================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 ------------------ FORM 10-Q ------------------ Quarterly Report Pursuant to Section 13 or 15(d) Of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 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 November 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, September 30, 2001 3-4 and December 31, 2000 Consolidated Statements of Income for the 5-6 Three Months Ended September 30, 2001 and 2000 Consolidated Statements of Income for the 7-8 Nine Months Ended September 30, 2001 and 2000 Consolidated Statements of Changes in 9 Stockholders' Equity, Nine Months Ended September 30, 2001 and 2000 Consolidated Statements of Cash Flows, 10-11 Nine Months Ended September 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 September 30, 2001 and December 31, 2000 (Unaudited) (Audited) September 30, December 31, ($000's except share and per share data) 2001 2000 =============== ================= Assets Cash and due from banks $12,885 11,130 Interest-bearing deposits 12,517 13,579 Federal funds sold 8,769 29,090 Securities available for sale 102,217 123,785 Securities held to maturity (fair value $88,178 in 2001 and $32,602 in 2000) 86,210 32,559 Mortgage loans held for sale 613 --- Loans: Real estate construction loans 20,405 16,726 Real estate mortgage loans 80,500 71,163 Commercial and industrial loans 179,821 163,929 Loans to individuals 115,731 110,176 ------------- --------------- Total loans 396,457 361,994 Less: unearned income and deferred fees (1,847) (2,313) ------------ --------------- Loans, net of unearned income and deferred fees 394,610 359,681 Less: allowance for loan losses (4,124) (3,886) ------------ --------------- Loans, net 390,486 355,795 ------------ --------------- Bank premises and equipment, net 10,273 10,324 Accrued interest receivable 5,379 5,049 Other real estate owned, net 1,043 540 Intangible assets 12,104 9,038 Other assets 1,714 2,608 ------------ --------------- Total assets $ 644,210 593,497 ============= =============== Liabilities and stockholders' equity Noninterest-bearing demand deposits $70,203 60,165 Interest-bearing demand deposits 120,287 101,257 Savings deposits 48,964 42,560 Time deposits 336,030 326,666 ------------- --------------- Total deposits 575,484 530,648 ------------- --------------- Other borrowed funds 470 270 Accrued interest payable 1,330 1,538 Other liabilities 1,276 1,207 ------------- --------------- Total liabilities 578,560 533,663 ------------- --------------- 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 3,511,877 in 2000 8,778 8,780 Retained earnings 55,319 51,629 Accumulated other comprehensive income(loss) 1,553 (575) ------------ -------------- Total stockholders' equity 65,650 59,834 Commitments and contingent liabilities ------------- -------------- Total liabilities and Stockholders' equity $ 644,210 593,497 ============= ============== See accompanying notes to the consolidated financial statements 4
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income Three Months Ended September 30, 2001 and 2000 (Unaudited) September 30, September 30, ($000's except share and per share data) 2001 2000 ============== ============= Interest income Interest and fees on loans $ 8,507 7,160 Interest on interest-bearing deposits 66 194 Interest on federal funds sold 100 2 Interest on securities - taxable 1,888 1,666 Interest on securities - nontaxable 885 564 -------------- ------------- Total interest income 11,446 9,586 -------------- ------------- Interest expense Interest on time deposits $100,000 or more 1,139 899 Interest on other deposits 4,553 3,471 Interest on borrowed funds 3 180 -------------- ------------- Total interest expense 5,695 4,550 ------------- ------------- Net interest income 5,751 5,036 Provision for loan losses 377 331 -------------- ------------- Net interest income after provision for loan losses 5,374 4,705 ------------- ------------- Noninterest income Service charges on deposit accounts 554 423 Other service charges and fees 69 64 Credit card fees 321 256 Trust income 284 206 Other income 84 22 Realized securities losses, net --- 5 -------------- ------------- Total noninterest income 1,312 976 -------------- ------------- Noninterest expense Salaries and employee benefits 2,040 1,548 Occupancy and furniture and fixtures 437 317 Data processing and ATM 305 241 FDIC assessment 27 32 Credit card processing 255 369 Intangibles and goodwill amortization 239 38 Net costs of other real estate owned 32 33 ------------- ------------- Total noninterest expense 4,176 3,291 -------------- ------------- Income before income tax expense 2,510 2,390 Income tax expense (600) (639) -------------- ------------- Net income $ 1,910 1,751 ============== ============= Net income per share, basic and diluted $ 0.54 0.50 ============== ============= 5
Weighted average number of common shares outstanding 3,511,377 3,512,615 Dividends declared per share $ --- --- ============== ============= See accompanying notes to consolidated financial statements. 6
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Income Nine Months Ended September 30, 2001 and 2000 (Unaudited) September 30, September 30, ($000's except share and per share data) 2001 2000 ================ ================ Interest income Interest and fees on loans $25,110 20,545 Interest on interest-bearing deposits 475 369 Interest on federal funds sold 606 128 Interest on securities - taxable 5,955 5,004 Interest on securities - nontaxable 2,363 1,670 ---------------- ---------------- Total interest income 34,509 27,716 ---------------- ---------------- Interest expense Interest on time deposits $100,000 or more 3,562 2,351 Interest on other deposits 14,309 9,834 Interest on borrowed funds 7 525 ---------------- ---------------- Total interest expense 17,878 12,710 ---------------- ---------------- Net interest income 16,631 15,006 Provision for loan losses 1,041 997 ---------------- ---------------- Net interest income after provision for loan losses 15,590 14,009 ---------------- ---------------- Noninterest income Service charges on deposit accounts 1,639 1,184 Other service charges and fees 214 201 Credit card fees 917 760 Trust income 849 611 Other income 210 102 Realized securities losses, net (26) 5 ---------------- ---------------- Total noninterest income 3,803 2,863 ---------------- ---------------- Noninterest expense Salaries and employee benefits 6,006 4,662 Occupancy and furniture and fixtures 1,280 938 Data processing and ATM 1,014 705 FDIC assessment 73 74 Credit card processing 757 805 Intangible assets and goodwill amortization 674 114 Net costs of other real estate owned 52 59 Other operating expenses 2,666 2,019 ---------------- ---------------- Total noninterest expense 12,522 9,376 ---------------- ---------------- Income before income tax expense 6,871 7,496 Income tax expense (1,664) (2,024) ---------------- ---------------- Net income $ 5,207 5,472 ================ ================ Net income per share, basic and diluted $ 1.48 1.56 ================ ================ 7
Weighted average number of common shares outstanding 3,511,381 3,515,337 Dividends declared per share $ 0.43 0.42 ================ ================ See accompanying notes to consolidated financial statements. 8
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity Nine Months Ended September 30, 2001 and 2000 (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, 1999 $ 8,792 47,384 (3,453) --- 52,723 Net income --- 5,472 --- 5,472 5,472 Dividend ($0.42 per share) --- (1,477) --- --- (1,477) Dividend ($0.42 per share) (1,477) Other comprehensive income, net of tax: Unrealized gains on securities Available for sale, net of income tax expense $481 --- --- 933 933 933 ----------- ------------- ---------------- ---------------- ------------ Comprehensive income --- --- --- 6,405 --- ----------- ------------- ---------------- ---------------- ------------ Stock repurchase (12) (70) --- --- (82) ----------- ------------- ----------------- --------------- ------------ Balances, September 30, 2000 $ 8,780 51,309 (2,520) --- 57,569 =========== ============= ================= =============== ============ Balances, December 31, 2000 $ 8,780 51,629 (575) --- 59,834 Net income --- 5,207 --- 5,207 5,207 Dividend ($0.43 per share) --- (1,511) --- --- (1,511) Other comprehensive income, Unrealized gains on securities available for sale, net of income tax expense $9 --- --- 2,111 2,111 2,111 Re-class adjustment net of --- --- 17 17 17 ----------- ------------- ---------------- ---------------- ----------- Other comprehensive income --- --- --- 2,128 --- ----------- ------------- ---------------- ---------------- ----------- Comprehensive income --- --- --- 7,335 --- ----------- ------------- ---------------- ---------------- ----------- Stock repurchase (1) (2) (6) --- --- (8) ----------- -------------- --------------- ---------------- ------------ Balances, September 30,2001 $ 8,778 55,319 1,553 --- 65,650 =========== ============= ================ ================ =========== </TABLE> (1) Represents the repurchase of 500 shares at $16.25 per share. See accompanying notes to consolidated financial statements. 9
National Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows Nine Months Ended September 30, 2001 and 2000 (Unaudited) <TABLE> <CAPTION> September 30, September 30, ($000's) 2001 2000 ================= ================ <S> <C> <C> Cash flows from operating activities Net income $ 5,207 5,472 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,041 997 Depreciation of bank premises and equipment 841 750 Amortization of intangibles 674 114 Amortization of premiums and accretion of Discount, net 265 107 Gains on sales of bank premises and equipment (1) (6) Losses on sales and calls of securities Available for sale, net 26 4 Gains on calls of securities Held to maturity, net --- (9) Losses on other real estate owned 4 22 (Increase) decrease in: Mortgage loans held for sale (613) 107 Accrued interest receivable (330) (289) Other assets (194) (379) Increase (decrease) in: Accrued interest payable (208) 110 Other liabilities 69 (16) ---------------- ----------------- Net cash provided by operating activities 6,781 6,984 ---------------- ---------------- Cash flows from investing activities Net decrease in federal funds sold 20,321 2,700 Net (increase) decrease in interest-bearing Deposits 1,062 (8,784) Proceeds from calls and maturities of securities Available for sale 39,244 5,970 Proceeds from sales of securities available for Sale --- 751 Proceeds from calls and maturities of securities Held to maturity 12,736 2,498 Purchases of securities available for sale (14,609) (11,754) Purchases of securities held to maturity (66,521) --- Purchases of loan participations (3,401) (1,528) Collections of loan participations 3,099 620 Purchase of loans from acquisition (9,255) --- Net increase in loans to customers (27,044) (21,276) Proceeds from disposal of other real estate owned 273 252 Recoveries on loans charged off 89 (79) Purchase of bank premises and equipment (804) (638) Proceeds from disposal of bank premises and equipment 15 10 ---------------- ---------------- Net cash used in investing activities (44,795) (31,258) ------------------ ---------------- 10
Cash flows from financing activities Deposits purchased net of premium paid 29,885 --- Net increase (decrease) in time deposits (10,593) 29,320 Net increase (decrease)in other deposits 21,796 (7,235) Net increase (decrease) in other borrowed funds 200 (262) Dividends paid on common stock (1,511) (1,477) Repurchase of common stock (8) (82) ---------------- ------------------ Net cash provided by financing activities 39,769 20,264 ---------------- ----------------- Net increase (decrease) in cash and due from banks 1,755 (4,010) Cash and due from banks at beginning of period 11,130 13,311 ---------------- ------------------ Cash and due from banks at end of period $12,885 9,301 ================ ================== Supplemental disclosure of cash flow information Cash paid for interest $ 18,086 12,600 ================ ================== Cash paid for income taxes $ 1,713 2,395 ================ ================== Loans charged to the allowance for loan losses $ 892 575 ================ ================== Loans transferred to other real estate owned $ 780 294 ================ ================== Long-term debt $ --- 10,000 ================ ================== </TABLE> See accompanying notes to consolidated financial statements. 11
National Bankshares, Inc. and Subsidiaries Notes to Consolidated Financial Statements September 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 (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 nine months ended September 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 September 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 1,041 997 1,329 Loans charged off (892) (575) (770) Recoveries 89 79 96 ----------- ------------- ------------- Balance at the end of period $ 4,124 3,732 3,886 =========== ============== ============= Ratio of allowance for loan losses to the end of period loans net of unearned income and deferred fees 1.05% 1.18% 1.08% ============ ============== ============= Ratio of net charge-offs (recoveries) to average loans, net of unearned income and deferred fees(1) .29% .22% .21% ============ ============== ============= Ratio of allowance for loan losses to nonperforming loans(2) 930.93% 1,719.82% 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. September 30,2001 December 31, 2001 2000 2000 ============= ============ ================ ($000's, except for % data) Nonperforming Assets Nonaccrual loans $443 217 88 Restructured loans --- --- --- ------------- ------------ ---------------- Total nonperforming loans 443 217 88 Foreclosed property 1,043 467 540 ------------- ------------ ---------------- Total nonperforming assets $1,486 684 628 ============= ============ ================ Ratio of nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned .38% .22% .17% ============= ============ ================ 13
September 30, December 31, 2001 2000 2000 ============= ============ ================ Accruing Loans Past Due 90 Days or More Past due 90 days or more and still accruing $620 465 1,321 ============= ============ ================ Ratio of loans past due 90 days or more to loans, net of unearned income and deferred fees .16% .15% .37% ============= ============ ================ Impaired Loans Total impaired loans $811 603 456 ============= ============ ================ Impaired loans with a valuation allowance $191 267 135 Valuation allowance (114) (230) (135) ------------- ------------- ---------------- Impaired loans net of allowance $ 77 37 --- ============= ============ ================ Impaired loans with no valuation allowance $620 336 321 ============= ============ ================ Average recorded investment in impaired loans $646 543 657 ============= ============ ================ Income recognized on impaired loans $ 31 31 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 September 30, 2001 are as follows: <TABLE> <CAPTION> September 30, 2001 Gross Gross Amortized Unrealized Unrealized Fair ($ in thousands) Costs Gains Losses Values ----------------- ----------------- ----------------- ------------------ <S> <C> <C> <C> <C> Available for sale: U.S. Treasury $ 6,247 305 --- 6,552 U.S. Government agencies and corporations 23,230 136 --- 23,366 State and political subdivisions 44,147 1,285 20 45,412 Mortgage-backed securities 11,884 328 9 12,203 Corporate debt securities 11,539 225 51 11,713 Federal Reserve Bank stock 209 --- --- 209 Federal Home Loan Bank stock 1,411 --- --- 1,411 Other securities 1,196 155 --- 1,351 ----------------- ----------------- ----------------- ------------------ Total securities available for sale $ 99,863 2,434 80 102,217 ================= ================= ================= ================== </TABLE> The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities held to maturity by major security type as of September 30, 2001 are as follows: <TABLE> <CAPTION> September 30, 2001 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 $17,494 124 7 17,611 State and political subdivisions 38,150 933 30 39,053 Mortgage-backed securities 7,733 150 --- 7,883 Corporate securities 22,833 846 48 23,631 ----------------- ----------------- ----------------- ------------------ Total securities held to maturity $86,210 2,053 85 88,178 ================= ================= ================= ================== </TABLE> 15
Note (4) Restrictions on Dividend Payments and Capital Requirements Bankshares' and its subsidiaries' actual regulatory capital amounts and ratios are also presented in the following tables: <TABLE> <CAPTION> To Be Well Capitalized Under For Capital Prompt Corrective Adequacy Purposes Action Provisions ($ in thousands) Amount Ratio Amount Ratio Amount Ratio ------------ ------------ ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> <C> <C> September 30, 2001: Total capital(1) Bankshares Consolidated $56,252 12.7% 35,406 8.0% N/A N/A NBB 30,869 12.1% 20,388 8.0% 25,485 10.0% BTC 22,066 11.9% 14,833 8.0% 18,541 10.0% Tier I capital(1) Bankshares Consolidated $52,129 11.8% 17,703 4.0% N/A N/A NBB 28,347 11.1% 10,194 4.0% 15,291 6.0% BTC 20,465 11.0% 7,416 4.0% 11,124 6.0% Tier I capital(2) Bankshares Consolidated $52,129 8.3% 25,278 4.0% N/A N/A NBB 28,347 8.2% 13,775 4.0% 17,219 5.0% BTC 20,465 7.3% 11,257 4.0% 14,072 5.0% </TABLE> (1) To Risk Weighted Assets (2) To Average Assets 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 September 30, 2001, retained net income from the Company's NBB affiliate which was free of such restriction amounted to approximately $3,539. 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, as dividends have been paid to NBI in the past. 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 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. Earnings for the nine months ended September 30, 2001 may not be indicative of annualized earnings for 2001. 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 Nine Months Ended September 30, 2001 Net income for the nine months ended September 30 2001 was $5,207, which represents a decline of $265 or 4.8% when compared to the same period in 2000. The annualized return on average assets for the nine months ended September 30, 2001 was 1.10% and 1.51% for September 30, 2000. The annualized return on average equity was 11.13% for the period ended September 30, 2001 and 13.33% for September 30, 2000. Earnings per share for the period ended September 30, 2001 was $1.48 and $1.56 in 2000 for the same period. Net Interest Income Net interest income at the end of the third quarter of 2001 was $16,631, an increase of $1,625 or 10.8%. Interest income increased $6,793, or 24.5%, when the period ended September 30, 2001 and 2000 are compared. Interest expense increased $5,168, or 40.7%, when the two periods are compared. The yield on earning assets was 8.02%, decreasing 33 basis points from September 30, 2000. The cost to fund earning assets for the period ended September 30, 2001 was 4.00% or a 30 basis point increase from the same period in 2000. The underlying cause of these results was 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 September 30, 2000 to September 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. (For additional comments see the quarterly discussion.) While the short-term effects of the merger activities are deemed to be slightly negative initially, 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 1.05% at September 30, 2001 which, compares to 1.18% at September 30, 2000. The provision for the first nine months of 2001 was $1,041 up $44 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 September 30, 2001 was $3,803, an increase of $940 or 32.8%. All categories except realized gains/losses on securities experienced increases when the period ended September 30, 2001 and September 30, 2000 are compared. Service charges on deposit accounts increased $455, accounting for 48.4% of the total increase in noninterest income. This increase 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. Credit card fees increased $157 and 20.7%. This increase was in part due to debit card income, which improved due to acquisition activity and the introduction of the debit card service at BTC. Trust income increased by 38.9% when compared to the first nine 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 September 30, 2001. Included is the write-down of the Company's portion of two limited liability companies established for the sale of title insurance and insurance services. Noninterest Expense Noninterest expense for the period ended September 30, 2001 was $12,522, an increase of $3,146 or 33.6%. The majority of the increase as described below was associated with acquisition activity. Salaries and employee benefits increased by $1,344 or 28.8% when the periods ended September 30, 2001 and 2000 are compared. This increase was largely due to the acquisition of six branches in mid-November 2000 and a seventh branch acquired in March of 2001. Routine merit increases also contributed to the increase. 18
Occupancy expenses increased $342 when the third quarter of 2001 and 2000 are compared. The 36.5% increase was largely attributable to the branch acquisitions referred to above, which increased, depreciation expense, real estate taxes, insurance and other fixed asset costs. Data processing costs increased $309 or 43.8%. Maintenance costs, particularly on ATM's, increased as a result of the branch acquisitions. Credit card processing expense decreased $48 or 6.0%. This decline was due to a combination of a $156 nonrecurring loss experienced in 2000 and increased volume in 2001. Intangibles and goodwill amortization increased $560 or 491.0% as a result of the previously mentioned acquisition activity. Other operating costs increased $647 or 32.0% when the periods September 30, 2001 and 2000 are compared. The majority of these increases were caused by acquisition activities, which increased expenses such as stationery and supplies, telephone and courier services. Balance Sheet Total assets at September 30, 2001 were $644,210, an increase of $50,713 or 8.5% over period end assets at December 31, 2000. Deposits purchased in a branch acquisition accounted for approximately $34,000 of the increase of $44,836, the remainder was due to aggressive deposit marketing activities. Securities While securities available for sale declined by 17.4%, securities held to maturity increased $53,651 or 164.8%. This represents an investment of funds generated by the acquisition activity previously mentioned. A greater emphasis was placed on the held to maturity portfolio to moderate the fluctuations in unrealized gains and losses that generally accompany securities classified as available for sale Loans Loans net of unearned income grew by $34,929 or 9.7%. Loans purchased in a branch acquisition accounted for the majority of the increase. Fixed Assets The Company's investment in fixed assets decreased $51 when September 30, 2001 and December 31, 2000 are compared. The net decrease included the addition of fixed assets associated with a first quarter branch acquisition less depreciation expense. 19
Deposits Total deposits increased $44,836 or 8.4% when September 30, 2001 and December 21, 2000 are compared. Branch acquisition accounted for the majority of this increase. Noninterest bearing deposits grew by 16.7% with interest bearing demand deposits growing by 18.8%. Saving deposits increased by 15.0% and time deposits grew by 2.9%. Daily Averages Daily averages for the major categories are as follows: (000's) September 30, 2001 September 30, 2000 =================== ================== Federal funds sold $16,793 3,422 FHLB deposits 13,394 7,953 Loans, net 375,538 301,836 Securities available for sale 114,789 118,378 Securities held to maturity 75,742 22,197 Total assets 633,032 482,966 Noninterest-bearing deposits 65,534 55,178 Interest-bearing deposits 501,982 360,862 Stockholders' equity 62,546 54,679 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 $6,781 primarily due to earnings. Cash used in investing activities totaled $44,795. Primary uses were purchases of securities held to maturity, loans purchased and interest-bearing deposits. Capital Resources Total stockholders' equity increased by $5,816 from December 31, 2000 to September 30, 2001. Of that increase $2,128 was due to the change in unrealized gains and losses on securities available for sale. Net income of $5,207, offset by a dividend to shareholders of $1,511 accounted for the remainder of the increase. During the first nine months of 2001, 500 shares of the Company's common stock were repurchased at $16.25 per share. 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 with 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. 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 20
resulted in the addition of approximately $34,000 in deposits and approximately $9,200 in loans. The acquisition was completed in March 2001. 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. Recent Accounting Pronouncements In July, 2001, the Financial Accounting Standards Board issued two statements - Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets, which will potentially impact the accounting for goodwill and other intangible assets. Statement 141 eliminates the pooling method of accounting for business combinations and requires that intangible assets that meet certain criteria be reported separately from goodwill. The Statement also requires negative goodwill arising from a business combination to be recorded as an extraordinary gain. Statement 142 eliminates 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. Upon adoption of these Statements, an organization is required to re-evaluate goodwill and other intangible assets that arose from business combinations entered into before July 1, 2001. If the recorded other intangibles assets do not meet the criteria for recognition, they should be classified as goodwill. Similarly, if there are other intangible assets that meet the criteria for recognition but were not separately recorded from goodwill, they should be reclassified as goodwill. An organization also must reassess the useful lives of intangible assets and adjust the remaining amortization periods accordingly. Any negative goodwill must be written-off. The Company has not yet completed its full assessment of the effects of these new pronouncements on its financial statements and so is uncertain as to the impact. The standards generally are required to be implemented by the Company in its 2002 financial statements. 21
Analysis of the Financial Condition and Results of Operations for the Three Months Ended September 30, 2001 Net income for the three months ended September 30, 2001 was $1,910, an increase of $159 or 9.1% over the same period in 2000. The annualized return on average assets or the third quarter of 2001 was 1.18% as compared to the third quarter of 2000. The annualized return on average equity for the third quarter of 2001 was 11.84%. This compares to 12.42% for the same period in 2000. Basic earnings per share for the three months ended September 30,2001 was $0.54, an increase of $0.04 over the third quarter of 2000. Net interest income Net interest income for the quarter ended September 30, 2001 was $5,751 or a 14.2% increase over the same quarter in 2000. During the first half of 2001 and continuing into the third quarter interest rates declined sharply. In the third quarter of 2001 total interest expense was $5,695 down $490 or 7.9% from the second quarter of 2001. At the same time total interest income declined by $236 or 2.0%. The net effect was to increase net interest income for the quarter by $254. Management expects that net interest income will show more improvement, provided that recent trends continue. Provision for loan losses The provision for loan losses for the third quarter of 2001 was $377. This compares to $331 for the same period the prior year. During the third quarter of 2001 the Company made a provision to the allowance for loan losses in the amount of $377, up $45 from the second quarter. This increase was due primarily to loan growth and the need to maintain an adequate allowance. Noninterest income Noninterest income for the third quarter of 2001 was $1,312,an increase of $336 over the period ending September 30, 2000. This increase was due in part to acquisition activity, expansion of debit card services and general increase in volume. Noninterest expense Noninterest expense for the quarter ended September 30, 2001 was $4,176. This represents an increase of $885 or 26.9% when compared to the quarter ended September 30, 2000. Salaries and employee benefits were up $492, primarily due to acquisition activity, as was occupancy expense, which increased $120. Credit card expense was down $114. As previously discussed, the Company experienced a one time loss in the third quarter of 2000 which inflated expense for that period. Intangibles amortization expense was up $201, and the increase was directly attributable to acquisition activity. Other expense was up $128 over the third quarter of 2000. Acquisition activity was the primary cause of the increase. 22
Balance Sheet Total assets at September 30, 2001 were $644,210, which represents an increase of $145,313 or 29.1% over total assets at September 30, 2000. A comparison of selected quarterly average balance sheet categories follow. <TABLE> <CAPTION> ($000) September 30, 2001 September 30, 2000 Percent change ------------------ ------------------ -------------- <S> <C> <C> <C> Federal funds sold $ 9,234 103 8,865.0 % Federal Home Loan Bank deposits 11,555 12,817 9.8 % Securities available for sale 109,332 120,247 (9.1)% Securities held to maturity 88,583 21,287 317.4 % Loans net of unearned income and fees 387,997 313,196 23.9 % Noninterest-bearing deposits 69,489 56,556 22.9 % Interest-bearing deposits 507,744 367,228 38.3 % Borrowed money 276 10,174 (97.3)% Stockholders' equity 63,995 56,390 13.5 % </TABLE> 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 September 30,2001 approximated $4,222. 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 affects 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 September 30, 2001 the cumulative interest-sensitivity gap declined to ($213,482). This change was the result primarily of a Branch acquisition that closed in March 2001 and changes in the investment portfolio. The Company, however, remains liability sensitive to a large degree, which may prove to be advantageous in the current falling rate environment, but could have a negative impact should interest rates rise. 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 September 30, 2001. Item 4. Submission of Matters to a Vote of Security Holders None for the three months ended September 30, 2001 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: 11/13/01 /s/James G. Rakes ------------ -------------------------------------------- James G. Rakes, Chairman President and Chief Executive Officer Date: 11/13/01 /s/J. Robert Buchanan -------------- -------------------------------------------- J. Robert Buchanan, Treasurer (principal financial officer) 26