================================================================================ 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 June 30, 2001 ------------------ Commission file number 0-15204 National Bankshares, Inc. (Exact name of registrant as specified in its charter) ------------------ State or other jurisdiction of incorporation or organization - Virginia Internal Revenue Service - Employer Identification No. 54-1375874 101 Hubbard Street, P.O. Box 90002, Blacksburg, VA 24062-9002 (540) 951-6300 ------------------ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such requirements for the past 90 days. Yes |X| No |_| Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at August 1, 2001 - -------------------------------------- ----------------------------- Common Stock, $2.50 Par Value 3,511,377 (This report contains 26 pages) ================================================================================
NATIONAL BANKSHARES, INC. AND SUBSIDIARIES Form 10-Q Index Page ------- Part I Financial Information Item 1 - Financial Statements Consolidated Balance Sheets, June 30, 2001 3-4 and December 31, 2000 Consolidated Statements of Income for the 5-6 Three Months Ended June 30, 2001 and 2000 Consolidated Statements of Income for the 7-8 Six Months Ended June 30, 2001 and 2000 Consolidated Statements of Changes in 9 Stockholders' Equity, Six Months Ended June 30, 2001 and 2000 Consolidated Statements of Cash Flows, 10-11 Six Months Ended June 30, 2001 and 2000 Item 2 - Management's Discussion and Analysis of 17-23 Financial Condition and Results of Operations Item 3 - Quantitative and Qualitative Disclosures about 24 Market Risk Part II Other Information Items 1 - 3 - Legal Proceedings; Changes in 25 Securities and Use of Proceeds; Defaults Upon Senior Securities Item 4 - Submission of Matters to a Vote of 25 Security Holders Item 5 - Other Information 25 Item 6 - Exhibits and Reports on Form 8-K 25 Signatures 26 - ---------- 2
National Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets June 30, 2001 and December 31, 2000 (Unaudited) (Audited) June 30, December 31, ($000's except share and per share data) 2001 2000 ============= ============= Assets Cash and due from banks $12,410 11,130 Interest-bearing deposits 9,958 13,579 Federal funds sold 11,117 29,090 Securities available for sale 114,329 123,785 Securities held to maturity (fair value $89,779 in 2001 and $32,602 in 2000) 89,078 32,559 Mortgage loans held for sale 254 --- Loans: Real estate construction loans 18,778 16,726 Real estate mortgage loans 72,200 71,163 Commercial and industrial loans 176,664 163,929 Loans to individuals 118,998 110,176 ------------ ------------- Total loans 386,640 361,994 Less unearned income and deferred fees (2,041) (2,313) ------------ ------------- Loans, net of unearned income and deferred fees 384,599 359,681 Less: allowance for loan losses (3,987) (3,886) ------------ ------------- Loans, net 380,612 355,795 ------------ ------------- Bank premises and equipment, net 10,419 10,324 Accrued interest receivable 5,457 5,049 Other real estate owned, net 399 540 Intangible assets 12,343 9,038 Other assets 2,145 2,608 ------------ ------------- Total assets $ 648,521 593,497 ============ ============= Liabilities and stockholders' equity Noninterest-bearing demand deposits $67,968 60,165 Interest-bearing demand deposits 119,340 101,257 Savings deposits 47,557 42,560 Time deposits 347,775 326,666 ------------ ------------- Total deposits 582,640 530,648 ------------ ------------- Other borrowed funds 362 270 Accrued interest payable 1,560 1,538 Other liabilities 989 1,207 ------------ ------------- Total liabilities 585,551 533,663 ------------ ------------- 3
Stockholders' equity Preferred stock of no par value. Authorized 5,000,000 shares; none issued and outstanding --- --- Common stock of $2.50 par value. Authorized 5,000,000 shares; issued and outstanding 3,511,377 shares in 2001 and 3,512,977 in 2000 8,778 8,780 Retained earnings 53,410 51,629 Accumulated other comprehensive (loss) 782 (575) ------------ ------------- Total stockholders' equity 62,970 59,834 Commitments and contingent liabilities ------------ ------------- Total liabilities and Stockholders' equity $ 648,521 593,497 ============ ============= See accompanying notes to the consolidated financial statements 4
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income Three Months Ended June 30, 2001 and 2000 (Unaudited) June 30, June 30, ($000's except share and per share data) 2001 2000 ============== ============= Interest income Interest and fees on loans $ 8,371 6,846 Interest on interest-bearing deposits 171 124 Interest on federal funds sold 196 80 Interest on securities - taxable 2,080 1,678 Interest on securities - nontaxable 864 558 ------------ ----------- Total interest income 11,682 9,286 ------------ ----------- Interest expense Interest on time deposits $100,000 or more 1,223 811 Interest on other deposits 4,961 3,284 Interest on borrowed funds 1 179 ------------ ----------- Total interest expense 6,185 4,274 ------------ ----------- Net interest income 5,497 5,012 Provision for loan losses 332 313 ------------ ----------- Net interest income after provision for loan losses 5,165 4,699 ------------ ----------- Noninterest income Service charges on deposit accounts 575 399 Other service charges and fees 73 78 Credit card fees 335 285 Trust income 287 195 Other income 26 5 ------------ ----------- Total noninterest income 1,296 962 ------------ ----------- Noninterest expense Salaries and employee benefits 2,047 1,556 Occupancy and furniture and fixtures 427 322 Data processing and ATM 348 246 FDIC assessment 31 21 Credit card processing 265 222 Goodwill amortization 10 10 Net costs of other real estate owned 16 23 Other operating expenses 1,141 694 ------------ ----------- Total noninterest expense 4,285 3,094 ------------ ----------- Income before income tax expense 2,176 2,567 Income tax expense (495) (698) ------------- ----------- Net income $ 1,681 1,869 ============= =========== Net income per share, basic and diluted $ 0.48 0.53 ============= =========== 5
Weighted average number of common shares outstanding 3,511,377 3,516,428 Dividends declared per share $ 0.43 0.42 ============= =========== See accompanying notes to consolidated financial statements. 6
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income Six Months Ended June 30, 2001 and 2000 (Unaudited) June 30, June 30, ($000's except share and per share data) 2001 2000 ============ =========== Interest income Interest and fees on loans $16,603 13,385 Interest on interest-bearing deposits 540 126 Interest on federal funds sold 375 175 Interest on securities - taxable 4,067 3,338 Interest on securities - nontaxable 1,478 1,106 ----------- ----------- Total interest income 23,063 18,130 ----------- ----------- Interest expense Interest on time deposits $100,000 or more 2,423 1,452 Interest on other deposits 9,756 6,363 Interest on borrowed funds 4 345 ----------- ----------- Total interest expense 12,183 8,160 ----------- ----------- Net interest income 10,880 9,970 Provision for loan losses 664 666 ----------- ----------- Net interest income after provision for loan losses 10,216 9,304 ----------- ----------- Noninterest income Service charges on deposit accounts 1,085 761 Other service charges and fees 145 137 Credit card fees 596 504 Trust income 565 405 Other income 126 80 Realized securities losses, net (26) --- ----------- ----------- Total noninterest income 2,491 1,887 ----------- ----------- Noninterest expense Salaries and employee benefits 3,966 3,114 Occupancy and furniture and fixtures 843 621 Data processing and ATM 709 464 FDIC assessment 46 42 Credit card processing 502 436 Goodwill amortization 19 19 Net costs of other real estate owned 20 26 Other operating expenses 2,241 1,363 ----------- ----------- Total noninterest expense 8,346 6,085 ----------- ----------- Income before income tax expense 4,361 5,106 Income tax expense (1,064) (1,385) ----------- ----------- Net income $ 3,297 3,721 =========== =========== 7
Net income per share, basic and diluted $ 0.94 1.06 =========== =========== Weighted average number of common shares outstanding 3,511,383 3,516,702 Dividends declared per share $ 0.43 0.42 =========== =========== See accompanying notes to consolidated financial statements. 8
<TABLE> <CAPTION> National Bankshares, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity Six Months Ended June 30, 2001 and 2000 (Unaudited) Accumulated Other ($000's, except for per Common Retained Comprehensive Comprehensive share data) Stock Earnings Income (Loss) Income Total =========== ============= ================ ================ ============ <S> <C> <C> <C> <C> <C> Balances, December 31, 1999 $ 8,792 47,384 (3,453) $52,723 Net income --- 3,721 --- 3,721 3,721 Dividend ($0.42 per share) --- (1,477) --- --- (1,477) ividend ($0.42 per share) (1,477) Other comprehensive income, net of tax: Unrealized gains on securities available for sale, net of income tax expense $30 --- --- 59 59 59 Reclass adjustment net of tax --- --- --- --- --- Other comprehensive income --- --- --- --- --- ----------- ------------- ---------------- ---------------- ------------ Comprehensive income --- --- --- 3,780 --- ----------- ------------- ---------------- ---------------- ------------ Stock repurchase (10) (62) --- (72) ----------- ------------- ----------------- --------------- ------------ Balances, June 30, 2000 $ 8,782 49,566 (3,394) 54,954 =========== ============= ================= =============== ============ Balances, December 31, 2000 $ 8,780 51,629 (575) --- 59,834 Net income --- 3,297 --- 3,297 3,297 Dividend ($0.43 per share) --- (1,510) --- --- (1,510) Other comprehensive income, net of tax Unrealized gains on securities available for sale, net of income tax expense $699 --- --- 1,340 1,340 1,340 Reclass adjustment net of income tax expense $9 --- --- 17 17 17 Other comprehensive income --- --- --- --- --- ----------- ------------- ---------------- ---------------- ----------- Comprehensive income --- --- --- 4,654 --- ----------- ------------- ---------------- ---------------- ----------- Stock repurchase (1) (2) (6) --- (8) ----------- -------------- --------------- ---------------- ------------ Balances, June 30,2001 $ 8,778 53,410 782 62,970 =========== ============= ================ ================ =========== (1) Represents the repurchase of 500 shares at $16.25 per share. See accompanying notes to consolidated financial statements. </TABLE> 9
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows Six Months Ended June 30, 2001 and 2000 (Unaudited) June 30, June 30, ($000's) 2001 2000 =========== =========== Cash flows from operating activities Net income $ 3,297 3,721 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 664 666 Depreciation of bank premises and equipment 558 499 Amortization of intangibles 435 76 Amortization of premiums and accretion of Discount, net 142 73 Gains on sales of bank premises and equipment (1) (2) Losses on sales and calls of securities Available for sale, net 26 15 Losses on other real estate owned 4 17 (Increase) decrease in: Mortgage loans held for sale (254) (514) Accrued interest receivable (408) (359) Other assets (227) (182) Increase (decrease) in: Accrued interest payable 22 25 Other liabilities (218) (492) ------------ ---------- Net cash provided by operating activities 4,040 3,543 ----------- ---------- Cash flows from investing activities Net decrease in federal funds sold 17,973 2,650 Net (increase) decrease in interest-bearing Deposits 3,621 (855) Proceeds from calls and maturities of securities Available for sale 24,518 4,563 Proceeds from sales of securities available for Sale --- 451 Proceeds from calls and maturities of securities Held to maturity 8,937 1,778 Purchases of securities available for sale (13,096) (11,476) Purchases of securities held to maturity (65,534) --- Purchases of loan participations (3,114) (1,770) Collections of loan participations 2,474 880 Purchase of loans from acquisition (9,255) --- Net increase in loans to customers (15,716) (15,923) Proceeds from disposal of other real estate owned 210 211 Recoveries on loans charged off 57 44 Purchase of bank premises and equipment (668) (387) Proceeds from disposal of bank premises and equipment 16 2 ----------- ---------- Net cash used in investing activities (49,577) (19,832) ---------- ---------- 10
Cash flows from financing activities Deposits purchased net of premium paid 29,885 --- Net increase in time deposits 1,152 20,794 Net increase (decrease)in other deposits 17,206 (3,205) Net decrease in other borrowed funds 92 54 Dividends paid on common stock (1,510) (1,477) Repurchase of common stock (8) (72) ----------- ----------- Net cash provided by financing activities 46,817 16,094 ----------- ----------- Net increase (decrease) in cash and due from banks 1,280 (195) Cash and due from banks at beginning of period 11,130 13,311 ----------- ----------- Cash and due from banks at end of period $12,410 13,116 =========== =========== Supplemental disclosure of cash flow information Cash paid for interest $12,161 8,135 =========== =========== Cash paid for income taxes $ 1,263 1,638 =========== =========== Loans charged to the allowance for loan losses $ 620 396 =========== =========== Loans transferred to other real estate owned $ 73 17 =========== =========== Long-term debt $ --- 10,000 =========== =========== See accompanying notes to consolidated financial statements. 11
National Bankshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements June 30, 2001 (Unaudited) Note (1) The consolidated financial statements of National Bankshares, Inc. (Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg (NBB), Bank of Tazewell County (BTC) and National Bankshares Financial Services Inc. (NBFS), (the Company), conform to 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 six months ended June 30, 2001 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 2000 Annual Report to Stockholders and additional information supplied in the 2000 Form 10-K. 12
Note (2) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans For the periods ended June 30, December 31, 2001 2000 2000 =========== =========== ============= ($000's, except for % data) Balance at beginning of period $ 3,886 3,231 3,231 Provision for loan losses 664 666 1,329 Loans charged off (620) (396) (770) Recoveries 57 44 96 ----------- ---------- ---------- Balance at the end of period $ 3,987 3,545 3,886 =========== ========== ========== Ratio of allowance for loan losses to the end of period loans net of unearned income and deferred fees 1.04% 1.14% 1.08% =========== ========== ========== Ratio of net charge-offs (recoveries) to average loans, net of unearned income and deferred fees(1) .31% .23% .21% =========== ========== ========== Ratio of allowance for loan losses to nonperforming loans(2) 2,345.29% 1,508.31% 4,415.91% =========== ========== ========== (1) Net charge-offs are on an annualized basis. (2) The Company defines nonperforming loans as total nonaccrual and restructured loans. Loans 90 days past due and still accruing are excluded. June 30, December 31, 2001 2000 2000 ========== ========== ============= ($000's, except for % data) Nonperforming Assets Nonaccrual loans $170 235 88 Restructured loans --- --- --- -------- --------- ---------- Total nonperforming loans 170 235 88 Foreclosed property 399 219 540 -------- --------- ---------- Total nonperforming assets $569 454 628 ======== ========= ========== Ratio of nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned .15% .15% .17% ======== ========= ========== 13
June 30, December 31, 2001 2000 2000 ========= ========= ============= Accruing Loans Past Due 90 Days or More Past due 90 days or more and still accruing $1,400 523 1,321 ========= ======== =========== Ratio of loans past due 90 days or more to loans, net of unearned income and deferred fees .36% .17% .37% ========= ======== =========== Impaired Loans Total impaired loans $721 522 456 ========= ======== =========== Impaired loans with a valuation allowance $--- 216 135 Valuation allowance --- (179) (135) --------- --------- ----------- Impaired loans net of allowance $--- 37 --- ========= ======== =========== Impaired loans with no valuation allowance $721 306 321 ========= ======== =========== Average recorded investment in impaired loans $591 523 657 ========= ======== =========== Income recognized on impaired loans $ 29 21 43 ========= ======== =========== Amount of income recognized on a cash basis --- --- --- ========= ======== =========== 14
Note (3) Securities The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities available for the sale by major security type as of June 30, 2001 are as follows: June 30, 2001 Gross Gross Amortized Unrealized Unrealized Fair ($ in thousands) Costs Gains Losses Values ------------ ------------ ------------ ---------- Available for sale: U.S. Treasury $ 6,247 201 --- 6,448 U.S. Government agencies and corporations 35,222 155 158 35,219 State and political subdivisions 42,846 748 124 43,470 Mortgage-backed securities 12,996 223 6 13,213 Corporate debt securities 13,056 143 139 13,060 Federal Reserve Bank stock 209 --- --- 209 Federal Home Loan Bank stock 1,411 --- --- 1,411 Other securities 1,157 142 --- 1,299 ----------- --------- -------- --------- Total securities available for sale $ 113,144 1,612 427 114,329 =========== ========= ======== ========= The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities held to maturity by major security type as of June 30, 2001 are as follows: June 30, 2001 Gross Gross Amortized Unrealized Unrealized Fair ($ in thousands) Costs Gains Losses Values ------------ ------------- ------------- ---------- Held to Maturity: U.S. Government agencies and corporations $18,494 65 44 18,515 State and political subdivisions 39,060 429 68 39,421 Mortgage-backed securities 8,684 56 3 8,737 Corporate securities 22,840 416 150 23,106 ----------- --------- --------- ----------- Total securities held to maturity $89,078 966 265 89,779 =========== ========= ========= =========== 15
<TABLE> <CAPTION> Note (4) Restrictions on Dividend Payments and Capital Requirements Bankshares' and its subsidiaries' actual regulatory capital amounts and ratios are also presented in the following tables: To Be Well Capitalized Under For Capital Prompt Corrective Adequacy Purposes Action Provisions ($ in thousands) Amount Ratio Amount Ratio Amount Ratio ------------ ------------ ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> <C> <C> June 30, 2001: Total capital(1) Bankshares Consolidated $53,938 12.2% 35,253 8.0% N/A N/A NBB 29,384 11.5% 20,422 8.0% 25,527 10.0% BTC 21,305 11.7% 14,570 8.0% 18,212 10.0% Tier I capital(1) Bankshares Consolidated $49,951 11.3% 17,627 4.0% N/A N/A NBB 26,966 10.6% 10,211 4.0% 15,316 6.0% BTC 19,736 10.8% 7,285 4.0% 10,927 6.0% Tier I capital(2) Bankshares Consolidated $49,951 7.2% 27,667 4.0% N/A N/A NBB 26,966 7.7% 13,974 4.0% 17,468 5.0% BTC 19,736 7.1% 11,191 4.0% 13,988 5.0% (1) To Risk Weighted Assets (2) To Average Assets </TABLE> 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 June 30, 2001, retained net income from the Company's NBB affiliate which was free of such restriction amounted to approximately $2,269. At present, no dividends are available from the Company's BTC affiliate without prior regulatory approval. BTC remains well capitalized and management does not believe that such approvals will be withheld. Note (5) Comprehensive Income Effective January 1, 2001 the Company changed its method of presentation concerning comprehensive income. Prior to 2001, comprehensive income was reflected as part of the consolidated statement of income. Comprehensive income is now presented as a separate component of the Company's consolidated statement of changes in stockholders' equity. 16
National Bankshares, Inc. and Subsidiaries (In 000's, except for % data) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (In thousands, except for per share data) The purpose of this discussion is to provide information about the financial condition and results of operations of National Bankshares, Inc. and its wholly-owned subsidiaries (the Company), which are not otherwise apparent from the consolidated financial statements and other information included in this report. Reference should be made to the financial statements and other information included in this report as well as the 2000 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. Analysis of Financial Condition and Results of Operations for the Six Months Ended June 30, 2001 - -------------------------------------------------------------------------------- Net income for the six months ended June 30 2001 was $3,297 which represents a decline of $424 or 11.4% when compared to the same period in 2000. The annualized return on average assets for the six months ended June 30, 2001 was 1.06% and 1.56% for June 30, 2000. The annualized return on average equity was 10.68 for the period ended June 30, 2001 and 13.87% for June 30, 2000. Earnings per share for the period ended June 30, 2001 was $0.94 and $1.06 in 2000 for the same period. Net Interest Income - ------------------- Net interest income at the end of the second quarter of 2001 was $10,880, an increase of $910 or 9.1%. Interest income increased $4,933 or 27.2%, when the period ended June 30, 2001 and 2000 are compared. The yield on earning assets was 8.09%, decreasing 23 basis points from June 30, 2000. Interest expense increased $4,023, or 49.3%, when the two periods are compared. The cost to fund earning assets for the period ended June 30, 2001 was 4.15% or a 53 basis point increase from the same period in 2000. The underlying cause of these results was in part due to the rising interest rate environment that existed until January 2001. During the year 2000 rates remained high and negatively affected loan growth while at the same time deposit costs were steadily increasing. Acquisition activity also played a role in the decline. During the period from June 30, 2000 to June 30, 2001 the Company acquired seven branches divested from other banks. This involved approximately $128,000 in new deposits. While assumption of the interest expense on these deposits was immediate, it was not possible to channel the new funds into the loan portfolio due to economic conditions. Surplus funds, instead, were placed in the lower yielding investment portfolio. Accordingly, interest expense grew at a faster rate than interest income, causing a marked decline in the net interest margin of 77 basis points to 3.94%. While the short-term effects of the merger activities are deemed to be slightly negative, management believes the intermediate and long term effects to be very positive. Overall, management believes that the prospects for improvement are good, barring any unforeseen events and assuming that overall economic conditions improve as expected. 17
Provision and Allowance for Loan Losses - --------------------------------------- The adequacy of the allowance for loan losses is based on management's judgement and analysis of current and historical loss experience, risk characteristics of the loan portfolio, concentrations of credit and asset quality, as well as other internal and external factors such as general economic conditions. An internal credit review department performs pre-credit analyses of large credits and also conducts credit review activities that provide management with an early warning of asset quality deterioration. Changing trends in the loan mix are also evaluated in determining the adequacy of the allowance for loan losses. The ratio of the allowance for loan losses to loans net of unearned income was 1.04% at June 30, 2001. This compares to 1.14% at June 30, 2000. The provision for the first six months of 2001 was $664, down $2 over the same period the prior year. Noninterest Income - ------------------ Noninterest income is an important source of the Company's income. This category is comprised of service charges on deposit accounts, other service charges and fees, credit card fees, trust income and other income. Net securities gains and losses are also included in this category. Noninterest income for the period ended June 30, 2001 was $2,491, an increase of $604 or 32.0%. All categories except realized gains/losses on securities experienced increases when the period ended June 30, 2001 and June 30, 2000 are compared. Service charges on deposit accounts increased, accounting for $324 or 53.6% of the total increase in noninterest income. This was primarily due to an increase in volume caused by the acquisition of six branches in mid-November 2000 and to a single branch acquisition in March 2001. Other service charges and fees increased by $8 when June 30, 2001 and June 30, 2000 are compared. Credit card fees increased $92, or 18.3%. This increase was in part due to debit card income, which improved due to acquisition activity and the introduction of the service at BTC. Trust income increased by 39.5% when compared to the first six months of 2000. Trust income is dependent on market conditions as well as the types of accounts being handled at any given point in time. The level of estate business, for example, cannot be predicted with any degree of precision. So far, in 2001, there has been a higher level of estate activity. Realized securities gains/losses were $(26) for the quarter ended June 30, 2001. Included in this is the write-down of the Company's investment in two limited liability companies established for the sale of title insurance and insurance services. Noninterest Expense - ------------------- Noninterest expense for the period ended June 30, 2001 was $8,346, an increase of $2,261 or 37.2%. The majority of the increase as described below was associated with acquisition activity. Salaries and employee benefits increased by $852 or 27.4% when the periods ended June 30, 2001 and 2000 are compared. This increase was largely due to the acquisition of six branches in mid-November 2000 and to a lesser extent a seventh branch acquired in March of 2001. Routine merit increases also contributed to the increase. 18
Occupancy expenses increased $222 when the second quarter of 2001 and 2000 are compared. The 35.8% increase was largely attributable to the branch acquisition referred to above, which increased depreciation costs, taxes, insurance and other fixed asset costs. Data processing costs increased $245 or 52.8%. Maintenance costs, particularly on ATM's, increased as a result of the branch acquisitions. Credit card processing increased $66 or 15.1% due to volume. Other operating costs increased $878 or 64.4% when the periods June 30, 2001 and 2000 are compared. The majority of these increases were caused by acquisition activities, which include intangibles expense and other operating expenses such as stationary and supplies, telephone and courier services. Balance Sheet - ------------- Total assets at June 30, 2001 were $648,521, an increase of $55,024 or 9.3% over period end assets at December 31, 2000. Loans net of unearned income grew by $24,918 or 6.9%. Loans purchased in a branch acquisition accounted for approximately $9,200 of the increase. Deposits purchased in a branch acquisition accounted for approximately $34,000 of the increase of $51,992; the remainder of which was due to deposit marketing activities. Securities - ---------- While securities available for sale declined by 8.3%, securities held to maturity increased $56,519 or 173.6%. This represents an investment of funds generated by the acquisition activity previously mentioned. Loans - ----- As previously mentioned a portion of this loan growth was achieved by purchasing a branch. The category experiencing the largest growth was loans to individuals, which increased $8,822, or 8.0%, followed by commercial and industrial loans, which increased $12,735 or 7.8%. Real estate construction loans increased by $2,052 or 12.3%. Fixed Asset - ----------- The Company's investment in fixed assets, net of depreciation increased $95 when June 30, 2001 and December 31, 2000 are compared. The increase was in part due to acquisition activities. 19
Deposits - -------- Total deposits increase $51,992 or 9.8% when June 30, 2001 and December 21, 2000 are compared. Branch acquisitions accounted for the approximately $34,000 of this increase. Noninterest bearing deposits grew by 13.0% with interest bearing demand deposits growing by 17.9%. Saving deposits increased by 11.7% with the largest increase occurring in interest-bearing demand deposits, which grew by 17.9%. Time deposits grew by $21,109 or 6.5%. Daily Averages - -------------- Daily averages for the major categories are as follows: (000's) June 30, 2001 June 30, 2000 =================== ================== Federal funds sold $20,635 5,099 FHLB deposits 14,328 5,494 Loans, net 365,273 297,919 Securities available for sale 117,562 117,435 Securities held to maturity 69,128 22,657 Total assets 627,375 478,364 Noninterest-bearing deposits 63,567 54,483 Interest-bearing deposits 499,055 357,643 Stockholders' equity 61,720 53,813 Liquidity - --------- Liquidity is the ability to provide sufficient cash levels to meet financial commitments and to fund loan demand and deposit withdrawals. Cash from operating activities was $4,040 primarily due to earnings. Cash used in investing activities totaled $49,577. Primary uses were purchases of securities, purchased and short-term investments. Capital Resources - ----------------- Total stockholders' equity increased by $3,136 from December 31, 2000 to June 30, 2001. Of that increase $1,357 was due to the change in unrealized gains and losses on securities available for sale. Net income of $3,297, offset by a $1,510 dividend to shareholders, accounted for the remainder of the increase. During the first half of 2001, 500 shares of the Company's common stock were repurchased at $16.25 per share. Branch Acquisitions - ------------------- In September of 2000 the Company's BTC affiliate announced that it would acquire a branch in Bluefield Virginia from First Union Bank. The acquisition resulted in the addition of approximately $34,000 in deposits and approximately $9,200 in loans. The acquisition was completed in March 2001. Financial Services - ------------------ On April 9, 2001 National Bankshares Financial Services Inc., a wholly-owned subsidiary began offering non-deposit investment products and insurance products for sale to the public. NBFS is working through Bankers Insurance, LLC, a joint effort of Virginia banks originally sponsored by the Virginia Bankers Association. In another cooperative effort NBFS is working with UVEST Financial Services Group, Inc to offer investment services. It is anticipated that these ventures will ultimately result in new and substantial sources of noninterest income. Given the highly competitive commercial banking market, management believes that diversity in revenue sources will be critical to the ongoing success of the Company. 20
Comprehensive Income - -------------------- Effective January 1, 2001 the Company changed its method of presentation concerning comprehensive income. Prior to 2001, comprehensive income was reflected as part of the consolidated statement of income. Comprehensive income is now presented as a separate component of the Company's consolidated statement of changes in stockholders' equity. Accounting Change - ----------------- In May 2001, the Financial Accounting Standards Board announced certain changes to the accounting rules related to business combinations. The announcement focused on two main issues. First, the pooling of interest method of accounting for mergers will be eliminated for all transactions taking place after June 30, 2001. Second, it made certain changes to the treatment of goodwill and intangible assets. It requires that other intangibles be identified as a separate asset from goodwill and defines the rules for amortization of other intangibles and non-amortization and subsequent impairment testing for goodwill. Based upon available information it is believed that the primary impact will be on future transactions. However, a secondary matter may arise when required tests for impairment of existing goodwill is performed. While it is not anticipated, management cannot rule out the possibility of a write-down of goodwill as no testing has been performed. Full implementation of this statement is required for financial statements issued after December 15, 2001. 21
Analysis of the Financial Condition and Results of Operations for the Three Months Ended June 30, 2001 - -------------------------------------------------------------------------------- Net income for the three months ended June 30, 2001 was $1,681, a decrease of $188 or 10.1% over the same period in 2000. The annualized return on average or the second quarter of 2001 was 1.04% and 1.54% for the second quarter of 2000. The annualized return on average equity for the second quarter of 2001 was 10.83%. This compares to 13.94% for the same period in 2000. Basic earnings per share for the three month ended June 30,2001 was $0.48 a decrease of $0.05 from the second quarter of 2000. Net interest income - ------------------- Net interest income for the quarter ended June 30, 2001 was $5,497 or a 9.7% increase from the same quarter in 2000. Interest rate trends, asset distribution and acquisition activities previously discussed contributed to the increase. Provision for loan losses - ------------------------- The provision for loan losses for the second quarter of 2001 was $332. This compares to $313 for the same period the prior year. Noninterest income - ------------------ Noninterest income for the second quarter of 2001 was $1,296, an increase of $334 over the period ending June 30, 2000. Service charges on deposits increased $176 or 44.1% when the quarter-ended June 30, 2001 is compared to the same period in 2000. The acquisition of seven branches was the primary cause. Credit card income also showed improvement. Debit card activity in the newly acquired branches and the introduction of the service into the BTC trade area accounted for the majority of the increase. Trust income increased by 47.2% when the two periods are compared. As previously discussed the level of estate business and certain fee schedule adjustments contributed to the improvement. Noninterest expense - ------------------- Noninterest expense for the quarter ended June 30, 2001 was $4,285. This represents an increase of $1,191 or 38.5% when compared to the quarter ended June 30, 2000. With the exception of OREO expense, all categories showed increases, which were due primarily to the branch acquisitions. 22
Balance Sheet - ------------- Total average assets for the quarter ended June 30, 2001 were $646,891, which represents an increase of $161,375 or 33.2% over total assets at June 30, 2000. A comparison of selected quarterly averages follows. ($000) June 30, 2001 June 30, 2000 ------------- ------------- Federal funds sold $ 16,934 5,400 Federal Home Loan Bank deposits 16,476 7,645 Securities available for sale 115,613 119,328 Securities held to maturity 85,938 21,384 Loans net of unearned income and fees 371,907 302,561 Noninterest-bearing deposits 66,527 55,742 Interest-bearing deposits 515,149 363,764 Borrowed money 246 10,354 The substantial growth represented above was primarily due to acquisition activities. 23
Item 3. Quantitative and Qualitative Disclosures about Market Risk Derivatives The Company is not a party to derivative financial instruments with off-balance sheet risks such as futures, forwards, swaps and options. The Company is a party to financial instruments with off-balance sheet risks such as commitments to extend credit, standby letters of credit, and recourse obligations in the normal course of business to meet the financing needs of its customers. Management does not plan any future involvement in high risk derivative products. The Company has investments in collateralized mortgage obligations, structured notes and other similar instruments that are included in securities available for sale and securities held to maturity. The fair value of these investments at June 30,2001 approximated $4,216. Interest Rate Sensitivity The Company's securities and loans and its 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 method of analysis presented in the following table has certain inherent shortcomings. For example, although 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. In addition, loan prepayments and early withdrawals of certificates of deposit could cause the interest sensitivities to vary from those which appear on the table. The classification of securities as held to maturity or available for sale also effects rate sensitivity. Available for sale securities which may be sold can be used to adjust the Company's interest rate sensitivity position. Finally, call features in the investment portfolio can have a considerable effect. Since the call decision is dependent on interest rate levels at a future point in time, the ultimate effect on interest rate sensitivity cannot be precisely determined. A substantial number of bonds in the investment portfolio contain these features. At December 31, 2000 the Company reported its cumulative interest-sensitivity gap to be ($172,742) at twelve months. At June 30, 2001 the cumulative interest-sensitivity gap declined to ($222,369) an increase of $49,627 or 28.4%. This change was the result primarily of a Branch acquisition that closed in March 2001. The cumulative gap ratio at twelve months was .46 compared to .52 at December 31, 2000. 24
National Bankshares, Inc. and Subsidiaries Part II Other Information Items 1-3. Legal Proceedings; Changes in Securities and Use of Proceeds; Defaults upon Senior Securities None for the three months ended June 30, 2001. Item 4. Submission of Matters to a Vote of Security Holders Three class 2 Directors of the company were elected by a vote of the security holders for a term of three years each. (a) This matter was submitted to a vote at the company's Annual Meeting of Stockholders held on April 10, 2001. (b) The name of each director elected at the meeting follows: Alonzo A. Crouse James G. Rakes Jeffery R. Stewart The name of each director whose term of office continued after the meeting is listed: Charles L. Boatwright L.A. Bowman James A. Deskins Sr. Paul A. Duncan Cameron L. Forrester Wiliam T. Peery (c) The number votes cast for or against each nominee is provided below. There were no abstaining votes and non-broker non-votes. Election of directors Director Votes For Votes Against -------- --------- ------------- Alonzo A. Crouse 2,704,092 35,848 James G. Rakes 2,710,758 29,182 Jeffery R. Stewart 2,714,059 25,881 Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K None 25
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: 08/09/01 /s/James G. Rakes ------------ ------------------------------------------- James G. Rakes, Chairman President and Chief Executive Officer Date: 08/09/01 /s/J. Robert Buchanan -------------- ------------------------------------------- J. Robert Buchanan, Treasurer (principal financial officer) 26