its contingency plans in early 1999.
22
As has been mentioned, the Company's subsidiaries have recently completed
an upgrade of internal information processing systems, including the acquisition
of new hardware and software. While the project does enhance Y2K preparedness,
its major goals are to provide a shared information processing systems for
affiliates and to provide additional processing capacity and the ability to use
the most advanced version of software available. The costs of the upgrade were
substantial, but the total of costs of the upgrade directly related to the Y2K
component and other expenses identified by the banks' Y2K project management
teams are now estimated to be approximately $100,000. Included in this total
are certain completed and planned bank security system upgrades, accelerated
replacement for a small number of personal computers and some required completed
and planned upgrades of personal computers and applications software. Total
estimated Y2K expenses of $100,000 are not deemed material to the consolidated
financial statements.
Future Accounting Considerations
- --------------------------------
In March 1998, the AICPA Accounting Standards Executive Committee (AcSEC)
issued Statement of Position 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use." SOP 98-1 is applicable for
the costs of computer software developed or obtained for internal use. The SOP
requires that certain costs related to the development or purchase of internal-
use software be capitalized and amortized over the estimated useful life of the
software. The SOP also requires that costs related to the preliminary project
stage and the post-implementation/operation stage (as defined in SOP 98-1) is an
internal-use computer software development project be expensed as incurred.
SOP 98-1 is effective for financial statements issued for fiscal years
beginning after December 15, 1998. Earlier application is encourages in fiscal
years for which annual financial statements have not been issued. Initial
application should be as of the beginning of the fiscal year in which the SOP is
first adopted and applied to costs incurred for all projects during that fiscal
year, including those in progress upon initial application. Costs incurred
prior to initial application of the SOP, whether capitalized or not, should not
be adjusted to the amounts that would have been capitalized had the SOP been in
effect when those costs were incurred.
In late 1998, BTC plans to complete an upgrade of information system
hardware and software and expand its microcomputer network.
However, the Company does not plan to adopt SOP 98-1 until January 1, 1999,
therefore it is not anticipated SOP 98-1 will have a material effect in the
consolidated financial position, results of operations or liquidity of the
Company.
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The Company adopted FASB 133 as of October
1, 1998. In connection with the adoption of FASB 133, the Company transferred
23
securities with a carrying value of approximately $20,500,000 from held to
maturity to available for sale. This transfer of securities resulted in an
increase in unrealized gains (losses) on securities available for sale,
comprehensive income, accumulated other comprehensive income and stockholders'
equity of approximately $469,000, net of income taxes of $242,000, as of October
1, 1998. Except as discussed above the adoption of FASB 133 did not have a
material effect on the consolidated financial position, results of operations or
liquidity of the Company.
There have been no other recent accounting pronouncements issued that would
have a material effect on the consolidated financial position, results of
operations or liquidity of the Company.
24
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Derivatives
The Company is not a party to derivative financial instruments with off-
balance sheet risks such as futures, forwards, swaps and options. The Company
is a party to financial instruments with off-balance sheet risks such as
commitments to extend credit, standby letters of credit, and recourse
obligations in the normal course of business to meet the financing needs of its
customers. Management does not plan any future involvement in high risk
derivative products. The Company has investments in 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 September 30, 1998
approximated $8,575,000.
Interest Rate Sensitivity
The Company's securities, loans, and deposits are subject to interest rate
risk. 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. The table below sets forth, as of September 30, 1998, the
distribution of repricing opportunities of the Company's interest-earning assets
and interest-bearing liabilities, the interest rate sensitivity gap (i.e.,
interest rate sensitive assets less interest rate sensitive liabilities), and
the cumulative interest rate sensitivity gap. The table sets forth the time
periods during which interest-earning assets and interest-bearing liabilities
will mature or may reprice in accordance with their contracted terms.
The method of analysis presented the following table has certain inherent
shortcomings. For example, although in certain assets and liabilities may have
similar maturities or periods of repricing, they may react in different degrees
and at different times to changes in market interest rates. Also, loan
prepayments and early withdrawals of certificates of deposit could cause the
interest sensitivities to vary from those which appear on the table.
($000's) <3 Months 6 Months 12 Months 1-5 Years >5 Years
========= ======== ========= ========= ========
Interest-earning
Assets $ 89,232 32,775 55,618 152,905 80,946
Interest-bearing
Liabilities 159,093 35,168 67,879 52,769 ---
------- ------ ------- ------- -------
Gap (69,861) (2,393) (12,261) 100,136 80,946
======== ======= ======= ======= =======
Cumulative gap $(69,861) (72,254) (84,515) 15,621 96,567
======== ======= ======= ====== =======
25
National Bankshares, Inc. and Subsidiaries
PART II
OTHER INFORMATION
Items 1-3. Legal Proceedings; Changes in Securities; Defaults Upon Senior
Securities
None for the three months ended
September 30, 1998.
Item 4. Submission of Matters to a Vote of Security Holders
None for the three months ended September 30, 1998
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K filed during the three months ended
September 30, 1998:
None
26
National Bankshares, Inc. and Subsidiaries
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
National Bankshares, Inc.
(Registrant)
Date:
------------- ------------------------------------
James G. Rakes, President and
Chief Executive Officer
Date:
------------- ------------------------------------
J. Robert Buchanan, Treasurer
(principal financial officer)
27