================================================================================ 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 March 31, 2002 ------------------ 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 May 1, 2002 - ----------------------------- -------------------------- Common Stock, $2.50 Par Value 3,511,377 (This report contains 22 pages) ================================================================================
NATIONAL BANKSHARES, INC. AND SUBSIDIARIES Form 10-Q Index Part I Financial Information Page - ----------------------------- Item 1 - Financial Statements - ------------------------------ Consolidated Balance Sheets, March 31, 2002 (Unaudited) 3-4 and December 31, 2001 Consolidated Statements of Income for the 5-6 Three Months Ended March 31, 2002 and 2001 (Unaudited) Consolidated Statements of Changes in 7 Stockholders' Equity, Three Months Ended March 31, 2002 and 2001 (Unaudited) Consolidated Statements of Cash Flows, 8-9 Three Months Ended March 31, 2002 and 2001 (Unaudited) Item 2 - Management's Discussion and Analysis of 14-19 Financial Condition and Results of Operations Item 3 - Quantitative and Qualitative Disclosures about 20 Market Risk Part II Other Information - ------------------------- Items 1 - 3 - Legal Proceedings; Changes in 21 Securities and Use of Proceeds; Defaults Upon Senior Securities Item 4 - Submission of Matters to a Vote of 21 Security Holders Item 5 - Other Information 21 Item 6 - Exhibits and Reports on Form 8-K 21 Signatures 22
National Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets March 31, 2002 and December 31, 2001 (Unaudited) (Audited) March 31, December 31, ($ In thousands except share 2002 2001 and per share data) ============== ================ Assets: Cash and due from banks $10,716 12,293 Interest-bearing deposits 9,768 15,510 Federal funds sold 1,820 1,080 Securities available for sale 85,425 88,667 Securities held to maturity (fair value $98,474 in 2002 and $103,234 in 2001) 98,486 102,809 Mortgage loans held for sale 707 1,145 Loans: Real estate construction loans 21,747 19,573 Real estate mortgage loans 78,490 77,339 Commercial and industrial loans 204,001 189,764 Loans to individuals 107,669 113,413 -------------- ---------------- Total loans 411,907 400,089 Less unearned income and deferred fees (1,659) (1,775) ------------- ---------------- Loans, net of unearned income and deferred fees 410,248 398,314 Less: allowance for loan losses (4,614) (4,272) ------------- ---------------- Loans, net 405,634 394,042 ------------- ---------------- Bank premises and equipment, net 10,025 10,132 Accrued interest receivable 4,992 4,917 Other real estate owned, net 224 211 Intangible assets and goodwill, net 11,628 11,866 Other assets 1,872 1,951 ------------- ---------------- Total assets $ 641,297 644,623 ============== ================ Liabilities and stockholders' equity: Noninterest-bearing demand deposits $75,224 71,751 Interest-bearing demand deposits 133,112 134,230 Savings deposits 49,974 48,827 Time deposits 312,237 321,810 -------------- ---------------- Total deposits 570,547 576,618 -------------- ---------------- Other borrowed funds 668 203 Accrued interest payable 910 1,101 Other liabilities 1,769 1,440 -------------- ---------------- Total liabilities 573,894 579,362 -------------- ---------------- 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 2002 and 3,511,377 in 2001 8,778 8,778 Retained earnings 58,021 55,917 Accumulated other comprehensive income 604 566 -------------- ---------------- Total stockholders' equity: Commitments and contingent liabilities 67,403 65,261 -------------- ---------------- Total liabilities and Stockholders' equity $ 641,297 644,623 ============== ================ See accompanying notes to the consolidated financial statements 4
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income Three Months Ended March 31, 2002 and 2001 (Unaudited) March 31, March 31, ($000's except share and per share data) 2002 2001 ================ ================ Interest income: Interest and fees on loans $ 8,059 8,232 Interest on interest-bearing deposits 45 179 Interest on federal funds sold 9 369 Interest on securities - taxable 1,403 1,987 Interest on securities - nontaxable 1,078 614 ---------------- ---------------- Total interest income 10,594 11,381 ---------------- ---------------- Interest expense Interest on time deposits $100,000 or more 920 1,200 Interest on other deposits 3,344 4,795 Interest on borrowed funds 2 3 ---------------- ---------------- Total interest expense 4,266 5,998 ---------------- ---------------- Net interest income 6,328 5,383 Provision for loan losses 646 332 ---------------- ---------------- Net interest income after provision for loan losses 5,682 5,051 ---------------- ---------------- Noninterest income: Service charges on deposit accounts 535 510 Other service charges and fees 55 72 Credit card fees 305 261 Trust income 239 278 Other income 255 100 Realized securities losses, net (20) (26) ---------------- ---------------- Total noninterest income 1,369 1,195 ---------------- ---------------- Noninterest expense: Salaries and employee benefits 2,227 1,919 Occupancy and furniture and fixtures 397 416 Data processing and ATM 284 361 FDIC assessment 11 15 Credit card processing 257 237 Intangibles and goodwill amortization 238 197 Net costs of other real estate owned 84 4 Other operating expenses 891 912 ---------------- ---------------- Total noninterest expense 4,389 4,061 ---------------- ---------------- Income before income tax expense 2,662 2,185 Income tax expense (558) (569) ----------------- ---------------- Net income $ 2,104 1,616 ================== ================ 5
Net income per share, basic and diluted $ 0.60 0.46 ================== ================ Weighted average number of common shares outstanding 3,511,377 3,511,388 Dividends declared per share $ --- --- ================== ================ See accompanying notes to consolidated financial statements. 6
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity Three Months Ended March 31, 2002 and 2001 (Unaudited) <TABLE> <CAPTION> 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, 2000 $ 8,780 51,629 (575) --- $59,834 Net income --- 1,616 --- $ 1,616 1,616 Other comprehensive income, net of tax: Unrealized gains on securities available for sale, net of income tax $729 --- --- --- 1,416 --- Reclass adjustment net of tax $9 --- --- --- 17 --- ---------------- Other comprehensive income --- --- 1,433 1,433 1,433 ----------- ------------- ---------------- ---------------- ----------- Comprehensive income --- --- --- $ 3,049 --- ----------- ------------- ---------------- ================ ----------- Stock purchase (1) (2) (6) --- --- (8) ----------- ------------- ---------------- ---------------- ----------- Balances, March 31, 2001 $ 8,778 53,239 858 --- 62,875 =========== ============= ================ ================ =========== Balances, December 31, 2001 $ 8,778 55,917 566 --- 65,261 Net income --- 2,104 --- 2,104 2,104 Other comprehensive income, net of tax Unrealized gains on securities available for sale, net of income tax $26 --- --- --- 51 --- Reclass adjustment net of income tax $7 --- --- --- (13) --- Other comprehensive income --- --- 38 38 38 ----------- ------------- ---------------- ---------------- ----------- Comprehensive income --- --- --- 2,142 --- ----------- ------------- ---------------- ---------------- ----------- Stock repurchase --- --- --- --- --- ----------- -------------- --------------- ---------------- ----------- Balances, March 31,2002 $ 8,778 58,021 604 --- 67,403 =========== ============= ================ ================ =========== </TABLE> (1) Represents the repurchase of 500 shares at $16.25 per share. See accompanying notes to consolidated financial statements. 7
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows Three Months Ended March 31, 2002 and 2001 (Unaudited) March 31, March 31, ($000's) 2002 2001 ========== ========= Cash flows from operating activities Net income $ 2,104 $ 1,616 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 646 332 Depreciation of bank premises and equipment 251 280 Amortization of intangibles 238 197 Amortization of premiums and accretion of Discount, net 122 47 Gains on sales of bank premises and equipment --- (1) Losses on sales and calls of securities Available for sale, net 20 26 Losses and writedowns on other real estate owned 70 --- (Increase) decrease in: Mortgage loans held for sale 438 (505) Accrued interest receivable (75) (94) Other assets 59 26 Increase (decrease) in: Accrued interest payable (191) (130) Other liabilities 329 328 ---------- --------- Net cash provided by operating activities 4,011 2,122 ---------- --------- Cash flows from investing activities Net (increase) decrease in federal funds sold (740) 5,677 Net (increase) decrease in interest-bearing Deposits 5,742 (13,566) Proceeds from calls and maturities of securities Available for sale 5,976 17,229 Proceeds from calls and maturities of securities Held to maturity 4,259 5,744 Purchases of securities available for sale (2,753) (3,372) Purchases of securities held to maturity --- (50,448) Purchases of loan participations (1,581) (701) Collections of loan participations 801 1,295 Purchase of loans from acquisition --- (9,255) Net increase in loans to customers (11,595) (2,998) Proceeds from disposal of other real estate owned 13 --- Recoveries on loans charged off 40 36 Purchase of bank premises and equipment (144) (593) Proceeds from disposal of bank premises and equipment --- 12 ---------- --------- Net cash (used in)provided by investing activities 18 (50,940) ---------- --------- 8
Cash flows from financing activities Deposits purchased net of premium paid --- 29,885 Net increase (decrease)deposits (9,573) 3,060 Net increase in other time deposits 3,502 17,021 Net increase(decrease)in other borrowed funds 465 (137) Repurchase of common stock --- (8) ---------- --------- Net cash (used in) provided by financing activities (5,606) 49,821 ---------- --------- Net (decrease) increase in cash and due from banks (1,577) 1,003 Cash and due from banks at beginning of period 12,293 11,130 ---------- --------- Cash and due from banks at end of period $10,716 12,133 ========== ========= Supplemental disclosure of cash flow information: Cash paid for interest $ 4,457 6,128 ========== ========= Cash paid for income taxes $ --- --- ========== ========= Loans charged to the allowance for loan losses $ 344 263 Loans transferred to other real estate owned $ 97 26 ========== ========= Unrealized gains on securities available for sale $ 58 2,171 ========== ========= See accompanying notes to consolidated financial statements. 9
National Bankshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements March 31, 2002 (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 (NBFS), (the Company), conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The accompanying interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments consisting of normal recurring adjustments which are necessary for a fair presentation of the consolidated financial statements have been included. The results of operations for the three months ended March 31, 2002 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 2001 Annual Report to Stockholders and additional information supplied in the 2001 Form 10-K. 10
Note (2) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans <TABLE> <CAPTION> For the periods ended March 31, December 31, 2002 2001 2001 ($000's, except for % data) ============== ============== ================ <S> <C> <C> <C> Balance at beginning of period $ 4,272 3,886 3,886 Provision for loan losses 646 332 1,408 Loans charged off (344) (264) (1,128) Recoveries 40 36 106 -------------- -------------- ---------------- Balance at the end of period $ 4,614 3,990 4,272 ============== ============== ================ Ratio of allowance for loan losses to the end of period loans net of unearned income and deferred fees 1.12% 1.08% 1.07% =============== ============== ================ Ratio of net charge-offs (recoveries) to average loans, net of unearned income and deferred fees(1) .31% .26% .27% =============== ============== ================ Ratio of allowance for loan losses to nonperforming loans(2) 1,243.67% 1,697.87% 1,206.78% =============== ============== ================ </TABLE> (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. <TABLE> <CAPTION> March 31, December 31, ($000's, except for % data) 2002 2001 2001 ============= ============ ================ <S> <C> <C> <C> Nonperforming Assets Nonaccrual loans $371 236 354 Restructured loans --- --- --- ------------- ------------ ---------------- Total nonperforming loans 371 236 354 Foreclosed property 224 566 211 ------------- ------------ ---------------- Total nonperforming assets $595 802 565 ============= ============ ================ Ratio of nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned .14% .22% .14% ============= ============ ================ </TABLE> 11
March 31, December 31, 2002 2001 2001 =========== =========== ============ Accruing Loans Past Due 90 Days or More Past due 90 days or more and still accruing $473 1,849 980 =========== =========== ============ Ratio of loans past due 90 days or more to loans, net of unearned income and deferred fees .12% .50% .25% =========== =========== ============ Impaired Loans Total impaired loans $437 596 340 =========== =========== ============ Impaired loans with a valuation allowance $311 242 65 Valuation allowance (122) (242) (39) ----------- ----------- ------------ Impaired loans net of allowance $189 --- 26 =========== =========== ============ Impaired loans with no valuation allowance $126 354 275 =========== =========== ============ Average recorded investment in impaired loans $389 526 671 =========== =========== ============ Income recognized on impaired loans $ 4 19 57 =========== =========== ============ Amount of income recognized on a cash basis --- --- --- =========== =========== ============ 12
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 March 31, 2002 are as follows: <TABLE> <CAPTION> March 31, 2002 Gross Gross Amortized Unrealized Unrealized Fair ($ in thousands) Costs Gains Losses Values ----------------- ----------------- ----------------- ------------------ <S> <C> <C> <C> <C> Available for sale: U.S. Treasury $ 5,247 170 --- 5,417 U.S. Government agencies and corporations 2,400 22 48 2,374 State and political subdivisions 51,696 668 279 52,085 Mortgage-backed securities 13,020 295 83 13,232 Corporate debt securities 9,062 97 127 9,032 Federal reserve bank stock 208 --- --- 208 Federal Home Loan Bank stock 1,501 --- --- 1,501 Other securities 1,376 200 --- 1,576 ----------------- ----------------- ----------------- ------------------ Total securities available for sale $84,510 1,452 537 85,425 ================= ================= ================= ================== </TABLE> The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities held to maturity by major security type as of March 31, 2002 are as follows: <TABLE> <CAPTION> March 31, 2002 Gross Gross Amortized Unrealized Unrealized Fair ($ in thousands) Costs Gains Losses Values ----------------- ----------------- ----------------- ------------------ <S> <C> <C> <C> <C> Held to Maturity: U.S. Government agencies and corporations $ 14,998 34 235 14,797 State and political subdivisions 48,369 392 329 48,432 Mortgage-backed securities 12,295 117 203 12,209 Corporate securities 22,824 380 168 23,036 ----------------- ----------------- ----------------- ------------------ Total securities held to maturity $98,486 923 935 98,474 ================= ================= ================= ================== </TABLE> 13
National Bankshares, Inc. and Subsidiaries (In 000's, except for per share data) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - ----------------------------------------------------------------------- The purpose of this discussion is to provide information about the financial condition and results of operations of National Bankshares, Inc. and its wholly-owned subsidiaries (the Company), which are not otherwise apparent from the consolidated financial statements and other information included in this report. Reference should be made to the financial statements and other information included in this report as well as the 2001 Annual Report and Form 10-K for an understanding of the following discussion and analysis. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company's actual results could differ materially from those set forth in the forward-looking statements. Critical Accounting Policies - ---------------------------- General The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. We use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ significantly from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change. Allowance for Loan Losses The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance. Our allowance for loan losses has three basic components: the formula allowance, the specific allowance and the unallocated allowance. Each of these components is determined based upon estimates that can and do change when the actual events occur. The formula allowance uses a historical loss view as an indicator of future losses and, as a result, could differ from the loss incurred in the future. However, since this history is updated with the most recent loss information, the errors that might otherwise occur are mitigated. The specific allowance uses various techniques to arrive at an estimate of loss. Historical loss information, expected cash flows and fair market value of collateral are used to estimate these losses. The use of these values in inherently subjective and our actual losses could be greater or less than the estimates. The unallocated allowance captures losses that are attributable to various economic 14
events, industry or geographic sectors whose impact on the portfolio have occurred but have yet to be recognized in either the formula or specific allowance. Core deposit intangibles In July, 2001, the Financial Accounting Standards Board issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets, which could potentially impact the accounting for goodwill and other intangible assets. Statement 141 eliminated the pooling method of accounting for business combinations and required that intangible assets that meet certain criteria be reported separately from goodwill. Statement 142 eliminated the amortization of goodwill and other intangibles that are determined to have an indefinite life. The Statement requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life. Subsequent to the effective date of SFAS 142 an apparent conflict with SFAS 72 was raised as an issue, which allows certain intangibles arising from Bank and Thrift acquisitions to be amortized over their estimated useful lives. Upon adoption of these Statements, the Company re-evaluated its intangible assets that arose from branch acquisitions prior to July 1, 2001. It was determined that the intangible assets arising from branch acquisitions will continue to be amortized over their estimated lives in accordance with SFAS 72. In the past, the Company has classified intangibles arising from branch purchases exclusively to core deposit intangibles. The Company will to continue to amortize these intangibles awaiting a decision by FASB as to the final accounting treatment of these assets. As it is unknown how this accounting issue will ultimately be resolved, the Company cannot predict what impact, if any, there will be on future earnings. Analysis of Financial Condition and Results of Operations for the Three Months Ended March 31, 2002 - ------------------------------------------------------------------------------ Net income for the three months ended March 31, 2002 was $2,104, which represents an increase of $488 or 30.2% when compared to the same period in 2001. The annualized return on average assets for the three months ended March 31, 2002 was 1.34% and 1.08% for March 31, 2001. The annualized return on average equity was 12.77% for the period ended March 31, 2002 and 10.69% for March 31, 2001. Earnings per share for the period ended March 31, 2002 was $0.60 and $0.46 in 2001 for the same period. Net Interest Income Net interest income at the end of the first quarter of 2002 was $6,328, an increase of $945 or 17.6%. Interest income decreased $787 or 6.9%, when the period ended March 31, 2002 and 2001 are compared. The yield on earning assets was 7.52%, decreasing 81 basis points from March 31, 2001. Interest expense decreased $1,732, or 28.9%, when the two periods are compared. The cost to fund earning assets for the period ended March 31, 2002 was 2.87% or a 139 basis point decrease from the same period in 2001. This resulted in a increase in the net interest margin. As seen by this data, substantially lower funding costs due to the low rate environment accounted for most of the improvement. 15
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 1.12% at March 31, 2002. This compares to 1.08% at March 31, 2001. The provision for the first three months of 2002 was $646, up $314 over the same period the prior year. While management continues to believe that over all credit quality remains good, net charge-offs are expected to be at slightly higher levels in 2002. Loan growth, which was $11,934 or 3.0% in the first quarter of 2002, also contributed to the need to enhance the allowance for loan losses. The ratio of the allowance for loan losses to loans at December 31, 2001 was 1.07%. The combined effect of loan growth and additional provisions in 2002 resulted in a nominal 5 basis point increase in this ratio which was 1.12% at March 31,2002. 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 March 31, 2002 was $1,369, an increase of $174 or 14.6%. Service charges on deposit accounts increased $25 or 4.9% increase when compared to the same period in 2001. The increase in service charges was due in part to an increased level of business activity. In addition, the acquisition of a branch in the latter part of March of 2001, while having little effect in that year had a greater impact in 2002. Other service charges and fees decreased $17 when March 31, 2002 and March 31, 2001 are compared. The majority of this decrease was due to a decline in credit life insurance commissions. Credit card fees increased $44 and 16.9%. This increase was primarily due to volume. Trust income decreased by 14.0% when compared to the first three months of 2001. Trust income is dependent on market conditions as well as the types of accounts being handled at any given point in time. The level of estate business, for example, cannot be predicted with any degree of precision. Realized securities gains/(losses) were $(20) for the first quarter of 2002. Other income for the first quarter contained some nonrecurring or infrequent items as well as two newer forms of revenues, which accounted for a $155 increase over 2001. Contributing to this increase were proceeds from a life insurance policy, which was approximately $36 and a recovery of legal fees of $14 incurred in a prior year. In addition, there was a nonrecurring adjustment to fees for approximately $48. Other income also included commissions from the sale of securities and insurance products in the amount of $82. There were no similiar commissions in the first quarter of 2001 as the Company's financial services affiliate was not formed until the second quarter of 2001. 16
Noninterest Expense Noninterest expense for the period ended March 31, 2002 was $4,389, an increase of $328 or 8.1%. The majority of the increase, as described below, was associated with acquisition activity referred to previously. Salaries and employee benefits increased by $308 or 16.1% when the periods ended March 31, 2002 and 2001 are compared. This increase was due in part to the acquisition of a branch in late March 2001. Due to the timing of the purchase the full impact of the additional expense was not experienced in 2001. Also, included in the 2002 expense is the full effect of salaries and employee benefits associated with the Company's financial services affiliate. Routine merit salary and promotional salary increases also contributed to the increase in this category. Occupancy expenses decreased $19 when the first quarter of 2002 and 2001 are compared. While occupancy expenses were pushed upward by the acquisition of a new branch, previously mentioned, efforts to restrain expenditures in this category produced a slight decrease, when the first quarter of 2001 and 2002 are compared. Data processing costs decreased $77 or 21.3%. This decline was primarily due to a reduction achieved in maintenance costs and the absence of conversion costs associated with the branch acquisition that has been discussed. Credit card processing increased $20 or 8.4% due to volume. Intangibles expense for the first quarter of 2002 was $238 compared to $197 during the same period last year. This increase was related to a branch acquisition that occurred in the latter part of March 2001. Since the transaction occurred late in the first quarter of 2001 intangibles expense was prorated. Other operating costs decreased $21 or 2.3% when the periods March 31, 2002 and 2001 are compared. Expenses for 2001 included certain start-up costs associated with the acquisition of a new branch. A loss of $41 related to check forgeries is included in the first quarter of 2002 expenses. Balance Sheet Total assets at March 31, 2002 were $641,297, a decrease of $3,326 or 0.52% from period end assets at December 31, 2001. This decline was primarily due to a decrease in higher cost time deposits. Securities Securities available for sale declined by 3.7%, while securities held to maturity decreased $4,323 or 4.2%. (Refer to the table previously presented for portfolio composition.) Funds derived from these decreases were used primarily to fund loan growth. Loans Loans net of unearned income grew by $11,934 or 3.0% from December 31, 2001. Since December 31, 2001, construction loans increased by $2,174 or 11.1% with real estate mortgage loans increasing $1,151 or 1.5%. The largest increase, 17
however was experienced in the commercial loan category which grew by $14,237 or 7.5% due to demand. The only category to show a decrease was in loans to individuals which declined by $5,744 or 5.1%. It is not known to what extent loans to individuals will ultimately decline or when growth in this area will resume given the general economic conditions. Deposits Total deposits decreased $6,071 or 1.1% when March 31, 2002 and December 31, 2001 are compared. Noninterest-bearing demand deposits increased $3,473 or 4.8% when March 31,2002 and December 31, 2001 are compared. During the same period interest-bearing demand deposits declined by 0.83%, while savings deposits were up 2.4%. The largest decrease in deposits took place in time deposits, which declined by $9,573 or 3.0%, as management has allowed higher cost time deposits to run-off. Daily Averages Daily averages for the major categories are as follows: (000's) March 31, 2002 December 31,2001 ------------------- --------------------- Loans, net $402,754 380,970 Securities available for sale 86,575 109,682 Securities held to maturity 100,951 79,127 Total assets 638,157 635,692 Total deposits 568,355 569,139 Stockholders' equity 66,838 63,460 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 $4,011. The primary sources were net income and net sales of real estate loans held for sale. Cash from investing activities was $18. As can be seen from the cash flow statement the principal use of cash was for lending activities, which were funded in the most part by maturities or calls of investments. Financing activities during the period was a user of cash, mainly due to a decline in in the area of time deposits previously noted. Management is not aware of any commitments that will result in, or are likely to result in a material and adverse decrease in liquidity. 18
Capital Resources Total stockholders' equity increased by $2,142 from December 31, 2001 to March 31, 2002. Of that increase, $38 was due to the change in unrealized gains and losses on securities available for sale. Net income of $2,104 accounted for the remainder of the increase. The Company's risk based capital ratios at March 31, 200 are as follows. Total capital 13.2% Tier I 12.2% Leverage ratio 8.8% The Company's banking affiliates continue to meet the regulatory criteria for well capitalized. 19
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 March 31, 2002 approximated $4,520. Interest Rate Sensitivity The Company considers interest rate risk to be a significant market risk and systems in place to measure the exposure of net interest income to adverse movement in interest rates. Interest rate shock analyses provides management with an indication of potential economic loss due to future rate changes. There have not been any changes, which would significantly alter the results disclosed as of December 31, 2001. 20
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 March 31, 2002. Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K None 21
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: May 13, 2002 /s/ James G. Rakes -------------- -------------------------------------------- James G. Rakes, Chairman President and Chief Executive Officer Date: May 13, 2002 /s/ J. Robert Buchanan -------------- -------------------------------------------- J. Robert Buchanan, Treasurer (principal financial officer) 22