U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark One)
X Annual Report under Section 13 or 15(d) of the Securities Exchange Act
- ----- 1934 (Fee required). For the fiscal year ended December 31, 1998.
or
_____ Transition Report under Section 13 or 15(d) of the Securities Exchange
Act of 1934 (No fee required)
For the transition period from _____ to _____
Commission file No. _0-28780_
Cardinal Bankshares Corporation
(Name of small business issuer in its charter)
Virginia 54-1804471
(State or other jurisdiction (IRS Employer
of incorporation or organization Identification No.)
101 Jacksonville Circle, Floyd, Virginia 24091
(Address of principal executive offices)
(540) 745-4191
Issuer's telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $10.00 per share
----------------------------------------
Title of Class
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for past 90 days.
Yes X No_____
-----
Check if there is no disclosure of delinquent filers in response to
Item 405 of regulation S-B is not contained in this form, and no disclosure
will be contained, to the best of registrant's knowledge, in definitive proxy
or information statements incorporated by reference in Part III of the Form
10-KSB or any amendment to this Form 10-KSB. [X]
The issuer's revenues for its most recent fiscal year were $11,758,000
The aggregate market value of the voting stock as of March 15, 1998, held
by non-affiliates of the registrant computed by reference to the price at which
the stock was sold, or the average bid and asked prices of such stock, as of a
specified date within the last 60 days was $22,465,000.
511,911 shares of the Issuer's common stock were issued and outstanding as
of March 15, 1999.
Transitional Small Business Disclosure Format. (Check one):
Yes_____ No X
-----
DOCUMENTS INCORPORATED BY REFERENCE
The annual report to security holders for fiscal year ended December 31, 1998 is
incorporated by reference into Form 10-KSB Part II, Items 7 and 8, and Part III,
Item 13. The issuer's Proxy Statement dated March 24, 1999 is incorporated by
reference into Form 10-KSB Part III, Items 9, 10, 11, and 12.
<PAGE>
PART I
ITEM 1. DESCRIPTION OF BUSINESS
- --------------------------------
(A) BUSINESS DEVELOPMENT
Cardinal Bankshares Corporation (the Company) was incorporated as a Virginia
corporation on March 12, 1996 to acquire the stock of The Bank of Floyd (the
Bank). The Bank was acquired by the Company on June 30, 1996.
The Bank was organized as a state chartered bank on February 24, 1951
through the consummation of a plan of consolidation between two state
chartered community banks then operating in Floyd County, Virginia.
The Bank and its wholly-owned subsidiary, FBC, Inc., are incorporated and
operate under the laws of the Commonwealth of Virginia. As a state chartered
Federal Reserve member, the Bank is subject to regulation by the Virginia
Bureau of Financial Institutions and the Federal Reserve. FBC, Inc.'s assets
and operations consist primarily of a minority interest in a title insurance
company.
(B) DESCRIPTION OF THE BUSINESS
The principal business of the Company and Bank is to provide comprehensive
individual and corporate banking services through its main office in Floyd,
Virginia, and its branch in Hillsville, Roanoke and Willis, Virginia.
Effective April 6, 1994, the Bank acquired a 7-1/2% interest in Virginia
Title Center, LLC (a title insurance company) through its acquisition by
FBC, Inc. (a wholly owned subsidiary of the Bank). FBC, Inc. has no
significant assets or operations other than its interest in Virginia Title
Center, LLC.
(1) SERVICES
The Bank is a full service retail commercial bank offering a wide range of
services, including demand and time deposits as well as installment,
mortgage and other consumer lending services. The Bank makes seasonal and
term commercial loans, both alone and in conjunction with other banks or
governmental agencies.
(2) COMPETITIVE CONDITIONS
The banking business is highly competitive. The Company competes as a
financial intermediary with other commercial banks, savings and loan
associations, credit unions and money market mutual funds operating in its
trade area and elsewhere. As of December 31, 1998, there were two commercial
banks (one of which is the Bank) operating a total of three offices in Floyd
County, Virginia. The competing institution is not locally owned.
Floyd County generates approximately 70% of the Bank's total deposits. In
the other parts of the Bank's trade area (the Virginia Counties of Roanoke
and Montgomery and the City of Roanoke, Virginia), there are a number of
locally owned community banks, statewide banking organizations, and
affiliate banks of southeast regional bank holding companies in operation.
(3) MATERIAL CUSTOMERS
Deposits are derived from a broad base of customers in its trade area. No
material portion of deposits have been obtained from a single person or a
few persons (including Federal, State, and local governments and agencies
thereunder), the loss of which would have a materially adverse effect on the
business of the Bank.
The majority of loans, commitments to extend credit, and standby letters of
credit have been granted to customers in the Company's market area. The
majority of such customers are depositors. The Company generally does not
extend credit to any single borrower or group of related borrowers in excess
of approximately $1,750,000. Although the Company has a reasonably
diversified loan portfolio, it has a loan concentration relating to
customers who are motel and bed-and-breakfast owners and operators. Total
loans and loan commitments to this industrial group amounted to
approximately $8,900,000 and $6,400,000 at December 31, 1998 and 1997,
respectively.
<PAGE>
(B) DESCRIPTION OF BUSINESS, CONTINUED
(4) RIGHTS
No patents, trademarks, licenses, franchises or concessions held are of
material significance to the Company.
(5) NEW SERVICES
The Company has expended no material dollars on research activities relating
to new lines of business in the last two years and has not announced any new
line of business which will require an investment of material assets.
(6) ENVIRONMENTAL LAWS
Compliance with Federal, State, or Local provisions regulating the discharge
of materials into the environment has not had, nor is it expected to have in
the future, a material effect upon the Company's capital expenditures,
earnings or competitive position.
(7) EMPLOYEES
The Bank had 20 officers, 32 full-time employees and seven part-time
employees as of December 31, 1998. Employee relations have been good.
ITEM 2. DESCRIPTION OF PROPERTY
- --------------------------------
The present headquarters of the Company consists of a three-story brick
building, with approximately 21,200 square feet of floor space located at
101 Jacksonville Circle, Floyd, Virginia. The Bank also operates branch
offices in Hillsville and Roanoke, Virginia. All facilities are owned by the
Bank and each has drive-up facilities. The Bank's Willis, Virginia office
operates from a leased facility.
The Bank also owns a three-story brick building adjacent to its main office
which serves primarily as community meeting rooms and off-site data backup
storage.
<PAGE>
ITEM 3. LEGAL PROCEEDINGS
- --------------------------
Neither the Company nor the Bank or its subsidiary are a party to, nor is
any of their property the subject of, any material pending legal proceedings
incidental to the business of the Company or the Bank or its subsidiary.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
- -----------------------------------------------------------
No matter was submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- -----------------------------------------------------------------
(A) Beginning in 1997, the Company's stock was listed on the NASDAQ Bulletin
Board under the symbol CDBK. Prior to 1997, no active public market existed for
the common stock of the Bank. Transfers of the common stock occurred from time
to time, but management had no direct access to the prices realized in those
trades. Based on information available to the Bank concerning such trading, the
following table shows the trading ranges of the Common Stock for the previous
five years. The table has been adjusted for the effects of a four for one stock
split in 1995 and a 10% stock dividend in 1997.
Year High Low
---- ------ ------
1998 $57.00 $48.25
1997 $47.00 $44.00
1996 $44.00 $35.45
1995 $35.45 $21.59
1994 $21.59 $20.45
(B) The approximate number of holders of the Bank's 511,911 Common Stock
Securities as of December 31, 1998, is 721.
(C) Dividends paid for 1998 were $1.06 and 1997 were $1.00 per share
(adjusted for the effects of a four for one stock split in 1995 and a
10% stock dividend in 1997) owned. The Company's ability to declare and
pay dividends in the future will be dependent upon its consolidated
income and fiscal condition, tax considerations, and general business
condition. Subject to these considerations, dividends may be declared
only in the discretion of the Board of Directors. The Company presently
expects that dividends will continue to be paid in the future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------
The information required under this item is incorporated by reference to the
Company's Annual Report to Stockholders, Exhibit 13.1, pages 24-42 and
inside front cover.
ITEM 7. FINANCIAL STATEMENTS
- -----------------------------
The following consolidated financial statements of the registrant and the
independent Auditor's Report set forth on pages 2 through 23 of the
Company's 1998 Annual Report to Stockholders are incorporated herein by
reference:
(1) Independent Auditor's Report
(2) Consolidated Balance Sheets as of December 31, 1998 and 1997
(3) Consolidated Statements of Income for the years ended December 31,
1998, 1997, and 1996
(4) Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997, and 1996
(5) Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997, and 1996
(6) Notes to Consolidated Financial Statements
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
--------------------
NONE
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS:
- ----------------------------------------------------------------------
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
-------------------------------------------------
The Executive Officer of the Company as of December 31, 1998 is listed on
page 3 of the Company's Proxy statement dated March 24, 1999 and is
incorporated herein by reference. Information with respect to the directors
of the Company is set out under the caption "Election of Directors" on page
2 of The Company's Proxy statement dated March 24, 1999, which information
is incorporated herein by reference.
The disclosure required by item 405 of regulation S-K is set out under the
caption "Beneficial Ownership Reporting Compliance" section 16(a) on page 5
of the Company's Proxy Statement dated March 24, 1999, which information is
incorporated by reference.
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
- --------------------------------
The information set forth under "Executive Compensation" and "Directors
Meetings, Committees and Fees" on page 4 of the Company's Proxy Statement
dated March 24, 1999 is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
The information set forth under "Ownership of Common Stock" on pages 3, 4
and 5 of the Company's Proxy Statement dated March 24, 1999 is incorporated
herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
The information contained under "Certain Transactions" on page 5 of the
Company's Proxy Statement dated March 24, 1999 is incorporated herein by
reference.
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
- ------------------------------------------
(a) The following documents are filed as part of the report:
1998 Annual Report
To Stockholders Pages(s)*
-------------------------
1. Financial Statements:
--------------------
Independent Auditors' Report 2
Consolidated Balance Sheets
December 31, 1998 and 1997 3
Consolidated Statements of Income
Years ended December 31, 1998,
1997, and 1996 4
Consolidated Statements of Stock-
holders' Equity-Years ended
December 31, 1998, 1997, and 1996 5
Consolidated Statements of Cash
Flows-Years ended December 31,
1998, 1997, and 1996 6
Notes to Consolidated Financial
Statements 7 - 23
* Incorporated by reference from the indicated pages of the 1998 Annual Report
to Stockholders
<PAGE>
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K, CONTINUED
- -----------------------------------------------------
2. Financial Statement Schedules:
-----------------------------
All schedules are omitted as the
required information is inapplicable
or the information is presented in
the Consolidated Financial Statements
or related notes.
3. Exhibits
--------
The exhibits filed as part of this
report and exhibits incorporated
herein by reference to other
documents are listed in the Index
to Exhibits to this Annual Report
on Form 10-KSB.
REPORTS ON FORM 8-K
-------------------
None.
EXHIBITS
--------
See Item 13(a)3 above.
FINANCIAL STATEMENT SCHEDULES
-----------------------------
See Item 13(a)2 above.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CARDINAL BANKSHARES CORPORATION
Date: March 22, 1999 By: /s/ Ronald Leon Moore
--------------------
Ronald Leon Moore
President and CEO
In accordance with the Exchange Act, this report has to be signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
Signature Title Date
--------- ----- ----
Director, President and
Chief Executive Officer
(principal financial and
/s/ Ronald Leon Moore accounting officer). 3/22/99
- ---------------------
Ronald Leon Moore
/s/ K. Venson Bolt Director 3/22/99
- ------------------
K. Venson Bolt
/s/ J. H. Conduff Director 3/22/99
- -----------------
J. H. Conduff
/s/ W. R. Gardner, Director 3/22/99
- ----------------------
W. R. Gardner, Jr.
/s/ C. W. Harman Director 3/22/99
- ----------------
C. W. Harman
/s/ Kevin D. Mitchell Director 3/22/99
- ---------------------
Kevin D. Mitchell
/s/ Dorsey H. Thompson Director 3/22/99
- ----------------------
Dorsey H. Thompson
<PAGE>
INDEX TO EXHIBITS
PAGE NO. IN
EXHIBIT NO. DESCRIPTION SEQUENTIAL SYSTEM
- ----------- ----------- -----------------
13.1 1998 Annual Report to Stock-
holders (Such Report, except
to the extent incorporated
herein by reference, is being
furnished for the information
of the Commission only and is
not deemed to be filed as part
of this Report on Form 10-KSB). ---
3.1 Cardinal Bankshares Corporation, Incorporated by
Articles of Incorporation reference to the
Company's Registration
on Form 8-A, filed
August 16, 1996
3.2 Cardinal Bankshares Corporation Incorporated by
by-laws reference to the
Company's 1996 Annual
Report filed on Form
10-KSB on March 26, 1997
21.1 Subsidiaries of Cardinal
Bankshares Corporation ---
27.1 Financial Data Schedule ---
<PAGE>
Sec.8-Reference herein to directors, officers, employees or agents shall
include former directors, officers, employees and agents and their
respective heirs, executors and administrators.
1998 ANNUAL REPORT
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
Letter to Stockholders.....................................................................................1
Independent Auditor's Report...............................................................................2
Consolidated Balance Sheets................................................................................3
Consolidated Statements of Income..........................................................................4
Consolidated Statements of Changes in Stockholders' Equity.................................................5
Consolidated Statements of Cash Flows......................................................................6
Notes to Consolidated Financial Statements.................................................................7
Management's Discussion of Financial Condition and Results of Operations..................................24
Staff.....................................................................................................43
Directors and Officers....................................................................................44
Stockholder Information...................................................................................45
</TABLE>
<PAGE>
FINANCIAL HIGHLIGHTS SUMMARY(1)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
SUMMARY OF OPERATIONS(2)
Interest income $ 11,269 $ 11,078 $ 10,289 $ 10,003 $ 8,724
Interest expense 5,797 5,681 5,307 5,060 3,887
-------- -------- -------- -------- --------
Net interest income 5,472 5,397 4,982 4,943 4,837
Provision for loan losses 175 500 325 136 255
Other income 489 543 343 225 233
Other expense 3,066 2,934 2,823 3,088 2,811
Income taxes 781 652 594 548 564
-------- -------- -------- -------- --------
Net income $ 1,939 $ 1,854 $ 1,583 $ 1,396 $ 1,440
======== ======== ======== ======== ========
PER SHARE DATA(3)
Basic earnings per share $ 3.79 $ 3.62 $ 3.09 $ 2.73 $ 2.81
Cash dividends declared 1.06 1.00 .94 .88 .86
Book value 33.84 31.22 28.38 26.62 23.59
YEAR-END BALANCE SHEET SUMMARY
Loans, net $ 85,810 $ 85,305 $ 85,372 $ 78,630 $ 79,635
Securities 41,329 45,094 43,722 43,998 31,449
Total assets 153,410 145,072 136,422 130,901 122,097
Deposits 135,211 128,189 118,424 116,537 109,299
Stockholders' equity 17,321 15,984 14,535 13,631 12,081
Interest earning assets $147,666 $140,397 $130,458 $125,121 $115,872
Interest bearing liabilities 119,657 115,960 108,639 105,669 98,394
SELECTED RATIOS
Return on average assets 1.3% 1.3% 1.2% 1.1% 1.2%
Return on average equity 11.5% 12.0% 11.6% 10.7% 12.7%
Dividends declared as percent of
net income 28.0% 27.7% 30.3% 32.4% 29.3%
</TABLE>
- -----------------
(1) In thousands of dollars, except per share data.
(2) Reflects Bank of Floyd operations prior to formation of Cardinal
Bankshares Corporation on March 12, 1996.
(3) Adjusted for the effects of a four for one stock split in 1995 and 10%
stock dividend in 1997.
<PAGE>
Dear Shareholders:
We are pleased to present the annual report of Cardinal Bankshares Corporation.
Our financial statements are audited by Larrowe & Company, PLC, Certified Public
Accountants.
Cardinal Bankshares Corporation experienced another year of hard work,
expansion, community involvement, and financial growth.
We become an active participant in the America's Promise Program, endorsed by
General Colin Powell and the American Bankers Association. Working with
America's youth has much to offer the future of America and our financial
industry.
We opened our Hillsville office in June 1998. The growth in our new office has
surpassed our expectations. Our presence in the Carroll County market has been
well received.
Our financial growth continued to be good in 1998. We again experienced record
earnings while placing added funds in reserve for potential losses and paying a
record $781,368.00 in federal income taxes. Net earnings of $1,938,852.00 and
ending assets of $153,409.703.00 compare very favorably with peer banks.
Earnings per share increased to $3.79 for 1998 from $3.62 in 1997. We paid
shareholders a cash dividend of $1.06 per share, the seventh year of increased
dividends. The market value of our stock continued to perform well in 1998.
Stock quotes for Cardinal can be found under the bulletin board symbol CDBK.
A significant new issue addressed in 1998 was Year 2000 or Y2K. In 1998 we made
a major investment in hardware and software to assure our readiness for Year
2000 and beyond. As of the writing of this report all our mission critical
systems have been tested and Y2K certified. We will continue to monitor all
systems in 1999. We want to begin the new millennium on a strong and positive
note, and build on our success of the past.
We thank our Board of Directors, our staff, and you our shareholders, for a very
good 1998 and we look forward to a prosperous 1999.
Sincerely,
Leon Moore J. H. Conduff
President and Chief Executive Officer Chairman of the Board
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Stockholders
Cardinal Bankshares Corporation
Floyd, Virginia
We have audited the consolidated balance sheets of Cardinal Bankshares
Corporation and subsidiaries as of December 31, 1998 and 1997 and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Cardinal Bankshares
Corporation and subsidiaries at December 31, 1998 and 1997, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Larrowe & Company, plc
Galax, Virginia
January 8, 1999
<PAGE>
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
- --------------------------------------------------------------------------------
1998 1997
------------ ------------
ASSETS
Cash and due from banks $ 2,985,331 $ 1,941,494
Interest-bearing deposits with banks 7,100,000 5,000,000
Federal funds sold 11,825,000 3,825,000
Investment securities available for sale 25,981,443 31,663,068
Investment securities held to maturity 15,347,979 13,430,624
Loans, net of allowance for loan losses
$1,668,201 in 1998 and $1,452,126 in 1997 85,809,506 85,304,739
Property and equipment, net 2,173,693 1,687,859
Accrued income 984,457 1,093,063
Other assets 1,202,294 1,126,470
------------ ------------
$153,409,703 $145,072,317
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Demand deposits $ 15,553,868 $ 12,229,167
NOW deposits 9,991,178 8,923,777
Savings deposits 18,476,177 17,507,178
Large denomination time deposits 15,666,927 15,120,658
Other time deposits 75,522,910 74,407,946
------------ ------------
Total deposits 135,211,060 128,188,726
Accrued interest payable 240,709 269,032
Other liabilities 636,809 630,408
------------ ------------
136,088,578 129,088,166
------------ ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Common stock, $10 par value; 5,000,000 shares
authorized; 511,911 shares issued
in 1998 and 1997 5,119,110 5,119,110
Surplus 2,925,150 2,925,150
Retained earnings 9,123,733 7,727,506
Unrealized appreciation on investment securities
available for sale, net of income taxes 153,132 212,385
------------ ------------
17,321,125 15,984,151
------------ ------------
$153,409,703 $145,072,317
============ ============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
INTEREST INCOME
Loans and fees on loans $ 8,034,738 $ 8,074,494 $ 7,472,380
Federal funds sold and securities purchased
under agreements to resell 476,913 315,065 169,334
Investment securities:
Taxable 1,843,843 2,159,381 2,177,067
Exempt from federal income tax 625,769 491,074 469,751
Deposits with banks 288,227 38,009 --
----------- ----------- -----------
11,269,490 11,078,023 10,288,532
----------- ----------- -----------
INTEREST EXPENSE
Deposits 5,797,887 5,538,989 5,288,779
Borrowings -- 142,467 17,812
----------- ----------- -----------
5,797,887 5,681,456 5,306,591
----------- ----------- -----------
Net interest income 5,471,603 5,396,567 4,981,941
PROVISION FOR LOAN LOSSES 175,000 500,000 325,000
----------- ----------- -----------
Net interest income after provision
for loan losses 5,296,603 4,896,567 4,656,941
----------- ----------- -----------
NONINTEREST INCOME
Service charges on deposit accounts 152,001 143,794 114,280
Other service charges and fees 37,977 36,128 27,411
Net realized gains on sales of securities 27,315 7,018 5,856
Gain on sale of other real estate owned 89,637 232,732 --
Other income 182,435 123,313 195,741
----------- ----------- -----------
489,365 542,985 343,288
----------- ----------- -----------
NONINTEREST EXPENSE
Salaries and employee benefits 1,871,271 1,760,878 1,754,020
Occupancy expense 136,641 115,612 122,006
Equipment expense 274,861 273,026 230,367
Other expense 782,975 783,882 717,169
----------- ----------- -----------
3,065,748 2,933,398 2,823,562
----------- ----------- -----------
Income before income taxes 2,720,220 2,506,154 2,176,667
INCOME TAX EXPENSE 781,368 652,470 593,747
----------- ----------- -----------
Net income $ 1,938,852 $ 1,853,684 $ 1,582,920
=========== =========== ===========
BASIC EARNINGS PER SHARE $ 3.79 $ 3.62 $ 3.09
=========== =========== ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 511,904 512,090 512,090
=========== =========== ===========
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4
<PAGE>
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMMON RETAINED COMPREHENSIVE
STOCK SURPLUS EARNINGS INCOME (LOSS) TOTAL
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 $ 4,655,360 $ 1,200,000 $ 7,481,589 $ 294,529 $ 13,631,478
COMPREHENSIVE INCOME
Net income -- -- 1,582,920 -- 1,582,920
Net change in unrealized
appreciation on investment
securities available for sale,
net of taxes of $(103,019) -- -- -- (194,121) (194,121)
Reclassification adjustment -- -- -- (5,856) (5,856)
------------
TOTAL COMPREHENSIVE INCOME 1,382,943
Dividends paid
($1.03 per share) -- -- (479,502) -- (479,502)
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1996 4,655,360 1,200,000 8,585,007 94,552 14,534,919
COMPREHENSIVE INCOME
Net income -- -- 1,853,684 -- 1,853,684
Net change in unrealized
appreciation on investment
securities available for sale,
net of taxes of $61,118 -- -- -- 124,851 124,851
Reclassification adjustment -- -- -- (7,018) (7,018)
------------
TOTAL COMPREHENSIVE INCOME 1,971,517
Dividends paid
($.51 per share) -- -- (237,423) -- (237,423)
10% stock dividend 465,540 1,731,790 (2,197,330) -- --
Redemption of fractional shares (1,790) (6,640) -- -- (8,430)
Dividends paid
($.54 per share) -- -- (276,432) -- (276,432)
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1997 5,119,110 2,925,150 7,727,506 212,385 15,984,151
COMPREHENSIVE INCOME
Net income -- -- 1,938,852 -- 1,938,852
Net change in unrealized
appreciation on investment
securities available for sale,
net of taxes of $(30,525) -- -- -- (31,938) (31,938)
Reclassification adjustment -- -- -- (27,315) (27,315)
------------
TOTAL COMPREHENSIVE INCOME 1,879,599
Dividends paid
($1.06 per share) -- -- (542,625) -- (542,625)
Common stock purchased (2,500) -- (11,000) -- (13,500)
Common stock reissued 2,500 -- 11,000 -- 13,500
------------ ------------ ------------ ------------ ------------
BALANCE, DECEMBER 31, 1998 $ 5,119,110 $ 2,925,150 $ 9,123,733 $ 153,132 $ 17,321,125
============ ============ ============ ============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,938,852 $ 1,853,684 $ 1,582,920
Adjustments to reconcile net income
to net cash provided by operations:
Depreciation and amortization 176,587 190,065 166,307
Accretion of discount on securities, net
of amortization of premiums 68,587 176 (73,699)
Provision for loan losses 175,000 500,000 325,000
Deferred income taxes (82,635) (213,850) 168,713
Net realized (gains) losses on securities (27,315) (7,018) (5,857)
Deferred compensation and pension expense 65,599 70,748 38,989
Changes in assets and liabilities:
Accrued income 108,606 (39,487) 15,908
Other assets 37,336 494,783 529,779
Accrued interest payable (28,323) 22,032 (5,957)
Other liabilities (59,198) 144,305 (103,546)
------------ ------------ ------------
Net cash provided by operating activities 2,373,096 3,015,438 2,638,557
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Net increase in interest-bearing deposits (2,100,000) (5,000,000) --
Net (increase) decrease in federal funds sold (8,000,000) (3,325,000) 1,250,000
Purchases of investment securities (19,326,465) (15,236,219) (19,551,812)
Sales of available for sale securities 12,125 2,075,317 3,466,994
Maturities of investment securities 22,947,560 11,974,853 16,137,232
Net (increase) decrease in loans (679,767) (437,099) (7,106,355)
Purchases of property and equipment (922,050) (317,342) (200,586)
Sales of property and equipment 259,629 -- --
------------ ------------ ------------
Net cash used in investing activities (7,808,968) (10,265,490) (6,004,527)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in demand, NOW,
and savings deposits 5,361,101 (404,102) 1,318,505
Net increase in time deposits 1,661,233 10,168,381 569,304
Net increase (decrease) in short-term debt -- (400,000) 400,000
Net increase (decrease) in long-term debt -- (2,400,000) 2,400,000
Redemption of fractional shares -- (8,430) --
Dividends paid (542,625) (513,855) (479,502)
Common stock purchased (13,500) -- --
Common stock reissued 13,500 -- --
------------ ------------ ------------
Net cash provided by financing activities 6,479,709 6,441,994 4,208,307
------------ ------------ ------------
Net increase (decrease) in cash and
cash equivalents 1,043,837 (808,058) 842,337
CASH AND CASH EQUIVALENTS, BEGINNING 1,941,494 2,749,552 1,907,215
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, ENDING $ 2,985,331 $ 1,941,494 $ 2,749,552
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid $ 5,826,210 $ 5,659,424 $ 5,312,548
============ ============ ============
Income taxes paid $ 874,869 $ 750,470 $ 357,964
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES
Other real estate acquired in settlement of loans $ -- $ 4,819 $ 39,194
============ ============ ============
</TABLE>
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
Cardinal Bankshares Corporation (the Company) was incorporated as a Virginia
corporation on March 12, 1996 to acquire the stock of The Bank of Floyd (the
Bank). The Bank was acquired by the Company on June 30, 1996.
The Bank of Floyd and its wholly-owned subsidiary, FBC, Inc., are incorporated
and operate under the laws of the Commonwealth of Virginia. As a state chartered
Federal Reserve member, the Bank is subject to regulation by the Virginia Bureau
of Financial Institutions and the Federal Reserve. The Bank serves the counties
of Floyd, Carroll, and Roanoke, Virginia and the City of Roanoke, Virginia,
through four banking offices. FBC, Inc.'s assets and operations consist
primarily of annuity sales and a minority interest in a title insurance company.
The accounting and reporting policies of the Company, the Bank and FBC, Inc.
follow generally accepted accounting principles and general practices within the
financial services industry. Following is a summary of the more significant
policies.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company, the
Bank and FBC, Inc.. All material intercompany accounts and transactions are
eliminated in consolidation.
BUSINESS SEGMENTS
The Company reports its activities as a single business segment. In determining
the appropriateness of segment definition, the Company considers components of
the business about which financial information is available and regularly
evaluated relative to resource allocation and performance assessment.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements, and the reported
amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the determination of the allowance for loan losses and the valuation
of real estate acquired in connection with foreclosures or in satisfaction of
loans. In connection with the determination of the allowances for loan and
foreclosed real estate losses, management obtains independent appraisals for
significant properties.
The majority of the Company's loan portfolio consists of loans in Southwest
Virginia. Accordingly, the ultimate collectibility of a substantial portion of
the Company's loan portfolio and the recovery of a substantial portion of the
carrying amount of foreclosed real estate are susceptible to changes in local
market conditions. The regional economy is diverse, but is influenced by the
agricultural, textile and governmental segments.
While management uses available information to recognize loan and foreclosed
real estate losses, future additions to the allowances may be necessary based on
changes in local economic conditions. In addition, regulatory agencies, as a
part of their routine examination process, periodically review the Company's
allowances for loan and foreclosed real estate losses. Such agencies may require
the Bank to recognize additions to the allowances based on their judgments about
information available to them at the time of their examinations. Because of
these factors, it is reasonably possible that the allowances for loan and
foreclosed real estate losses may change materially in the near term.
CASH AND CASH EQUIVALENTS
For purpose of presentation in the consolidated statements of cash flows, cash
and cash equivalents are defined as those amounts included in the balance sheet
caption "cash and due from banks."
7
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
TRADING SECURITIES
The Company does not hold securities for short-term resale and therefore does
not maintain a trading securities portfolio.
SECURITIES HELD TO MATURITY
Bonds, notes, and debentures for which the Company has the positive intent and
ability to hold to maturity are reported at cost, adjusted for premiums and
discounts that are recognized in interest income using the interest method over
the period to maturity or to call dates.
SECURITIES AVAILABLE FOR SALE
Available-for-sale securities are reported at fair value and consist of bonds,
notes, debentures, and certain equity securities not classified as trading
securities or as held-to-maturity securities.
Unrealized holding gains and losses, net of tax, on available-for-sale
securities are reported as a net amount in a separate component of stockholders'
equity. Realized gains and losses on the sale of available-for-sale securities
are determined using the specific-identification method. Premiums and discounts
are recognized in interest income using the interest method over the period to
maturity or to call dates.
Declines in the fair value of individual held-to-maturity and available-for-sale
securities below cost that are other than temporary are reflected as write-downs
of the individual securities to fair value. Related write-downs are included in
earnings as realized losses.
LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
outstanding principal amount adjusted for any charge-offs, the allowance for
loan losses, and any deferred fees or costs on originated loans and unamortized
premiums or discounts on purchased loans.
Loan origination fees and certain direct origination costs are capitalized and
recognized as an adjustment of the yield of the related loan. Discounts and
premiums on any purchased residential real estate loans are amortized to income
using the interest method over the remaining period to contractual maturity,
adjusted for anticipated prepayments. Discounts and premiums on any purchased
consumer loans are recognized over the expected lives of the loans using methods
that approximate the interest method.
Interest is accrued and credited to income based on the principal amount
outstanding. The accrual of interest on impaired loans is discontinued when, in
management's opinion, the borrower may be unable to meet payments as they become
due. When interest accrual is discontinued, all unpaid accrued interest is
reversed. Interest income is subsequently recognized only to the extent cash
payments are received.
The allowance for loan losses is increased by charges to income and decreased by
charge-offs, net of recoveries. Management's periodic evaluation of the adequacy
of the allowance is based on the Company's past loan loss experience, known and
inherent risks in the portfolio, adverse situations that may affect the
borrower's ability to repay, the estimated value of any underlying collateral,
and current economic conditions.
PROPERTY AND EQUIPMENT
Land is carried at cost. Bank premises, furniture and equipment are carried at
cost, less accumulated depreciation and amortization computed principally by the
straight-line method over the following estimate useful lives:
Years
-----
Buildings and improvements 20-40
Furniture and equipment 5-20
8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
FORECLOSED PROPERTIES
Real estate properties acquired through, or in lieu of, loan foreclosure are to
be sold and are initially recorded at fair value less cost to sell at the date
of foreclosure establishing a new cost basis. After foreclosure, valuations are
periodically performed by management and the real estate is carried at the lower
of carrying amount or fair value less cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in loss on
foreclosed real estate. The historical average holding period for such
properties is in excess of 36 months.
PENSION PLAN
The Bank maintains a noncontributory defined benefit pension plan covering all
employees who meet eligibility requirements. To be eligible, an employee must be
21 years of age and have completed one year of service. Plan benefits are based
on final average compensation and years of service. The funding policy is to
contribute the maximum deductible for Federal income tax purposes.
INCOME TAXES
Provision for income taxes is based on amounts reported in the statements of
income (after exclusion of non-taxable income such as interest on state and
municipal securities) and consists of taxes currently due plus deferred taxes on
temporary differences in the recognition of income and expense for tax and
financial statement purposes. Deferred tax assets and liabilities are included
in the financial statements at currently enacted income tax rates applicable to
the period in which the deferred tax assets or liabilities are expected to be
realized or settled. As changes in tax laws or rates are enacted, deferred taxes
assets and liabilities are adjusted through the provision for income taxes.
Deferred income tax liability relating to unrealized appreciation (or the
deferred tax asset in the case of unrealized depreciation) on investment
securities available for sale is recorded in other liabilities (assets). Such
unrealized appreciation or depreciation is recorded as an adjustment to equity
in the financial statements and not included in income determination until
realized. Accordingly, the resulting deferred income tax liability or asset is
also recorded as an adjustment to equity.
BASIC EARNINGS PER SHARE
Basic earnings per share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding during
the period, after giving retroactive effect to stock splits and dividends.
DILUTED EARNING PER SHARE
The computation of diluted earnings per share is similar to the computation of
basic earnings per share except that the denominator is increased to include the
number of additional common shares that would have been outstanding if dilutive
potential common shares had been issued. The numerator is adjusted for any
changes in income or loss that would result from the assumed conversion of those
potential common shares. For the years presented, the Company has no potentially
dilutive securities outstanding.
COMPREHENSIVE INCOME
Annual comprehensive income reflects the change in the Company's equity during
the year arising from transactions and events other than investments by and
distributions to stockholders. It consists of net income plus certain other
changes in assets and liabilities that are reported as separate components of
stockholders' equity rather than as income or expense.
9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
FINANCIAL INSTRUMENTS
All derivative financial instruments held or issued by the Company are held or
issued for purposes other than trading.
In the ordinary course of business the Company has entered into
off-balance-sheet financial instruments consisting of commitments to extend
credit and commercial and standby letters of credit. Such financial instruments
are recorded in the financial statements when they are funded or related fees
are incurred or received.
The Bank does not utilize interest-rate exchange agreements or interest-rate
futures contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, Disclosures about Fair
Value of Financial Instruments, requires disclosure of fair value information
about financial instruments, whether or not recognized in the balance sheet. In
cases where quoted market prices are not available, fair values are based on
estimates using present value or other valuation techniques. Those techniques
are significantly affected by the assumptions used, including the discount rate
and estimates of future cash flows. In that regard, the derived fair value
estimates cannot be substantiated by comparison to independent markets and, in
many cases, could not be realized in immediate settlement of the instruments.
Statement No. 107 excludes certain financial instruments and all nonfinancial
instruments from its disclosure requirements. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the Company.
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts reported in the balance sheet
for cash and cash equivalents approximate their fair values.
INTEREST-BEARING DEPOSITS WITH BANKS: Fair values for time deposits are
estimated using a discounted cash flow analysis that applies interest rates
currently offered on certificates to a schedule of aggregated contractual
maturities on such time deposits.
AVAILABLE-FOR-SALE AND HELD-TO-MATURITY SECURITIES: Fair values for securities,
excluding restricted equity securities, are based on quoted market prices, where
available. If quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments. The carrying values of
restricted equity securities approximate fair values.
LOANS RECEIVABLE: For variable-rate loans that reprice frequently and with no
significant change in credit risk, fair values are based on carrying amounts.
The fair values for other loans are estimated using discounted cash flow
analysis, based on interest rates currently being offered for loans with similar
terms to borrowers of similar credit quality. Loan fair value estimates include
judgments regarding future expected loss experience and risk characteristics.
Fair values for impaired loans are estimated using discounted cash flow analysis
or underlying collateral values, where applicable. The carrying amount of
accrued interest receivable approximates its fair value.
DEPOSIT LIABILITIES: The fair values disclosed for demand and savings deposits
are, by definition, equal to the amount payable on demand at the reporting date.
The fair values for certificates of deposit are estimated using a discounted
cash flow calculation that applies interest rates currently being offered on
certificates to a schedule of aggregated contractual maturities on such time
deposits. The carrying amount of accrued interest payable approximates fair
value.
SHORT-TERM AND LONG-TERM DEBT: The carrying amounts of short-term debt
approximate their fair values. The fair values for long-term debt are estimated
using discounted cash flow analysis, based on interest rates currently being
offered for loans with similar terms.
10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED
FAIR VALUE OF FINANCIAL INSTRUMENTS, CONTINUED
OTHER LIABILITIES: For fixed-rate loan commitments, fair value considers the
difference between current levels of interest rates and the committed rates. The
carrying amounts of other liabilities approximates fair value.
IMPACTS OF NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. This Statement
(effective for fiscal quarters beginning after June 15, 1999) establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognize
all derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. While the Company has not
completed its analysis of all impacts of Statement No. 133, Management does not
believe that implementation of the Statement will be material to the financial
statements.
RECLASSIFICATION
Certain reclassifications have been made to the prior years' financial
statements to place them on a comparable basis with the current year. Net income
and stockholders' equity previously reported were not affected by these
reclassifications.
NOTE 2. RESTRICTIONS ON CASH AND DUE FROM BANKS
To comply with banking regulations, the Company is required to maintain certain
average cash reserve balances. The daily average cash reserve requirement was
approximately $686,000 and $576,000 for the two week periods including December
31, 1998 and 1997, respectively.
NOTE 3. SECURITIES
Debt and equity securities have been classified in the consolidated balance
sheets according to management's intent. The carrying amount of securities and
their approximate fair values at December 31 follow:
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
1998 COST GAINS LOSSES VALUE
- ---- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Government agency securities $ 7,897,742 $ 34,315 $ 1,070 $ 7,930,987
State and municipal securities 560,796 20,319 -- 581,115
Mortgage-backed securities 15,793,265 151,472 30,238 15,914,499
Other securities 1,497,207 57,635 -- 1,554,842
----------- ----------- ----------- -----------
$25,749,010 $ 263,741 $ 31,308 $25,981,443
=========== =========== =========== ===========
HELD TO MATURITY
State and municipal securities $14,025,427 $ 398,185 $ 5,388 $14,418,224
Mortgaged-backed securities 684,527 2,355 2,093 684,789
Other securities 638,025 -- -- 638,025
----------- ----------- ----------- -----------
$15,347,979 $ 400,540 $ 7,481 $15,741,038
=========== =========== =========== ===========
</TABLE>
11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 3. SECURITIES, CONTINUED
<TABLE>
<CAPTION>
AMORTIZED UNREALIZED UNREALIZED FAIR
1997 COST GAINS LOSSES VALUE
- ---- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
AVAILABLE FOR SALE
U.S. Government agency securities $15,613,575 $ 40,349 $ 5,320 $15,648,604
State and municipal securities 561,886 5,106 -- 566,992
Mortgage-backed securities 13,676,416 233,482 36,217 13,873,681
Other securities 1,488,980 84,811 -- 1,573,791
----------- ----------- ----------- -----------
$31,340,857 $ 363,748 $ 41,537 $31,663,068
=========== =========== =========== ===========
HELD TO MATURITY
U.S. Government agencies securities $ 498,191 $ 1,809 $ -- $ 500,000
State and municipal securities 11,165,507 183,311 -- 11,348,818
Mortgaged-backed securities 1,156,601 5,762 7,018 1,155,345
Other securities 610,325 -- -- 610,325
----------- ----------- ----------- -----------
$13,430,624 $ 190,882 $ 7,018 $13,614,488
=========== =========== =========== ===========
</TABLE>
Investment securities with amortized cost of approximately $4,400,562 and
$4,337,036 at December 31, 1998 and 1997, respectively, were pledged as
collateral on public deposits and for other purposes as required or permitted by
law.
Gross realized gains and losses for the years ended December 31, 1998, 1997 and
1996 are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Realized gains, available for sale securities $ 27,358 $ 8,855 $ 7,000
Realized losses, available for sale securities (43) (1,837) (1,144)
-------- -------- --------
$ 27,315 $ 7,018 $ 5,856
======== ======== ========
</TABLE>
The scheduled maturities of securities available for sale and held to maturity
at December 31, 1998, were as follows:
<TABLE>
<CAPTION>
AVAILABLE FOR SALE HELD TO MATURITY
------------------------- -------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Due in one year or less $11,196,104 $11,255,749 $ 1,342,613 $ 1,348,344
Due after one year through five years 8,181,464 8,262,834 6,573,488 6,738,523
Due after five years through ten years 5,231,515 5,306,102 6,611,939 6,833,089
Due after ten years 1,139,927 1,156,758 181,914 183,057
Restricted equity securities -- -- 638,025 638,025
----------- ----------- ----------- -----------
$25,749,010 $25,981,443 $15,347,979 $15,741,038
=========== =========== =========== ===========
</TABLE>
12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4. LOANS RECEIVABLE
The major components of loans in the consolidated balance sheets at December 31,
1998 and 1997 are as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Commercial $ 5,630 $ 6,208
Real estate:
Construction and land development 4,028 4,888
Residential, 1-4 families 24,545 25,629
Residential, 5 or more families 2,219 1,785
Farmland 4,134 3,905
Nonfarm, nonresidential 32,794 30,795
Agricultural 1,140 1,815
Consumer 7,244 7,689
Other 6,057 4,383
--------- ---------
87,791 87,097
Unearned discount (7) (44)
Unearned net loan origination costs, net of fees (306) (296)
--------- ---------
87,478 86,757
Allowance for loan losses (1,668) (1,452)
--------- ---------
$ 85,810 $ 85,305
========= =========
<CAPTION>
Nonperforming assets at December 31, 1998 and 1997 are detailed as follows:
1998 1997
--------- ---------
<S> <C> <C>
Nonaccrual loans $ 66,251 $ 278,782
Restructured loans -- --
Loans past due 90 days or more 343,225 312,332
--------- ---------
Total nonperforming loans 409,476 591,114
Foreclosed, repossessed and idled properties 101,756 210,709
--------- ---------
Total nonperforming assets $ 511,232 $ 801,823
========= =========
</TABLE>
Gross interest income that would have been recognized for each year if the
nonaccrual loans and restructured loans had been current in accordance with
their original terms and had been outstanding throughout the period or since
origination, if held part of the period, is detailed below. Applicable interest
income that was actually collected and included in net income for each year is
also summarized below:
<TABLE>
<CAPTION>
1998 1997 1996
---------------- ---------------- --------
<S> <C> <C> <C>
NONACCRUAL LOANS:
Interest income, original terms $ 4,433 $ 27,239 $13,033
================ ================= =======
Interest income recognized $ 1,140 $ 20,840 $ 3,212
================ ================= =======
RESTRUCTURED LOANS:
Interest income, original terms $ -- $ -- $ --
================ ================= =======
Interest income recognized $ -- $ -- $ --
================ ================= =======
</TABLE>
13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 4. LOANS RECEIVABLE, CONTINUED
An allowance determined in accordance with SFAS No. 114 and No. 118 is provided
for all impaired loans. The total recorded investment in impaired loans and the
related allowance for loan losses at December 31, the average annual recorded
investment in impaired loans, and interest income recognized on impaired loans
for the year (all approximate) are summarized below.
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Recorded investment at December 31 $1,103,551 $1,467,636 $2,205,464
========== ========== ==========
Allowance for loan losses $ 286,250 $ 594,105 $ 271,538
========== ========== ==========
Average recorded investment for the year $ 847,271 $ 453,875 $1,674,412
========== ========== ==========
Interest income recognized for the year $ 103,056 $ 133,973 $ 147,742
========== ========== ==========
</TABLE>
The Company is not committed to lend additional funds to debtors whose loans
have been modified.
NOTE 5. ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses are as follows:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
BALANCE, BEGINNING $ 1,452,126 $ 1,002,455
Provision charged to expense 175,000 500,000
Recoveries of amounts charged off 117,917 17,920
Amounts charged off (76,842) (68,249)
----------- -----------
BALANCE, ENDING $ 1,668,201 $ 1,452,126
=========== ===========
</TABLE>
NOTE 6. PROPERTY AND EQUIPMENT
Components of property and equipment and total accumulated depreciation at
December 31, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Land $ 377,612 $ 407,245
Bank premises 2,301,028 1,719,754
Furniture and equipment 1,867,069 1,593,952
Construction in progress -- 162,337
----------- -----------
4,545,709 3,883,288
Less accumulated depreciation (2,372,016) (2,195,429)
----------- -----------
$ 2,173,693 $ 1,687,859
=========== ===========
</TABLE>
NOTE 7. DEBT
SHORT-TERM DEBT
Short-term debt consists of short-term borrowings from Federal Home Loan Bank of
Atlanta. Additional information for the years ended December 31, 1998 and 1997
is summarized below:
<TABLE>
<CAPTION>
1998 1997
----------------- --------
<S> <C> <C>
Outstanding balance at December 31 $ -- $ --
================= ========
Year-end weighted average rate -- --
================= ========
Daily average outstanding during the year $ -- $ 63,561
================= ========
Average rate for the year -- 6.89%
================= ========
Maximum outstanding at any month-end during the year $ -- $400,000
================= ========
</TABLE>
14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 7. DEBT, CONTINUED
SHORT-TERM DEBT, CONTINUED
The Bank has established various credit facilities to provide additional
liquidity if and as needed. These include unsecured lines of credit with
correspondent banks totaling $6,500,000 and a secured line of credit with the
Federal Home Loan Bank of Atlanta of approximately $17,000,000. Additional
amounts are available from the Federal Home Loan Bank, with additional
collateral.
LONG-TERM DEBT
The Company had no long-term indebtedness at December 31, 1998 or 1997.
NOTE 8. EMPLOYEE BENEFIT PLAN
The Bank has a qualified noncontributory, defined benefit pension plan which
covers substantially all of its employees. The benefits are primarily based on
years of service and earnings. The following is a summary of the plan's funded
status as of December 31, 1998 and 1997.
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year $ 1,167,829 $ 984,721
Service cost 88,222 86,171
Interest cost 87,570 73,837
Plan participants' contributions -- --
Amendments -- --
Actuarial (gain) loss 76,439 31,599
Acquisition -- --
Benefits paid (139,738) (8,499)
----------- -----------
Benefit obligation at end of year $ 1,280,322 $ 1,167,829
=========== ===========
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 1,156,480 $ 970,764
Actual return on plan assets 5,294 194,215
Acquisition -- --
Employer contribution -- --
Plan participants' contributions -- --
Benefits paid (139,738) (8,499)
----------- -----------
Fair value of plan assets at end of year $ 1,022,036 $ 1,156,480
=========== ===========
CHANGE IN PREPAID (ACCRUED) BENEFIT COST
Prepaid (accrued) benefit cost, beginning $ (266,984) $ (196,284)
Contributions -- --
Pension cost (65,384) (70,700)
----------- -----------
Prepaid (accrued) benefit cost, ending $ (332,368) $ (266,984)
=========== ===========
Funded status $ (258,286) $ (11,349)
Unrecognized transitional net assets (44,313) (48,341)
Unrecognized prior service cost 77,729 83,708
Unrecognized net actuarial (gain) loss (107,498) (291,002)
----------- -----------
Prepaid (accrued) benefit cost $ (332,368) $ (266,984)
=========== ===========
WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31
Discount rate 7.5% 7.5%
Expected return on plan assets 9.0% 9.0%
Rate of compensation increase 5.0% 5.0%
</TABLE>
15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 8. EMPLOYEE BENEFIT PLAN, CONTINUED
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
COMPONENTS OF NET PERIODIC BENEFIT COST
Service cost $ 88,222 $ 86,171 $ 79,707
Interest cost 87,570 73,837 71,032
Return on plan assets (5,294) (194,215) (105,080)
Originating unrecognized asset gain (loss) (98,769) 109,015 21,974
Amortization (6,345) (4,108) (5,532)
--------- --------- ---------
Net periodic benefit cost $ 65,384 $ 70,700 $ 62,101
========= ========= =========
</TABLE>
NOTE 9. DEFERRED COMPENSATION AND LIFE INSURANCE
Deferred compensation plans have been adopted for certain members of the Board
of Directors for future compensation upon retirement. Under plan provisions
aggregate annual payments ranging from $1,568 to $8,482 are payable for ten
years certain, generally beginning at age 65. Liability accrued for compensation
deferred under the plan amounts to $117,625 and $117,410 at December 31, 1998
and 1997, respectively.
Charges to income are based on present value of future cash payments, discounted
at 8%, and amounted to $9,408, $9,404 and $9,310 for 1998, 1997 and 1996,
respectively.
The Bank is owner and beneficiary of life insurance policies on these directors.
Policy cash values, net of policy loans, totaled $26,785 and $21,530 at December
31, 1998 and 1997, respectively.
NOTE 10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the Company's financial instruments are as follows
(dollars in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------- -------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- -------- -------- --------
<S> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and cash equivalents $ 2,985 $ 2,985 $ 1,941 $ 1,941
Interest-bearing deposits with banks 7,100 7,100 5,000 5,000
Federal funds sold 11,825 11,825 3,825 3,825
Securities, available-for-sale 25,981 25,981 31,663 31,663
Securities, held to maturity 15,348 15,741 13,431 13,614
Loans, net of allowance for loan losses 85,810 89,213 85,305 87,934
FINANCIAL LIABILITIES
Deposits 135,211 136,993 128,189 128,845
OFF-BALANCE-SHEET ASSETS (LIABILITIES)
Commitments to extend credit and
standby letters of credit -- -- -- --
Commercial letters of credit -- -- -- --
</TABLE>
16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 11. INCOME TAXES
CURRENT AND DEFERRED INCOME TAX COMPONENTS
The components of income tax expense (substantially all Federal) are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Current $ 864,003 $ 866,320 $ 425,034
Deferred (82,635) (213,850) 168,713
--------- --------- ---------
$ 781,368 $ 652,470 $ 593,747
========= ========= =========
</TABLE>
RATE RECONCILIATION
A reconciliation of the expected income tax expense computed at 34% to income
tax expense included in the statements of income is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Expected tax expense $ 924,875 $ 852,092 $ 740,067
Tax exempt interest (233,669) (186,555) (178,641)
Other 90,162 (13,067) 32,321
--------- --------- ---------
$ 781,368 $ 652,470 $ 593,747
========= ========= =========
</TABLE>
DEFERRED TAX ANALYSIS
The components of net deferred tax assets (substantially all Federal) at
December 31, 1998 and 1997 are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Deferred tax assets $ 731,041 $ 653,399
Deferred tax liabilities (149,997) (185,515)
--------- ---------
$ 581,044 $ 467,884
========= =========
</TABLE>
The tax effects of each significant item creating deferred taxes are summarized
below:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
Net unrealized appreciation on securities available for sale $ (79,301) $(109,826)
Allowance for loan losses 383,999 324,499
Other valuation reserves 85,520 89,370
Deferred compensation and accrued pension costs 152,998 130,694
Depreciation (47,774) (37,718)
Accretion of discount on investment securities (22,922) (37,971)
Deferred loan fees 108,524 108,836
--------- ---------
$ 581,044 $ 467,884
========= =========
</TABLE>
NOTE 12. COMMITMENTS AND CONTINGENCIES
LITIGATION
In the normal course of business, the Company is involved in various legal
proceedings. After consultation with legal counsel, management believes that any
liability resulting from such proceedings will not be material to the
consolidated financial statements.
17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 12. COMMITMENTS AND CONTINGENCIES, CONTINUED
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Bank is party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit. These instruments involve, to varying degrees, credit risk in excess
of the amount recognized in the consolidated balance sheets.
The Bank's exposure to loan loss in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments and conditional
obligations as for on-balance-sheet instruments. A summary of the Bank's
commitments at December 31, 1998 and 1997, is as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Commitments to extend credit $7,097,000 $7,348,000
Standby letters of credit 132,000 307,000
---------- ----------
$7,229,000 $7,655,000
========== ==========
</TABLE>
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation of the party. Collateral held varies, but may include accounts
receivable, crops, livestock, inventory, property and equipment, residential
real estate and income producing commercial properties.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Collateral held varies
as specified above and is required in instances which the Bank deems necessary.
CONCENTRATIONS OF CREDIT RISK
The majority of the Company's loans, commitments to extend credit, and standby
letters of credit have been granted to customers in the Company's market area.
The majority of such customers are depositors of the Bank. Investments in state
and municipal securities involve governmental entities within and outside the
Company's market area. The concentrations of credit by type of loan are set
forth in Note 4. The distribution of commitments to extend credit approximates
the distribution of loans outstanding. Standby letters of credit are granted
primarily to commercial borrowers. The Company, as a matter of policy, does not
extend credit to any single borrower or group of related borrowers in excess of
approximately $1,750,000. Although the Bank has a reasonably diversified loan
portfolio, a substantial portion of its debtors' ability to honor their
contracts is dependent upon economic conditions in and around Floyd, Carroll,
and Roanoke Counties and the City of Roanoke, Virginia. A significant amount of
the real estate loans set forth in Note 4 are secured by commercial real estate.
In addition, the Company has a loan concentration relating to customers who are
motel and bed-and-breakfast owners and operators. Total loans and loan
commitments to this industrial group amounted to approximately $8,894,020 and
$6,439,303 at December 31, 1998 and 1997, respectively.
The Company has cash and cash equivalents on deposit with financial institutions
which exceed federally-insured limits.
18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 12. COMMITMENTS AND CONTINGENCIES, CONTINUED
YEAR 2000
Like most financial service providers, the Company and its operations could be
significantly affected by the Y2K issue due to its dependence on technology and
date-sensitive data. Computer software and hardware and other equipment, both
within and outside the Company's direct control, and third parties with whom the
Company electronically or operationally interfaces (including without limitation
its customers and third party vendors) could be affected. If computer systems
are not modified in order to be able to identify the year 2000, many computer
applications could fail or create erroneous results. Likewise, under certain
circumstances, a failure to adequately address the Y2K issue could adversely
affect the viability of the Company's suppliers and creditors and the
creditworthiness of its borrowers. Thus, if not adequately addressed, the Y2K
issue could result in a significant adverse impact on the Company's operations
and, in turn, its financial condition and results of operations.
The Company has formulated its plan to address the Y2K issue. Following are the
primary phases of the Company's Y2K plan:
1. Awareness phase
2. Assessment phase
3. Renovation phase
4. Validation or testing phase
5. Implementation phase
The Company is expensing a majority of the costs associated with required system
changes as those costs are incurred, and such costs are being funded through
operating cash flows.
During the awareness phase, Company management and the Board of Directors became
aware of the Y2K issue and potential risks. During the assessment phase, Company
management identified all hardware, software, and environmental systems such as
security systems, elevators, vaults and customer/vendor interdependencies
affected by the Y2K date change. These items and systems were prioritized by
assigning a significance rating of mission critical, mission necessary, mission
desirable, or mission unrelated. During the renovation phase management
performed necessary computer hardware and software upgrades and other system
replacements. During June 1998, management upgraded the mainframe computer. By
the end of the third quarter of 1999, management anticipates implementing a wide
area network which will enhance productivity and customer service.
During the validation and implementation phase, Company management tested all
mission critical applications falling into the categories of its core-banking
software, the Federal Reserve Fedline System, and new account and loan
processing systems. The Company has received warranties from vendors to the
effect of the core-banking software, the Federal Reserve Fedline System, and new
account and loan processing systems. In addition to the vendor warranties,
Company management has tested the mission critical systems and certified them as
Y2K compliant as of January 18, 1999.
With respect to each third party with whom the Company interfaces electronically
or from whom it obtains significant services or supplies, the Company has
requested information regarding that party's preparations and state of
preparedness with respect to Y2K issues. Interruptions in the services provided
by such third parties have been taken into account in the Company's contingency
plans (which, for example, provide for increased inventories of business forms
and supplies, increased levels of cash on hand, the use of a back-up site for
the Company's main computer system and operation functions, manual processing of
branch transactions, clearing of checks through a correspondent bank rather than
the Federal Reserve and, if necessary, a change to a different third party
supplier).
LEASES
During 1997 the bank leased a building used as a branch location under an
operating lease. Rental expense in 1998 and 1997 was $3,720 and $1,125,
respectively. Future minimum lease payments are $1,500 in 1999 and $375 in 2000.
19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13. REGULATORY RESTRICTIONS
DIVIDENDS
The Company's dividend payments are made from dividends received from the Bank.
The Bank, as a Virginia banking corporation, may pay dividends only out of its
retained earnings. However, regulatory authorities may limit payment of
dividends by any bank when it is determined that such a limitation is in the
public interest and is necessary to ensure financial soundness of the Bank.
INTERCOMPANY TRANSACTIONS
The Bank's legal lending limit on loans to the Company are governed by Federal
Reserve Act 23A, and differ from legal lending limits on loans to external
customers. Generally, a bank may lend up to 10% of its capital and surplus to
its Parent, if the loan is secured. If collateral is in the form of stocks,
bonds, debentures or similar obligations, it must have a market value when the
loan is made of at least 20% more than the amount of the loan, and if
obligations of a state or political subdivision or agency thereof, it must have
a market value of at least 10% more than the amount of the loan. If such loans
are secured by obligations of the United States or agencies thereof, or by
notes, drafts, bills of exchange or bankers' acceptances eligible for rediscount
or purchase by a Federal Reserve Bank, requirements for collateral in excess of
the loan amount do not apply. Under this definition, the legal lending limit for
the Bank on loans to the Company was approximately $1,252,900 at December 31,
1998. No 23A transactions were deemed to exist between the Company and the Bank
at December 31, 1998.
CAPITAL REQUIREMENTS
The Company is subject to various regulatory capital requirements administered
by federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory (and possibly additional discretionary) actions by
regulators that, if undertaken, could have a direct material effect on the
Company's consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Bank must meet specific capital guidelines that involve
quantitative measures of the Bank's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the table
below) of total and Tier I capital to risk-weighted assets, and of Tier I
capital to average assets, as all those terms are defined in the regulations.
Management believes, as of December 31, 1998, that the Bank meets all capital
adequacy requirements to which it is subject.
As of December 31, 1998, the most recent notification from the Federal Reserve
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized the Bank must
maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios
as set forth in the table. There are no conditions or events since that
notification that management believes have changed the institution's category.
20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 13. REGULATORY RESTRICTIONS, CONTINUED
CAPITAL REQUIREMENTS, CONTINUED
The Bank's actual capital amounts and ratios are also presented in the table (in
thousands).
<TABLE>
<CAPTION>
TO BE WELL
REQUIRED CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------------- ------------------ --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------- ------ -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
DECEMBER 31, 1998:
Total Capital
(to Risk-Weighted Assets) $ 13,501 15.1% >$7,159 >8.0% >$8,948 >10.0%
- - - -
Tier I Capital
(to Risk-Weighted Assets) $ 12,376 13.8% >$3,579 >4.0% >$5,369 > 6.0%
- - - -
Tier I Capital
(to Average Assets) $ 12,376 8.2% >$6,066 >4.0% >$7,582 > 5.0%
- - - -
DECEMBER 31, 1997:
Total Capital
(to Risk-Weighted Assets) $ 13,084 14.3% >$7,315 >8.0% >$9,144 >10.0%
- - - -
Tier I Capital
(to Risk-Weighted Assets) $ 11,938 13.0% >$3,658 >4.0% >$5,487 > 6.0%
- - - -
Tier I Capital
(to Average Assets) $ 11,938 8.2% >$5,777 >4.0% >$7,221 > 5.0%
- - - -
</TABLE>
NOTE 14. TRANSACTIONS WITH RELATED PARTIES
The Bank has entered into transactions with its directors, significant
shareholders and their affiliates (related parties). Such transactions were made
in the ordinary course of business on substantially the same terms and
conditions, including interest rates and collateral, as those prevailing at the
same time for comparable transactions with other customers, and did not, in the
opinion of management, involve more than normal credit risk or present other
unfavorable features.
Aggregate 1998 and 1997 loan transactions with related parties were as follows:
<TABLE>
<CAPTION>
1998 1997
--------- ---------
<S> <C> <C>
BALANCE, BEGINNING $ 926,805 $ 900,464
New loans 590,946 575,194
Repayments (693,999) (548,853)
Relationship changes (51,399) --
--------- ---------
BALANCE, ENDING $ 772,353 $ 926,805
========= =========
</TABLE>
21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 15. PARENT COMPANY FINANCIAL INFORMATION
Condensed financial information of Cardinal Bankshares Corporation is presented
as follows:
BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Cash due from banks $ 3,011,801 $ 1,996,076
Loans, net of allowance for loan losses
of $25,000 in 1998 and 1997 1,722,064 1,797,087
Investment in affiliate bank at equity 12,528,906 12,150,482
Other assets 58,568 48,174
----------- -----------
$17,321,339 $15,991,819
=========== ===========
LIABILITIES
Accounts payable and other liabilities $ 214 $ 7,668
----------- -----------
SHAREHOLDERS' EQUITY
Common stock 5,119,110 5,119,110
Surplus 2,925,150 2,925,150
Retained earnings 9,123,733 7,727,506
Unrealized appreciation on affiliate's investment
securities available for sale, net of income taxes 153,132 212,385
----------- -----------
17,321,125 15,984,151
----------- -----------
$17,321,339 $15,991,819
=========== ===========
</TABLE>
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
AND THE SIX MONTHS ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
INCOME:
Dividends from affiliate bank $ 1,500,000 $ 1,100,000 $ 3,750,000
Interest on taxable securities 160,679 207,432 17,512
Other income 1,429 -- --
----------- ----------- -----------
1,662,108 1,307,432 3,767,512
----------- ----------- -----------
EXPENSES:
Salaries 88,078 27,166 --
Management and professional fees 37,692 132,588 30,794
Other expenses 34,443 25,791 30,452
----------- ----------- -----------
160,213 185,545 61,246
----------- ----------- -----------
Income before tax benefit and equity in
undistributed income of affiliate 1,501,895 1,121,887 3,706,266
INCOME TAX (EXPENSE) BENEFIT (720) (8,308) 15,611
----------- ----------- -----------
Income before equity in
undistributed income of affiliate 1,501,175 1,113,579 3,721,877
EQUITY IN UNDISTRIBUTED INCOME OF AFFILIATE 437,677 740,105 (2,914,620)
----------- ----------- -----------
Net income $ 1,938,852 $ 1,853,684 $ 807,257
=========== =========== ===========
</TABLE>
22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
NOTE 15. PARENT COMPANY FINANCIAL INFORMATION, CONTINUED
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998 AND 1997
AND THE SIX MONTHS ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,938,852 $ 1,853,684 $ 807,257
Adjustments to reconcile net income to net
cash provided by operating activities:
Amortization 5,929 5,929 2,564
Provision for loan losses -- -- 25,000
Increase (decrease) in equity in undistributed
income of affiliate (437,677) (740,105) 2,914,620
Deferred income taxes -- -- (8,500)
Net change in other assets (16,323) 2,096 (50,263)
Net change in other liabilities (7,454) 6,024 1,644
----------- ----------- -----------
Net cash provided by operating activities 1,483,327 1,127,628 3,692,322
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES,
NET (INCREASE) DECREASE IN LOANS 75,023 570,424 (2,392,511)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid (542,625) (513,855) (479,502)
Redemption of fractional shares -- (8,430) --
Common stock purchased (13,500) -- --
Common stock reissued 13,500 -- --
----------- ----------- -----------
Net cash used by financing activities (542,625) (522,285) (479,502)
----------- ----------- -----------
Net increase in cash and cash equivalents 1,015,725 1,175,767 820,309
CASH AND CASH EQUIVALENTS, BEGINNING 1,996,076 820,309 --
----------- ----------- -----------
CASH AND CASH EQUIVALENTS, ENDING $ 3,011,801 $ 1,996,076 $ 820,309
=========== =========== ===========
</TABLE>
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS
OVERVIEW
Management's Discussion and Analysis is provided to assist in the understanding
and evaluation of Cardinal Bankshares Corporation's financial condition and its
results of operations. The following discussion should be read in conjunction
with the Corporation's consolidated financial statements.
Cardinal Bankshares Corporation, the parent company of The Bank of Floyd,
currently operates four offices in Floyd, Roanoke and Carroll Counties of
Virginia. The main office is in Floyd with a limited service office in Willis.
The Roanoke office is in the Cave Spring area of Roanoke County. The Hillsville
office is located in Carroll County on Route 52 in Hillsville, Virginia.
The individual market conditions of each county vary from rural to urban with
Floyd County being the most rural and Roanoke the most urban. Each have their
own growth patterns which vary in intensity. The closing of the Cross Creek
Apparel manufacturing plant and Skyline Manufacturing have had an impact on the
Floyd economy and will continue to impact the economy during 1999. The Bank of
Floyd and bank personnel work with local government and leaders in an effort to
attract industry to Floyd County.
The earnings position of the Bank continues to improve. Cardinal Bankshares
Corporation experienced record net earnings for 1998, $1,938,852 compared to
$1,853,684 for 1997 and $1,582,920 in 1996. Return on average assets was 1.3%
for 1998 and 1997 compared to 1.2% for 1996. During 1998 revenues from the Bank
of Floyd represent 98.6% of Cardinal Bankshares Corporation's total revenues.
Revenues from the Bank of Floyd represented 98.2% of Cardinal Bankshares
Corporation's total 1997 revenues and 99.8% of 1996 total revenues.
Average equity to average assets shows the Bank with a strong capital position
with a ratio of 11.4%.
The total assets of Cardinal Bankshares Corporation grew to $153,409,703 from
$145,072,317, a 5.75% increase, continuing our strategy to grow the Company.
Foreclosed properties were reduced by 51.7% to a balance of $101,756 at year
end.
Management continues to look at increasing market share by expanding to
contiguous markets as it becomes feasible, with capital generated through normal
earnings supporting growth of the Company. Management of Cardinal Bankshares
Corporation has no plans to raise new capital from external sources to finance
expansion activities in the foreseeable future.
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE 1. NET INTEREST INCOME AND AVERAGE BALANCES (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
--------------------------- ---------------------------- ----------------------------
Interest Interest Interest
Average Income/ Yield/ Average Income/ Yield/ Average Income yield/
Balance Expense Cost Balance Expense Cost Balance Expense Cost
------- -------- ------ ------- ------- -------- ------- ------ --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Interest earning assets:
Deposit in other banks $ 5,278 $ 288 5.46% $ 652 $ 38 5.83% $ - $ - - %
Taxable investment securities 28,845 1,844 6.39% 31,364 2,159 6.88% 32,540 2,177 6.69%
Nontaxable investment
securities 13,331 626 4.70% 10,183 491 4.82% 8,660 470 5.43%
Federal funds sold 9,040 477 5.28% 5,743 315 5.48% 3,187 169 5.30%
Loans, net 83,611 8,035 9.61% 86,528 8,075 9.33% 80,721 7,473 9.26%
-------- ------ ---- -------- ------- ---- -------- ------- ----
Total interest-earning
assets 140,105 11,270 134,470 11,078 125,108 10,289
======== ======= ======== ======= ======= =======
Yield on average
interest-earning assets 8.04% 8.24% 8.22%
==== ==== ====
Noninterest-earning assets:
Cash and due from banks 2,150 1,942 1,912
Premises and equipment 2,020 1,593 1,572
Interest receivable and other 4,473 3,524 2,668
-------- -------- -------
Total noninterest-earning
assets 8,643 7,059 6,152
-------- -------- -------
Total assets $148,748 $141,529 $131,260
======== ======== ========
Interest-bearing liabilities:
Demand deposits $ 8,892 $ 250 2.81% $ 8,766 $ 253 2.89% $ 8,263 $ 208 2.52%
Savings deposits 18,055 582 3.22% 18,096 582 3.22% 18,530 588 3.17%
Time deposits 88,100 4,966 5.64% 83,002 4,703 5.67% 78,630 4,493 5.71%
Other borrowings - - - % 2,485 143 5.75% 306 18 5.88%
-------- ------ ---- -------- ------- ---- -------- ------ ----
Total interest-bearing
liabilities 115,047 5,798 112,349 5,681 105,729 5,307
-------- ------ -------- ------- -------- ------
Cost on average interest-
bearing liabilities 5.04% 5.06% 5.02%
==== ==== ====
Noninterest-bearing
liabilities
Demand deposits 15,537 12,863 11,043
Interest payable and other 1,272 908 831
-------- -------- --------
Total noninterest-bearing
liabilities 16,809 13,771 11,874
-------- -------- --------
Total liabilities 131,856 126,120 117,603
Stockholders' equity 16,892 15,409 13,657
-------- -------- --------
Total liabilities and
stockholders' equity $148,748 $141,529 $131,260
======== ======== ========
Net interest income $ 5,472 $ 5,397 $ 4,982
======== ======== =======
Net yield on
interest-earning assets 3.91% 4.01% 3.98%
==== ==== ====
</TABLE>
- --------------------------------------------------------------------------------
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
TABLE 2. RATE/VOLUME VARIANCE ANALYSIS (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 COMPARED TO 1997 1997 COMPARED TO 1996
------------------------- ------------------------
Interest Variance Interest Variance
Income/ Attributable Income/ Attributable
Expense To Expense To
Variance Rate Volume Variance Rate Volume
-------- ---- ------ -------- ---- ------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Deposits in other banks $ 250 $ (20) $ 270 $ 38 $ -- $ 38
Taxable investment securities (315) (142) (173) (18) 60 (78)
Nontaxable investment securities 135 (17) 152 21 (63) 84
Federal funds sold 162 (19) 181 146 11 135
Loans (40) 232 (272) 602 68 534
----- ----- ----- ----- ----- -----
Total 192 34 158 789 76 713
----- ----- ----- ----- ----- -----
Interest-bearing liabilities:
Demand deposits (3) (7) 4 45 32 13
Savings deposits -- 1 (1) (6) 8 (14)
Time deposits 263 (26) 289 210 (33) 243
Other borrowings (143) -- (143) 125 -- 125
----- ----- ----- ----- ----- -----
Total 117 (32) 149 374 7 367
----- ----- ----- ----- ----- -----
Net interest income $ 75 $ 66 $ 9 $ 415 $ 69 $ 346
===== ===== ===== ===== ===== =====
</TABLE>
- --------------------------------------------------------------------------------
NET INTEREST INCOME
Net interest income, the principal source of bank earnings, is the amount of
income generated by earning assets (primarily loans and investment securities)
less the interest expense incurred on interest-bearing liabilities (primarily
deposits used to fund earning assets). Table 1 summarizes the major components
of net interest income for the past three years and also provides yields and
average balances.
Net interest income in 1998 increased by 1.30% to $5.47 million from $5.40
million in 1997 and $4.98 million in 1996. The increase in net interest income
realized in 1998 was the result of a $5.64 million increase in the volume of
average interest earning assets. Competition for deposits and loans continue to
be a major factor in net margins. Predatory pricing and competition from
unregulated organizations have also been a factor in the declining net interest
margin. The net interest margin for 1998 was 3.91% compared to 4.01% for 1997
and 3.98% for 1996. Net interest income in 1997 increased by $415,000, or 8.33%,
over 1996. The increase in net interest income realized in 1997 was the result
of an increase in the volume of net average earning assets and a 3 basis point
increase in net interest margin. The effects of changes in volumes and rates on
net interest income in 1998 compared to 1997, and 1997 compared to 1996 are
shown in Table 2.
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Interest income for 1998 increased $200,000 to $11.3 million from $11.1 million
in 1997. Interest income in 1996 totaled $10.3 million. The increase in interest
income from 1997 to 1998 was the result of an increase in the volume of deposits
in other banks, federal funds sold and nontaxable investment securities along
with a 28 basis point increase in the yield on net average loans. The increase
in interest income from 1996 to 1997 was the result of an increase in the volume
of average earning assets and a 2 basis point increase in yield.
Interest expense increased by $117,000 in 1998 to $5.8 million from $5.7 million
in 1997 and $5.3 million in 1996. The increase from 1997 to 1998 was due
primarily to a $5.1 million or 6.1% increase in the volume of time deposits.
Interest expense increased by $374,000 from 1996 to 1997. The increase was due
to the average interest bearing liabilities increasing by $6.6 million while the
average rate paid on interest bearing liabilities increased by 4 basis points.
Interest paid on time deposits, which make up the largest portion of
interest-bearing deposits, increased $263,000, or 5.59% from 1997 to 1998. This
increase is due primarily to a $5.1 million increase in the volume of time
deposits. The average rate paid on time deposits decreased 3 basis points to
5.64% in 1997 from 5.67% in 1997 and 5.71% in 1996.
PROVISION FOR LOAN LOSSES
The allowance for loan losses is established to provide for potential losses in
the Bank's loan portfolio. Loan losses and recoveries are charged or credited
directly to the allowance. Management determines the provision for loan losses
required to maintain an allowance adequate to provide for any potential losses.
The factors considered in making this decision are the collectibility of past
due loans, volume of new loans, composition of the loan portfolio, and general
economic outlook.
In 1998, management decreased the provision for loan loss reserve from $500,000
in 1997 to $175,000 in 1998. The provision for loan losses was $325,000 in 1996.
The Bank's allowance for loan losses as a percentage of total loans at the end
of 1998 was 1.91% as compared to 1.67% in 1997 and 1.16% in 1996. When compared
to the most recent available peer bank information as of September 30, 1998 the
allowance for loan losses as percentage of total loans at the end of 1998 was in
the top 10% of all peer banks.
Additional information is contained in Tables 12, 13 and 14, and is discussed in
Nonperforming and Problem Assets.
OTHER INCOME
Noninterest income consists of revenues generated from a broad range of
financial services and activities. The majority of noninterest income is a
result of service charges on deposit accounts including charges for insufficient
funds checks and fees charged for nondeposit services. Noninterest income
totaled $489,000 in 1998, a decrease of 9.9% from the $543,000 recorded in 1997.
Noninterest income in 1996 totaled $343,000. The majority of the decrease in
noninterest income from 1997 to 1998 is explained by a lower amount of gains on
the sale of other real estate owned. The $8,000 increase in insurance
commissions is due to an increase in dividends from title insurance sales and
annuity sales by the Bank of Floyd's subsidiary. The primary sources of
noninterest income for the past three years are summarized in Table 3.
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE 3. SOURCES OF NONINTEREST INCOME (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Service charges on deposit accounts $152 $144 $114
Other service charges and fees 38 36 27
Insurance commissions 54 4 12
Gain on the sale of securities 27 7 6
Gain on sale of other real estate owned 90 233 --
Other income 128 77 184
---- ---- ----
Total noninterest income $489 $543 $343
==== ==== ====
</TABLE>
- --------------------------------------------------------------------------------
Other noninterest income was up $51,000 in 1998 to $128,000 from $77,000 in 1997
and $184,000 in 1996. Noninterest income includes fees charged for various bank
services such as safe deposit box rental fees, letters of credit fees, and gains
realized on the sale of fixed assets.
OTHER EXPENSE
Noninterest expense for 1998 increased by $133,000 or 4.5% to $3.1 million.
Noninterest expense in 1997 was $2.9 million and it was $2.8 million in 1996
(see Table 4). The overhead ratio of noninterest expense to adjusted total
revenues (net interest income plus noninterest income excluding securities
transactions) was 52.6% in 1998, 50.8% in 1997 and 53.1% in 1996.
Occupancy expense increased $21,000 or 18.1% to $137,000 in 1998 from $116,000
in 1997. This increase is due to an increased building depreciation expense of
$7,871, a utilities expense increase of $4,345, other occupancy expense increase
of $3,682, real estate tax increase of $1,258 and leasehold improvement
depreciation expense increase of $943. These increases are due primarily to the
addition of the Hillsville branch during June. In addition, leasehold
improvement depreciation expenses relating to the Willis branch were realized
for a full year versus approximately six months in 1997.
28
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE 4. SOURCES OF NONINTEREST EXPENSE (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
Salaries & wages $1,386 $1,298 $1,242
Employee benefits 485 463 512
------ ------ ------
Total personnel expense 1,871 1,761 1,754
Occupancy expense 137 116 122
Furniture & equipment 275 273 230
Printing & supplies 55 44 54
FDIC deposit insurance 15 14 2
Professional services 119 120 177
Postage 76 72 69
Telephone 49 40 33
Courier fees 29 21 21
Education & seminars 17 20 13
Travel expense 17 21 27
Director fees and expense 48 38 40
Advertising and public relations 33 31 38
Insurance expense 33 36 37
Capital Stock Tax 97 77 98
Outside services 28 26 --
Other real estate expense, net 4 46 35
Real estate loan servicing fee 16 12 16
Other operating expense 147 165 58
------ ------ ------
Total noninterest expense $3,066 $2,933 $2,824
====== ====== ======
</TABLE>
- --------------------------------------------------------------------------------
Other real estate expense decreased $42,000 or 91.3% to $4,000 in 1998 from
$46,000 in 1997. This decrease is the result of the disposal of a number of
properties reducing the net other real estate owned balance by $108,953 or 51.7%
from $210,709 as of December 31, 1997 to $101,756 as of December 31, 1998. The
sale of these properties reduces the amount of nonperforming assets and also
increases the amount of earning assets available to the bank.
Printing and supplies expense increased $11,000 or 25.0% from $44,000 in 1997 to
$55,000 in 1998. The primary reason for this increase was a $16,098 increase in
office supply printing attributed to the Hillsville branch and Year 2000
disclosures.
The increase occurring during 1998 in the remaining categories of noninterest
expense was primarily attributable to the higher level of activity associated
with the growth in deposits. Table 4 provides a further breakdown of noninterest
expense for the past three years.
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
INCOME TAXES
Income tax expense is based on amounts reported in the statements of income
(after adjustments for non-taxable income and non-deductible expenses) and
consists of taxes currently due plus deferred taxes on temporary differences in
the recognition of income and expense for tax and financial statement purposes.
The deferred tax assets and liabilities represent the future Federal income tax
return consequences of those differences, which will either be taxable or
deductible when the assets and liabilities are recovered or settled.
Income tax expense (substantially all Federal) was $781,368 in 1998, $652,470 in
1997 and $593,747 for 1996 representing 28.7%, 26.0% and 27.3% of income before
income taxes, respectively. The tax expense increased $128,898 or 19.8% from
1997 to 1998.
The Bank's deferred income tax benefits and liabilities result primarily from
temporary differences (discussed above) in provisions for credit losses,
valuation reserves, depreciation, deferred compensation, deferred income,
pension expense, and investment security discount accretion.
Net deferred income tax benefits of $581,000, $468,000 and $315,000 at December
31, 1998, 1997, and 1996, respectively, are included in other assets. At
December 31, 1998, $79,301 of the total deferred tax liability is applicable to
unrealized appreciation on investment securities available for sale.
Accordingly, this amount was not charged to income but recorded directly to the
related stockholders' equity account.
YEAR 2000 (Y2K) ISSUES
Y2K refers to the potential disruption to computers lacking the ability to
recognize years beyond 1999. During September 1997, management of the Bank
formed a Y2K committee to identify, monitor, and control the potential risks
associated with the Y2K computer problem. These risks include the inability to
process loan and deposit transactions such as payments and computation of
interest due to a computer failure. Another risk is a possible disruption to
bank operations due to the failure of equipment that relies on embedded
technology such as microprocessors. Other risks include disruptions in
operations of the bank's service vendors and large loan and deposit customers.
Total estimated expenses to assess and control Y2K risks are $180,000 for the
time period from September 1997 to March 2000. These expenses include the
following: (1) management time involved during risk assessment and testing, (2)
expenses for Y2K training conferences attended by management, (3) expenses for
seminars held by The Bank of Floyd for bank customers, (4) expenses for hardware
and software upgrades, (5) and potential increases in legal expenses. Total
expenditures through December 31, 1998 are $138,184 or 77% of the total
estimated expenses.
Bank management has established a Y2K plan with the following five phases:
awareness, assessment, renovation, validation and implementation. During the
awareness phase, management and the board of directions became aware of the Y2K
issue and potential risks. During the assessment phase, management identified
all hardware, software, and environmental systems such as security systems,
elevators, vaults and customer/vendor interdependencies affected by the Y2K date
change. These items and systems were prioritized by assigning a significance
rating of mission critical, mission necessary, mission desirable, or mission
unrelated. During the renovation phase management performed necessary computer
hardware and software upgrades and other system replacements. During June 1998,
management upgraded the mainframe computer. By the end of the third quarter of
1999, management anticipates implementing a wide area network which will enhance
productivity and customer service.
30
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
During the validation and implementation phase management tested all mission
critical applications. All mission critical systems were certified as Y2K
compliant as of January 18th, 1999. These mission critical systems include the
following items: mainframe hardware, software and interfaces with other bank
computer systems; the Federal Reserve Fedline system; and new account and loan
processing systems.
The Y2K risks involved in a worst case scenario involve malfunctions with
mission critical or mission desirable applications and systems. For example, if
certain systems such as the mainframe computer were to malfunction it would be
almost impossible to operate the bank without a backup system. If certain loan
and deposit processing software were to malfunction it would be difficult to
extend loans and open deposit accounts without an alternate process. Other
disruptions beyond management control would include loss of electrical and
telephone service.
To deal with the worst case possibilities, bank management has established a Y2K
contingency plan. This contingency plan includes identifying and using other
vendors who are fully Y2K compliant for critical functions, and maintaining
supplies necessary to perform functions manually. To plan for a mainframe
computer malfunction, management has back up arrangements in place with a third
party to use a comparable mainframe. Management has in place manual, paper based
processes in the event of the failure of loan and deposit processing software.
Bank management has maintained constant communication with electric and
telephone companies to evaluate their Y2K efforts and allow the Bank of Floyd to
develop needed plans. The Federal Reserve bank will have the ability to ship
extra currency to various locations to cover any potential increased demand for
currency.
31
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
EARNING ASSETS
Average earning assets increased 4.2% over the past twelve months. Total earning
assets represented 94.2% of total average assets in 1998 compared to 95.0% in
1997. The mix of average earning assets changed in 1998 with an increase in the
mix of federal funds sold and interest bearing bank balances and a decrease in
the mix of loans. Average federal funds sold accounted for 6.1% of total average
assets compared to 4.1% in 1997. Average interest bearing bank balances
accounted for 3.6% of total average assets compared to 0.5% in 1997. Average
loans accounted for 56.2% of total average assets in 1998 compared to 61.1% in
1997. For 1996, average net loans represented 61.5% of average assets. A summary
of average assets for the past three years is shown in Table 5.
- --------------------------------------------------------------------------------
TABLE 5. AVERAGE ASSET MIX (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- ------------------- --------------------
Average Average Average
Balance % Balance % Balance %
-------- ------ ------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
EARNING ASSETS:
Loans, net $ 83,611 56.21 $ 86,528 61.14 $ 80,721 61.50
Investment securities 42,176 28.35 41,547 29.36 41,200 31.39
Federal funds sold 9,040 6.08 5,743 4.06 3,187 2.42
Interest-bearing bank balances 5,278 3.55 652 0.45 -- 0.00
-------- ------ ------- ------ -------- ------
Total earning assets 140,105 94.19 134,470 95.01 125,108 95.31
-------- ------ ------- ------ -------- ------
NONEARNING ASSETS:
Cash and due from banks 2,150 1.44 1,942 1.37 1,912 1.46
Premises and equipment 2,020 1.36 1,593 1.13 1,572 1.20
Other assets 4,473 3.01 3,524 2.49 2,668 2.03
-------- ------ ------- ------ -------- ------
Total nonearning assets 8,643 5.81 7,059 4.99 6,152 4.69
-------- ------ ------- ------ -------- ------
Total assets $148,748 100.00 $141,529 100.00 $131,260 100.00
======== ====== ======== ====== ======== ======
</TABLE>
- --------------------------------------------------------------------------------
LOANS
Average net loans totaled $83.6 million during 1998, a decrease of $2.9 million
or 3.4% less than 1997. A significant portion of the loan portfolio, $67.7
million or 77.1%, is made up of loans secured by various types of real estate.
Total loans secured by 1-4 family residential properties represented 28% of
total loans at the end of 1998. The loans represented in the other loan
classification in Table 6 increased by 38.2% during 1998 to a total of $6.1
million, or 6.9% of total loans outstanding compared to a total of $4.4 million
at the end of 1997. The growth in the other loan classification is primarily the
result of an increase in commercial loans to leasing companies.
32
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
The Bank makes both consumer and commercial loans to all neighborhoods within
its market area, including the low- and moderate-income areas. The market area
is generally defined to be all or portions of the Floyd, Roanoke, Montgomery and
Carroll Counties of Virginia and the Cities of Roanoke and Radford, Virginia.
The Bank places emphasis on consumer based installment loans and commercial
loans to small and medium sized businesses. The local Floyd economy experienced
the closure of the Cross Creek Apparel manufacturing plant in 1998. Predatory
pricing and competition from unregulated organizations have also been a factor
when generating new loans. The amounts of loans outstanding by type at year-end
1998 and 1997, and the maturity distribution of variable and fixed rate loans as
of year-end 1998 are presented in Table 6 and Table 7, respectively.
- --------------------------------------------------------------------------------
TABLE 6. LOAN PORTFOLIO SUMMARY (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997
------------------- -------------------
Amount % Amount %
------- ----- ------- ------
<S> <C> <C> <C> <C>
Construction and development $ 4,028 4.59 $ 4,888 5.61
Farmland 4,134 4.71 3,905 4.48
1-4 family residential 24,545 27.96 25,629 29.43
Multifamily residential 2,219 2.53 1,785 2.05
Nonfarm, nonresidential 32,794 37.35 30,795 35.66
------- ----- ------- ------
Total real estate 67,720 77.14 67,002 76.93
Agricultural 1,140 1.30 1,815 2.08
Commercial & industrial 5,630 6.41 6,208 7.13
Consumer 7,244 8.25 7,689 8.83
Other 6,057 6.90 4,383 5.03
------- ------ ------- ------
Total $87,791 100.00 $87,097 100.00
======= ====== ======= ======
</TABLE>
- --------------------------------------------------------------------------------
Interest rates charged on loans vary with the degree of risk, maturity and
amount of the loan. Competitive pressures, money market rates, availability of
funds, and government regulation also influence interest rates. On average,
loans yielded 9.61% in 1998 compared to an average yield of 9.33% in 1997.
33
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE 7. MATURITY SCHEDULE OF LOANS (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMERCIAL CONSTRUCTION TOTAL
FINANCIAL AND AND ------------------------
AGRICULTURE DEVELOPMENT OTHERS AMOUNT %
------------- ------------ ------- ------- ------
<S> <C> <C> <C> <C> <C>
FIXED RATE LOANS:
Three months or less $ 469 $ -- $ 897 $ 1,366 1.56
Over three months to twelve months 581 -- 1,507 2,088 2.38
Over twelve months to three years 3,236 -- 6,972 10,208 11.63
Over three years to five years 2,331 -- 7,435 9,766 11.12
Over five years to fifteen years 5,365 10 3,775 9,150 10.42
Over fifteen years 257 -- 2,301 2,558 2.91
------- ------- ------- ------- ------
Total fixed rate loans $12,239 $ 10 $22,887 $35,136 40.02
------- ------- ------- ------- ------
VARIABLE RATE LOANS:
Three months or less $ 7,286 $ 2,547 $ 3,425 $13,258 15.10
Over three months to twelve months 9,389 -- 5,554 14,943 17.02
Over twelve months to three years 9,321 -- 7,781 17,102 19.49
Over three years to five years 4,343 529 1,538 6,410 7.30
Over five years to fifteen years -- 942 -- 942 1.07
Over fifteen years -- -- -- -- 0.00
------- ------- ------- ------- ------
Total variable rate loans $30,339 $ 4,018 $18,298 $52,655 59.98
------- ------- ------- ------- ------
TOTAL LOANS:
Three months or less $ 7,755 $ 2,547 $ 4,322 $14,624 16.66
Over three months to twelve months 9,970 -- 7,061 17,031 19.40
Over twelve months to three years 12,557 -- 14,753 27,310 31.11
Over three years to five years 6,674 529 8,973 16,176 18.43
Over five years to fifteen years 5,365 952 3,775 10,092 11.50
Over fifteen years 257 -- 2,301 2,558 2.91
------- ------- ------- ------- ------
Total loans $42,578 $ 4,028 $41,185 $87,791 100.00
======= ======= ======= ======= ======
</TABLE>
- --------------------------------------------------------------------------------
INVESTMENT SECURITIES
The Bank uses its investment portfolio to provide liquidity for unexpected
deposit decreases or loan generation, to meet the Bank's interest rate
sensitivity goals, and to generate income.
Management of the investment portfolio has always been conservative with
virtually all investments taking the form of purchases of U.S. Treasury, U.S.
Government agencies, Mortgage Backed Securities and State and local bond issues.
Management views the investment portfolio as a source of income, and purchases
securities with the intent of retaining them until maturity. However,
adjustments are necessary in the portfolio to provide an adequate source of
liquidity which can be used to meet funding requirements for loan demand and
deposit fluctuations and to control interest rate risk. Therefore, from time to
time, management may sell certain securities prior to their maturity. Table 8
presents the investment portfolio at the end of 1998 by major types of
investments and maturity ranges. Maturities may differ from scheduled maturities
in mortgage-backed securities because the mortgages underlying the securities
may be called or repaid prior to
34
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
the scheduled maturity date. Maturities on all other securities are based on the
earlier of the contractual maturity or the call date, if any.
The interest rate environment in 1998 caused the average yield of the investment
portfolio to decrease to 5.89% from 6.30% in 1997. At December 31, 1998, the
market value of the investment portfolio was $41.7 million, representing a
$625,000 appreciation over amortized cost. This compared to a market value of
$45.3 million and a $507,000 appreciation over amortized cost a year earlier.
- --------------------------------------------------------------------------------
TABLE 8. INVESTMENT SECURITIES (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31, 1998
AMORTIZED COST DUE
--------------------------------------
IN ONE AFTER ONE AFTER FIVE AFTER RESTRICTED
YEAR OR THROUGH THROUGH TEN EQUITY MARKET
LESS FIVE YRS. TEN YRS. YEARS SECURITIES TOTAL VALUE
---------- ---------- ---------- --------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
INVESTMENT SECURITIES:
U.S. Government agencies
and Mortgage Backed Securities $ 10,703 $ 7,574 $ 4,777 $ 1,322 -- $24,376 $24,530
State and political subs 840 6,679 7,067 -- -- 14,586 14,999
Other 995 502 -- -- -- 1,497 1,555
Restricted Equity Securities -- -- -- -- 638 638 638
---------- ---------- ---------- --------- ------- ------- -------
Total $ 12,538 $ 14,755 $ 11,844 $ 1,322 $ 638 $41,097 $41,722
========== ========== ========== ========= ======= ======= =======
WEIGHTED AVERAGE YIELDS:
U.S. Government agencies
and Mortgage Backed Securities 6.18% 6.43% 6.50% 6.96% -- -- --
States and political subs 4.72% 4.68% 4.64% -- -- -- --
Other 10.63% 7.72% -- -- -- -- --
Restricted Equity Securities -- -- -- -- 6.89% -- --
Consolidated 6.44% 5.68% 5.39% 6.96% 6.89% 5.89% --
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997 BOOK MARKET
VALUE VALUE
------- -------
<S> <C> <C>
INVESTMENT SECURITIES:
U.S. Government agencies and Mortgage Backed Securities $30,945 $31,178
States and political subdivisions 11,727 11,916
Other 1,489 1,574
Restricted Equity Securities 610 610
------- -------
Total $44,771 $45,278
======= =======
</TABLE>
- --------------------------------------------------------------------------------
35
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
DEPOSITS
The Bank relies on deposits generated in its market area to provide the majority
of funds needed to support lending activities and for investments in liquid
assets. More specifically, core deposits (total deposits less certificates of
deposits in denominations of $100,000 or more) are the primary funding source.
The Bank's balance sheet growth is largely determined by the availability of
deposits in its markets, the cost of attracting the deposits, and the prospects
of profitably utilizing the available deposits by increasing the loan or
investment portfolios. Market conditions have resulted in depositors shopping
for deposit rates more than in the past. An increased customer awareness of
interest rates adds to the importance of rate management. The Bank's management
must continuously monitor market pricing, competitor's rates, and internal
interest rate spreads to maintain the Bank's growth and profitability. The Bank
attempts to structure rates so as to promote deposit and asset growth while at
the same time increasing overall profitability of the Bank.
Average total deposits for the year ended December 31, 1998 amounted to $130.6
million which was an increase of $7.9 million, or 6.4% over 1997. Average core
deposits totaled $116.2 million in 1998 representing a 5.1% increase over the
$110.6 million in 1997. The percentage of the Bank's average deposits that are
interest-bearing decreased to 88.1% in 1998 from 89.5% in 1997. Average demand
deposits which earn no interest increased to $15.5 million in 1998 from $12.9
million in 1997 and $11.0 million in 1996.
Average deposits for the past three years are summarized in Table 9.
- --------------------------------------------------------------------------------
TABLE 9. DEPOSIT MIX (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
-------------------- -------------------- --------------------
AVERAGE AVERAGE AVERAGE
BALANCE % BALANCE % BALANCE %
-------- ------ -------- ------ -------- ------
<S> <C> <C> <C> <C> <C> <C>
Interest-bearing deposits:
NOW accounts $ 8,892 6.81 $ 8,766 7.14 $ 8,263 7.10
Money Market 3,365 2.58 3,228 2.63 3,417 2.93
Savings 14,690 11.25 14,868 12.12 15,113 12.98
Small denomination certificates 73,755 56.48 70,924 57.79 68,943 59.20
Large denomination certificates 14,345 10.98 12,078 9.84 9,687 8.32
-------- ------ -------- ------ -------- ------
Total interest-bearing deposits 115,047 88.10 109,864 89.52 105,423 90.53
Noninteresting-bearing deposits 15,537 11.90 12,863 10.48 11,043 9.47
-------- ------ -------- ------ -------- ------
Total deposits $130,584 100.00 $122,727 100.00 $116,466 100.00
======== ====== ======== ====== ======== ======
</TABLE>
- --------------------------------------------------------------------------------
The average balance of certificates of deposit issued in denominations of
$100,000 or more increased by $2.3 million or 18.8%, in 1998. Much of the
increase in large certificates of deposit is from local government funds. The
strategy of management has been to support loan and investment growth with core
deposits and not to aggressively solicit the more volatile, large denomination
certificates of deposit. Table 10 provides maturity information relating to
Certificate of Deposits of $100,000 or more at December 31, 1998.
36
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE 10. LARGE TIME DEPOSIT MATURITIES (THOUSANDS)
- --------------------------------------------------------------------------------
ANALYSIS OF TIME DEPOSITS OF $100,000 OR MORE AT DECEMBER 31, 1998:
Remaining maturity of three months or less $ 1,757
Remaining maturity over three through twelve months 8,646
Remaining maturity over twelve months 5,264
-------
Total time deposits of $100,000 or more $15,667
=======
- --------------------------------------------------------------------------------
CAPITAL ADEQUACY
Shareholder's equity amounted to $17.3 million at December 31, 1998, a 8.1%
increase over the 1997 year-end total of $16.0 million. The increase was
primarily a result of earnings increase. Average shareholders' equity as a
percentage of average total assets amounted to 11.5% in 1998 and 10.9% in 1997.
Regulatory guidelines relating to capital adequacy provide minimum risk-based
ratios which assess capital adequacy while encompassing all credit risks,
including those related to off-balance sheet activities. Capital ratios under
these guidelines are computed by weighing the relative risk of each asset
category to derive risk-adjusted assets. The risk-based capital guidelines
require minimum ratios of core (Tier 1) capital (common shareholders' equity )
to risk-weighted assets of 4.0% and total regulatory capital (core capital plus
allowance for loan losses up to 1.25% of risk-weighted assets) to risk-weighted
assets of 8%. As of December 31, 1998 the Bank has a ratio of Tier 1 capital to
risk-weighted assets of 13.8% and a ratio of total capital to risk-weighted
assets of 15.1%.
37
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE 11. YEAR-END RISK-BASED CAPITAL (THOUSANDS)
- --------------------------------------------------------------------------------
1998 1997
------- -------
Tier I capital $12,376 $11,938
Qualifying allowance for loan losses
(limited to 1.25% of risk-weighted assets) 1,125 1,146
------- -------
Total regulatory capital $13,501 $13,084
======= =======
Total risk-weighted assets $90,000 $91,680
======= =======
Tier I as a percent of risk-weighted assets 13.8% 13.0%
Total regulatory capital as a percent of risk-
weighted assets 15.1% 14.3%
Leverage Ratio* 8.1% 8.2%
* Tier I capital divided by average total assets for the quarter ended
December 31, 1998.
- --------------------------------------------------------------------------------
In addition, a minimum leverage ratio of Tier I capital to average total assets
for the previous quarter is required by federal bank regulators, ranging from 3%
to 5%, subject to the regulator's evaluation of the Bank's overall safety and
soundness. As of December 31, 1998, the Bank had a ratio of year-end Tier I
capital to average total assets for the fourth quarter of 1998 of 8.1%. Table 11
sets forth summary information with respect to the Bank's capital ratios at
December 31, 1998. All capital ratio levels indicate that the Bank is well
capitalized.
At December 31, 1998 the Company had 511,911 shares of common stock outstanding
which were held by approximately 620 shareholders of record.
NONPERFORMING AND PROBLEM ASSETS
Certain credit risks are inherent in making loans, particularly commercial and
consumer loans. Management prudently assesses these risks and attempts to manage
them effectively. The Bank attempts to use shorter-term loans and, although a
portion of the loans have been made based upon the value of collateral, it tries
to rely primarily on the cash flow of the borrower as the source of repayment
rather than the value of the collateral.
The Bank also attempts to reduce repayment risks by adhering to internal credit
policies and procedures. These policies and procedures include officer and
customer limits, periodic loan documentation review and follow up on exceptions
to credit policies.
Nonperforming Assets at December 31, 1998 and 1997 are analyzed in Table 12.
38
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE 12. NONPERFORMING ASSETS
- --------------------------------------------------------------------------------
1998 1997
-------- --------
Non-Accrual Loans $ 66,251 $278,782
Restructured -- --
Foreclosed and In-Substance
Foreclosed Properties 101,756 210,709
-------- --------
$168,007 $489,491
======== ========
- --------------------------------------------------------------------------------
Nonperforming assets at year-end 1998 were 0.2% of loans outstanding and 0.6% at
year-end 1997. In addition to the nonperforming assets, loans which were 90 days
and over past due amounted to $343,225 at December 31, 1998 and $312,332 at
December 31, 1997.
The allowance for loan losses is maintained at a level adequate to absorb
potential losses. Some of the factors which management considers in determining
the appropriate level of the allowance for loan losses are: past loss
experience, an evaluation of the current loan portfolio, identified loan
problems, the loan volume outstanding, the present and expected economic
conditions in general, and in particular, how such conditions relate to the
market areas that the Bank serves. Bank regulators also periodically review the
Bank's loans and other assets to assess their quality. Credits deemed
uncollectible are charged to the allowance. Provisions for loan losses and
recoveries on loans previously charged off are added to the allowance. The
accrual of interest on loans is discontinued on a loan when, in the opinion of
management, there is an indication that the borrower may be unable to meet
payments as they become due.
The provision for loan losses, net charge-offs and the activity in the allowance
for loan losses is detailed in Table 13.
- --------------------------------------------------------------------------------
TABLE 13. LOAN LOSSES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Allowance for loan losses, beginning $ 1,452,126 $ 1,002,455 $ 1,134,182
Provision for loan losses, added 175,000 500,000 325,000
Loans charged off (76,842) (68,249) (495,201)
Recoveries of loans previously charged off 117,917 17,920 38,474
----------- ----------- -----------
Net charge-offs 41,075 (50,329) (456,727)
----------- ----------- -----------
Allowance for loan losses, ending $ 1,668,201 $ 1,452,126 $ 1,002,455
=========== =========== ===========
</TABLE>
39
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Net loan recoveries as a percentage of average loans were 0.14% in 1998. Net
loan charge-offs as a percentage of average loans were 0.06% and 0.57% in 1997
and 1996, respectively. Gross charge offs during 1998 totaled $76,842 and
consisted of $73,309 in installment loans and $3,533 in real estate loans.
Recoveries during 1998 totaled $117,917 and consisted of $97,745 in installment
loans and $20,172 in real estate loans.
The loan portfolio also included loans to various borrowers (watch loans) at
year-end for which management had concerns about the ability of the borrowers to
continue to comply with present loan repayment terms, and which could result in
some or all of these loans being uncollectible. Management monitors these loans
carefully and has provided for these loans in the allowance for loan losses.
The allowance for loan losses was approximately $1.7 million, or 1.91% of gross
loans outstanding at December 31, 1998, an increase of $216,075 above the 1.67%
reserve at December 31, 1997. Management realizes that general economic trends
greatly affect loan losses and no assurances can be made about future losses.
Management does, however, consider the allowance for loan losses to be adequate
at December 31, 1998.
The allocation of the reserve for loan losses is detailed in Table 14 below:
- --------------------------------------------------------------------------------
TABLE 14. ALLOCATION OF THE RESERVE FOR LOAN LOSSES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ----------------- ------------------
Balance at end of period applicable to AMOUNT PERCENT(1) AMOUNT PERCENT(1) AMOUNT PERCENT(1)
- -------------------------------------- ------ -------- ------ ------ ------ -------
<S> <C> <C> <C> <C> <C> <C>
Commercial, financial and agricultural $ 502 7.71 $ 194 9.21 $ 93 9.24
Real estate, construction -- 4.59 60 5.61 65 6.49
Real estate, mortgage 657 72.55 1,089 71.32 723 72.19
Installment loans to individuals, other 509 15.15 109 13.86 121 12.08
------ ------ ------ ------ ------ ------
Total $1,668 100.00 $1,452 100.00 $1,002 100.00
====== ====== ====== ====== ====== ======
</TABLE>
- --------------------------------------------------------------------------------
LIQUIDITY AND INTEREST RATE SENSITIVITY
The principal goals of the Bank's asset and liability management strategy are
the maintenance of adequate liquidity and the management of interest rate risk.
Liquidity is the ability to convert assets to cash to fund depositors'
withdrawals or borrowers' loans without significant loss. Interest rate risk
management balances the effects of interest rate changes on assets that earn
interest or liabilities on which interest is paid, to protect the Bank from wide
fluctuations in its net interest income which could result from interest rates
changes.
- ---------
(1) Percent of loans in each category to total loans.
40
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
Management must insure that adequate funds are available at all times to meet
the needs of its customers. On the asset side of the balance sheet, maturing
investments, loan payments, maturing loans, federal funds sold, and unpledged
investment securities are principal sources of liquidity. On the liability side
of the balance sheet, liquidity sources include core deposits, the ability to
increase large denomination certificates, federal funds lines from correspondent
banks, borrowings from the Federal Reserve Bank and the Federal Home Loan Bank,
as well as the ability to generate funds through the issuance of long-term debt
and equity.
The liquidity ratio (the level of liquid assets divided by total deposits plus
short-term liabilities) was 20.2% at December 31, 1998 compared to 18.9% at
December 31, 1997. These ratios are considered to be adequate by management.
- --------------------------------------------------------------------------------
TABLE 15. INTEREST RATE SENSITIVITY (THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31, 1998
MATURITIES/REPRICING
-----------------------------------
1-3 4-12 13-60 OVER 60
MONTHS MONTHS MONTHS MONTHS TOTAL
------ ------ ------ ------- --------
<S> ` <C> <C> <C> <C> <C>
EARNINGS ASSETS:
Loans $13,215 $26,541 $40,420 $ 7,615 $ 87,791
Investments 5,228 7,310 14,755 13,804 41,097
Interest-bearing
deposits with other
banks 7,100 - - - 7,100
Federal Funds Sold 11,825 - - - 11,825
------- ------- ------ ------- --------
Total $37,368 $33,851 $55,175 $21,419 $147,813
======= ======= ======= ======= ========
INTEREST-BEARING DEPOSITS:
NOW accounts 9,991 - - - 9,991
Money market 3,327 - - - 3,327
Savings 15,149 - - - 15,149
Certificates of
Deposit 15,665 43,762 31,763 - 91,190
Other borrowing - - - - -
------- ------ ------ ------ --------
Total $44,132 $43,762 $31,763 - $119,657
======= ======= ======= ====== ========
Interest sensitivity
gap $(6,764) $(9,911) $23,412 $21,419 $ -
Cumulative interest
sensitivity gap $(6,764) $(16,675) $ 6,737 $28,156 $ 28,156
Ratio of sensitivity
gap to total earning
assets (4.6)% (6.7)% 15.8% 14.5% -
Cumulative ratio of
sensitivity gap to
total earning assets (4.6)% (11.3)% 4.6% 19.0% 19.0%
</TABLE>
- --------------------------------------------------------------------------------
Interest rate risk is the effect that changes in interest rates would have on
interest income and interest expense as interest-sensitive assets and
interest-sensitive liabilities either reprice or mature. Management attempts to
maintain the portfolios of earning assets and interest-bearing liabilities with
maturities or repricing opportunities at levels that will afford protection from
erosion of net interest margin, to the extent practical, from changes in
interest rates. Table 15 shows the sensitivity of the Bank's balance sheet on
December 31, 1998. This table reflects the sensitivity of the balance sheet as
of that specific date and is not necessarily indicative of the position on other
dates. At December 31, 1998, the Bank appeared to be cumulatively
asset-sensitive (earning assets subject to interest rate changes exceeding
interest-bearing liabilities subject to changes in interest rates). Included in
the interest-bearing liabilities subject to interest rate changes within
41
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
- --------------------------------------------------------------------------------
three months are NOW accounts and savings accounts totaling $25,140,000 which
historically have not been as interest-sensitive as other types of
interest-bearing deposits. Therefore, the Bank is asset sensitive in the three
month or less time period; liability sensitive in the four to twelve months time
period and asset-sensitive in the thirteen to sixty months time period and over
sixty months time period.
Matching sensitive positions alone does not ensure that the Bank has no interest
rate risk. The repricing characteristics of assets are different from the
repricing characteristics of funding sources. Thus, net interest income can be
impacted by changes in interest rates even if the repricing opportunities of
assets and liabilities are perfectly matched.
- --------------------------------------------------------------------------------
TABLE 16. KEY FINANCIAL RATIOS
- --------------------------------------------------------------------------------
1998 1997 1996
---- ---- ----
Return on average assets 1.3% 1.3% 1.2%
Return on average equity 11.5% 12.0% 11.6%
Average equity to average assets 11.4% 10.9% 10.4%
- --------------------------------------------------------------------------------
42
<PAGE>
STAFF
- --------------------------------------------------------------------------------
MAIN OFFICE
<TABLE>
<CAPTION>
CUSTOMER SERVICE LOAN OPERATIONS SECRETARIES
<S> <C> <C>
Diane Bishop Renee Akers Beulah Correll
Sherrie Janney Debra Funkhouser Yara Middleton
Betty Moran Gail Phillips, Supervisor Lisa Thomas
Sharon Zeman Jan Rorrer
DATA PROCESSING CENTER
Karen Sowers, Supervisor
Ruth Anders
PAYING AND RECEIVING TELLERS Wendy Taylor
Jill Caldwell
Jessica Bower COLLECTIONS
Gail Goad
Karen Bowman Ralph Edwards
Gay Grim
Regina Compton
CREDIT CARDS Leslie Moran
Regina Gibson
Shelia DeHart Patricia Whitlock
Helen Roberson
ACCOUNTING
Tammy Rutrough CUSTODIANS
Deborah Reed
Patsy Wallace Roger Dickerson
LENDING
Lucy Harris
Ola Lee Driskell
Dennis McDaniel
</TABLE>
----------
<TABLE>
<CAPTION>
CAVE SPRING OFFICE WILLIS OFFICE HILLSVILLE OFFICE
<S> <C> <C>
CUSTOMER SERVICE CUSTOMER SERVICE
HEAD TELLER
Margaret Caldwell Frances Sharpe
Karen Sutphin
PAYING AND RECEIVING PAYING AND RECEIVING
Kevin Harvey, Head Teller Rebecca Adams
Paula McDaniel Karen Arnold
Louise Goad, Head Teller
</TABLE>
43
<PAGE>
BOARD OF DIRECTORS OF CARDINAL BANKSHARES AND THE BANK OF FLOYD
- --------------------------------------------------------------------------------
K. VENSON BOLT C. W. HARMAN LEON MOORE
J. H. CONDUFF KEVIN D. MITCHELL DORSEY H. THOMPSON
WILLIAM R. GARDNER, JR.
<TABLE>
<S> <C>
OFFICERS OF CARDINAL BANKSHARES
- ---------------------------------------------------------------------------------------------------------------------------------
J. H. CONDUFF...............................................................................................CHAIRMAN OF THE BOARD
LEON MOORE..................................................................................PRESIDENT AND CHIEF EXECUTIVE OFFICER
CHRISTOPHER B. SNODGRASS.....................................................ASSISTANT VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
WANDA M. GARDNER....................................................................ASSISTANT VICE PRESIDENT AND INTERNAL AUDITOR
ANNETTE V. BATTLE.......................................................................................................SECRETARY
OFFICERS OF THE BANK OF FLOYD
- ---------------------------------------------------------------------------------------------------------------------------------
EXECUTIVE
J. H. CONDUFF...............................................................................................CHAIRMAN OF THE BOARD
K. VENSON BOLT.........................................................................................VICE CHAIRMAN OF THE BOARD
LEON MOORE..................................................................................PRESIDENT AND CHIEF EXECUTIVE OFFICER
LAWRENCE M. RENFROE......................................................................................EXECUTIVE VICE PRESIDENT
CHRISTOPHER B. SNODGRASS.....................................................ASSISTANT VICE PRESIDENT AND CHIEF FINANCIAL OFFICER
C. W. HARMAN............................................................................................................SECRETARY
SUNNY K. CORNWELL......................................................................ASSISTANT VICE PRESIDENT AND CREDIT REVIEW
MAIN OFFICE
LOIS A. BOND.............................................................................................ASSISTANT VICE PRESIDENT
PATRICIA K. HARRIS..............................................................................................ASSISTANT CASHIER
CAROLYN W. REED.................................................................................................ASSISTANT CASHIER
CAVE SPRING OFFICE
PATRICIA A. BOWER...............................................................................................ASSISTANT CASHIER
KIT C. EDWARDS..........................................................................................BRANCH OPERATIONS OFFICER
HILLSVILLE OFFICE
EUGENE G. SHOCKLEY....................................................................ASSISTANT VICE PRESIDENT AND BRANCH MANAGER
ADMINISTRATIVE
MARIE V. THOMAS................................................................................VICE PRESIDENT AND HUMAN RESOURCES
MARY ANN AYERS.........................................................ASSISTANT VICE PRESIDENT, FINANCIAL PRODUCTS AND MARKETING
ANNETTE V. BATTLE........................................................ASSISTANT SECRETARY TO THE BOARD AND RECORDING SECRETARY
PATRICIA B. SPANGLER.....................................................................................ADMINISTRATIVE ASSISTANT
SHELBY L. RUTHERFORD.....................................................................................ADMINISTRATIVE ASSISTANT
LENDING
DIANNE H. HAMM....................................................................ASSISTANT VICE PRESIDENT AND COMPLIANCE OFFICER
OPERATIONS
BETTY A. WHITLOCK................................................................ASSISTANT CASHIER AND MANAGER OF DATA PROCESSING
AUDIT
WANDA M. GARDNER....................................................................ASSISTANT VICE PRESIDENT AND INTERNAL AUDITOR
</TABLE>
44
<PAGE>
STOCKHOLDER INFORMATION
- --------------------------------------------------------------------------------
ANNUAL MEETING
The annual meeting of shareholders will be held Wednesday, April 28, 1999, at
2:00 p.m. in the community room at The Bank of Floyd, 101 Jacksonville Circle,
Floyd, Virginia.
----------
REQUESTS FOR INFORMATION
Requests for information should be directed to Mrs. Annette Battle, Recording
Secretary, at The Bank of Floyd, Post Office Box 215, Floyd, Virginia, 24091;
telephone (540) 745-4191. A copy of the Company's Form 10-KSB for 1998 will be
furnished, without charge, after March 31, 1999 upon written request.
----------
<TABLE>
<CAPTION>
INDEPENDENT AUDITORS STOCK TRANSFER AGENT
<S> <C>
Larrowe & Company, PLC The Bank of Floyd
Certified Public Accountants Post Office Box 215
Post Office Box 760 Floyd, Virginia 24091
Galax, Virginia 24333
</TABLE>
----------
FEDERAL DEPOSIT INSURANCE CORPORATION
The Bank is a member of the FDIC. This statement has not been reviewed, or
confirmed for accuracy or relevance by the Federal Deposit Insurance
Corporation.
----------
Member of Federal Reserve Bank of Richmond.
----------
Member of Federal Home Loan Bank of Atlanta.
----------
BANKING OFFICES
<TABLE>
<S> <C>
FLOYD OFFICE ROANOKE OFFICE
101 Jacksonville Circle 4094 Postal Drive
Floyd, Virginia 24091 Roanoke, Virginia 24018
(540) 745-4191 (540) 774-1111
ATM location ATM location
WILLIS OFFICE HILLSVILLE OFFICE
Floyd Highway South 185 South Main Street
Willis, Virginia 24380 Hillsville, Virginia 24343
(540) 745-4191 (540) 728-2341
ATM location
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION OF FINANCIAL CONDITION
AND
RESULTS OF OPERATION
- --------------------------------------------------------------------------------
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CARDINAL BANKSHARES AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET AT DECEMBER 30,
1998 AND THE CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED
DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,985,331
<INT-BEARING-DEPOSITS> 7,100,000
<FED-FUNDS-SOLD> 11,825,000
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 25,981,443
<INVESTMENTS-CARRYING> 15,347,979
<INVESTMENTS-MARKET> 15,741,038
<LOANS> 87,477,707
<ALLOWANCE> (1,688,201)
<TOTAL-ASSETS> 153,409,703
<DEPOSITS> 135,211,060
<SHORT-TERM> 0
<LIABILITIES-OTHER> 877,518
<LONG-TERM> 0
0
0
<COMMON> 5,119,110
<OTHER-SE> 12,202,015
<TOTAL-LIABILITIES-AND-EQUITY> 153,409,703
<INTEREST-LOAN> 8,034,738
<INTEREST-INVEST> 2,469,612
<INTEREST-OTHER> 765,140
<INTEREST-TOTAL> 11,269,490
<INTEREST-DEPOSIT> 5,797,887
<INTEREST-EXPENSE> 0
<INTEREST-INCOME-NET> 5,471,603
<LOAN-LOSSES> 175,000
<SECURITIES-GAINS> 27,315
<EXPENSE-OTHER> 3,065,748
<INCOME-PRETAX> 2,720,220
<INCOME-PRE-EXTRAORDINARY> 2,720,220
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,938,852
<EPS-PRIMARY> 3.79
<EPS-DILUTED> 3.79
<YIELD-ACTUAL> 3.91
<LOANS-NON> 66,251
<LOANS-PAST> 343,225
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 1,452,126
<CHARGE-OFFS> 76,842
<RECOVERIES> 117,917
<ALLOWANCE-CLOSE> 1,668,201
<ALLOWANCE-DOMESTIC> 1,668,201
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
