United States
Securities and Exchange Commission
Washington, D. C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended Commission File Number:
September 30, 1999 0-15204
National Bankshares, Inc.
- -------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Virginia 54-1375874
- -------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 South Main Street
P.O. Box 90002
Blacksburg, Virginia 24062-9002
- -------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(Registrant's telephone number, including area code) (540)552-2011
-------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 8, 1999
- ------------------------------- ---------------------------------
Common Stock, $2.50 Par Value 3,516,977
(This report contains 36 pages) <PAGE>
National Bankshares, Inc. and Subsidiaries
Form 10-Q
Index
Page
----
Part I Financial Information
- ----------------------------------------
Item 1 - Financial Statements
Consolidated Balance Sheets, September 30, 1999
and December 31, 1998 3-4
Consolidated Statements of Income and
Comprehensive Income, Three Months Ended
September 30, 1999 and 1998 5-6
Consolidated Statements of Income and
Comprehensive Income, Nine Months Ended
September 30, 1999 and 1998 7-8
Consolidated Statements of Changes in
Stockholders' Equity, Nine Months Ended
September 30, 1999 and 1998 9
Consolidated Statements of Cash Flows,
Nine Months Ended September 30, 1999 and 1998 10-11
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 18-29
Item 3 - Quantitative and Qualitative Disclosures About
Market Risk 32-34
Part II Other Information
- ----------------------------
Items 1 - 3 - Legal Proceedings; Changes in
Securities and Use of Proceeds;
Defaults Upon Senior Securities 35
Item 4 - Submission of Matters to a Vote of
Security Holders 35
Item 5 - Other Information 35
Item 6 - Exhibits and Reports on Form 8-K 35
Signatures 36
- ----------
-2-<PAGE>
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
September 30, 1999 and December 31, 1998
(Unaudited)
September 30, December 31,
($000's, except share and per share data) 1999 1998
============= ============
ASSETS
Cash and due from banks $ 11,899 14,421
Interest-bearing deposits 7,320 7,027
Federal funds sold 150 5,090
Securities available for sale 117,274 136,078
Securities held to maturity (fair value
$25,157 in 1999 and $31,151 in 1998) 25,185 30,676
Mortgage loans held for sale 570 2,180
Loans:
Real estate construction loans 17,451 12,827
Real estate mortgage loans 55,180 48,724
Commercial and industrial loans 142,866 110,509
Loans to individuals 73,155 69,493
-------- -------
Total loans 288,652 241,553
Less unearned income and deferred fees (2,023) (2,296)
-------- -------
Loans, net of unearned income
and deferred fees 286,629 239,257
Less allowance for loan losses (2,918) (2,679)
-------- -------
Loans, net 283,711 236,578
-------- -------
Bank premises and equipment, net 8,370 6,657
Accrued interest receivable 3,963 3,777
Other real estate owned, net 340 628
Other assets 3,891 2,054
-------- -------
Total assets $462,673 445,166
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Noninterest-bearing demand deposits $ 57,487 55,479
Interest-bearing demand deposits 83,001 84,319
Savings deposits 47,012 46,387
Time deposits 219,485 196,511
-------- -------
Total deposits 406,985 382,696
-------- -------
Other borrowed funds 559 214
Accrued interest payable 692 647
Other liabilities 1,113 926
-------- -------
Total liabilities 409,349 384,483
-------- -------
Common stock subject to ESOP put option 2,182 2,180
-------- -------
-3- (Continued)<PAGE>
Stockholders' equity:
Preferred stock of no par value.
Authorized 5,000,000 shares; none issued
and outstanding --- ---
Common stock of $2.50 par value.
Authorized 5,000,000 shares; issued and
outstanding 3,516,977 shares in 1999 and
3,792,833 in 1998 8,792 9,482
Retained earnings 47,022 50,182
Accumulated other comprehensive income
(loss) (2,490) 1,019
Common stock subject to ESOP put option (2,182) (2,180)
-------- -------
Total stockholders' equity 51,142 58,503
Commitments and contingent liabilities
-------- -------
Total liabilities and
stockholders' equity $462,673 445,166
======== =======
-4-<PAGE>
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
Three Months Ended September 30, 1999 and 1998
(Unaudited)
September 30, September 30,
($000's, except per share data) 1999 1998
============= =============
INTEREST INCOME
Interest and fees on loans $ 6,237 5,532
Interest on interest-bearing deposits --- 207
Interest on federal funds sold --- 99
Interest on securities - taxable 1,597 1,820
Interest on securities - nontaxable 582 492
---------- ---------
Total interest income 8,416 8,150
---------- ---------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 600 625
Interest on other deposits 2,830 2,961
Interest on borrowed funds 76 4
---------- ---------
Total interest expense 3,506 3,590
---------- ---------
Net interest income 4,910 4,560
Provision for loan losses 371 225
---------- ---------
Net interest income after provision
for loan losses 4,539 4,335
---------- ---------
NONINTEREST INCOME
Service charges on deposit accounts 391 295
Other service charges and fees 72 54
Credit card fees 216 170
Trust income 277 212
Other income --- 9
Realized securities gains, net --- 14
---------- ---------
Total noninterest income 956 754
---------- ---------
NONINTEREST EXPENSE
Salaries and employee benefits 1,486 1,460
Occupancy and furniture and fixtures 313 250
Data processing and ATM 242 197
FDIC assessment 12 17
Credit card processing 196 155
Goodwill amortization 9 9
Net costs of other real estate owned 18 ---
Other operating expense 749 692
---------- ---------
Total noninterest expense 3,025 2,780
---------- ---------
Income before income tax expense 2,470 2,309
Income tax expense 666 638
---------- ---------
Net income 1,804 1,671
-5- (Continued)<PAGE>
Other comprehensive income (loss), net of
taxes:
Unrealized gains (losses) on securities
available for sale (542) 691
---------- ---------
Comprehensive Income $ 1,262 2,362
========== =========
Net income per share $ 0.51 0.44
========== =========
Weighted average number of common
shares outstanding 3,516,977 3,792,833
========== =========
-6-<PAGE>
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income and Comprehensive Income
Nine Months Ended September 30, 1999 and 1998
(Unaudited)
September 30, September 30,
($000's, except per share data) 1999 1998
============= =============
INTEREST INCOME
Interest and fees on loans $ 17,612 16,129
Interest on interest-bearing deposits 77 544
Interest on federal funds sold 11 277
Interest on securities - taxable 5,203 5,334
Interest on securities - nontaxable 1,698 1,360
---------- ---------
Total interest income 24,601 23,644
---------- ---------
INTEREST EXPENSE
Interest on time deposits of $100,000 or more 1,846 1,813
Interest on other deposits 8,408 8,521
Interest on borrowed funds 6 10
---------- ---------
Total interest expense 10,260 10,344
---------- ---------
Net interest income 14,341 13,300
Provision for loan losses 840 319
---------- ---------
Net interest income after
provision for loan losses 13,501 12,981
---------- ---------
NONINTEREST INCOME
Service charges on deposit accounts 999 878
Other service charges and fees 186 153
Credit card fees 594 488
Trust income 718 565
Other income 57 63
Realized securities gains, net 24 99
---------- ---------
Total noninterest income 2,578 2,246
---------- ---------
NONINTEREST EXPENSE
Salaries and employee benefits 4,552 4,318
Occupancy and furniture and fixtures 840 741
Data processing and ATM 657 603
FDIC assessment 36 32
Credit card processing 538 446
Goodwill amortization 28 26
Net costs of other real estate owned 24 26
Other operating expense 2,222 2,134
---------- ---------
Total noninterest expense 8,897 8,326
---------- ---------
Income before income tax expense 7,182 6,901
Income tax expense 1,899 1,920
---------- ---------
Net income 5,283 4,981
-7- (Continued)<PAGE>
Other comprehensive income (loss), net of
taxes:
Unrealized gains (losses) on securities
available for sale (3,509) 768
---------- ---------
Comprehensive Income $ 1,774 5,749
========== =========
Net income per share $ 1.45 1.31
========== =========
Weighted average number of common
shares outstanding 3,638,232 3,792,833
========== =========
-8-<PAGE>
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Nine Months Ended September 30, 1999 and 1998
(Unaudited)
Common
Stock
Accumulated Subject
Other To ESOP
($000's, except for per Common Retained Comprehensive Put
share data) Stock Earnings Income Option Total
====== ========= ============= ======= =====
Balances, December 31,
1997 $9,482 46,191 194 (1,838) 54,029
Net income --- 4,981 --- --- 4,981
Unrealized gains
(losses) on securities
available for sale,
net of tax (1) --- --- 768 --- 768
Dividend ($0.36 per
share) --- (1,365) --- --- (1,365)
Change in common stock
subject to ESOP put
option --- --- --- 3 3
------ ------ ----- ------ ------
Balances, September 30,
1998 $9,482 49,807 962 (1,835) 58,416
====== ====== ===== ====== ======
Balances, December 31,
1998 $9,482 50,182 1,019 (2,180) 58,503
Net income --- 5,283 --- --- 5,283
Unrealized gains
(losses) on securities
available for sale,
net of tax (1) --- --- (3,509) --- (3,509)
Dividend ($0.39 per
share) --- (1,372) --- --- (1,372)
Stock tender offer (2) (690) (7,071) --- --- (7,761)
Change in common stock
subject to ESOP put
option --- --- --- (2) (2)
------ ------ ----- ------ ------
Balances, September 30,
1999 $8,792 47,022 (2,490) (2,182) 51,142
====== ====== ===== ====== ======
(1) Tax benefit of $1,808 in 1999 and tax expense of $396 for 1998.
(2) Represents the repurchase of 275,856 shares at $28.00 per share and
related expenses.
-9-<PAGE>
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1999 and 1998
(Unaudited)
September 30, Septmeber 30,
($000's) 1999 1998
============= =============
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 5,283 4,981
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 840 319
Depreciation of bank premises and equipment 655 593
Amortization of intangibles 114 106
Amortization of premiums and accretion of
discounts, net 361 47
Gains on bank premises and equipment
disposals --- (7)
Gains on sales and calls of securities
available for sale, net (24) ---
Gains on calls of securities held to
maturity, net --- (99)
(Gains) losses on other real estate owned 14 (19)
(Increase) decrease in:
Mortgage loans held for sale 1,610 (127)
Accrued interest receivable (186) (198)
Other assets (143) (706)
Increase in:
Accrued interest payable 45 3
Other liabilities 187 599
------- -------
Net cash provided by operating
activities 8,756 5,492
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Net decrease in federal funds sold 4,940 70
Net increase in interest-bearing
deposits (293) (6,404)
Proceeds from calls and maturities of securities
available for sale 23,903 23,000
Proceeds from sales of securities available for
sale 1,218 ---
Proceeds from calls and maturities of securities
held to maturity 5,464 30,472
Purchases of securities available for sale (11,944) (57,235)
Purchases of securities held to maturity --- (2,000)
Purchases of loan participations (6,763) (1,640)
Collections of loan participations 11,045 4,074
Loans purchased, including premium --- (3,811)
Net increase in loans made to customers (52,362) (15,215)
Proceeds from disposal of other real estate owned 336 194
Recoveries on loans charged off 45 215
Bank premises and equipment expenditures (2,368) (948)
Proceeds from sale of bank premises and equipment --- 7
------- -------
Net cash used in investing
activities (26,779) (29,221)
------- -------
-10- (Continued)<PAGE>
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits acquired, net of premium paid --- 6,827
Net increase in time deposits 22,974 7,974
Net increase in other deposits 1,315 7,875
Net increase (decrease) in other borrowed funds 345 (297)
Cash dividends paid (1,372) (1,365)
Repurchase of common stock (7,761) ---
------- -------
Net cash provided by financing
activities 15,501 21,014
------- -------
Net decrease in cash and due from banks (2,522) (2,715)
Cash and due from banks at beginning of period 14,421 12,435
------- -------
Cash and due from banks at end of period $11,899 9,720
======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $10,215 10,341
======= =======
Cash paid for income taxes $ 2,154 2,052
======= =======
Loans charged to the allowance for loan losses $ 646 313
======= =======
Loans transferred to other real estate owned $ 62 40
======= =======
-11-<PAGE>
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
September 30, 1999
(Unaudited)
Note (1)
The consolidated financial statements of National Bankshares, Inc.
(Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg
(NBB) and Bank of Tazewell County (BTC), (the Company), conform to generally
accepted accounting principles and to general practices within the banking
industry. The accompanying interim period consolidated financial statements
are unaudited; however, in the opinion of management, all adjustments
consisting of normal recurring adjustments which are necessary for a fair
presentation of the consolidated financial statements have been included. The
results of operations for the nine months ended September 30, 1999 are not
necessarily indicative of results of operations for the full year or any other
interim period. The interim period consolidated financial statements and
financial information included herein should be read in conjunction with the
notes to consolidated financial statements included in the Company's 1998
Annual Report to Stockholders and additional information supplied in the 1998
Form 10-K.
-12-<PAGE>
Note (2) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended
September 30, December 31,
1999 1998 1998 1997
($000's, except for % data) ========= ======== ============= ============
Balance at beginning of period $ 2,679 2,438 2,438 2,575
Provision for loan losses 840 319 624 435
Loans charged off (646) (313) (638) (679)
Recoveries 45 215 255 107
-------- -------- --------- ---------
Balance at the end of period $ 2,918 2,659 2,679 2,438
======== ======== ========= =========
Ratio of allowance for loan
losses to end of period loans,
net of unearned income and
deferred fees 1.02% 1.14% 1.12% 1.12%
======== ======== ========= =========
Ratio of net charge-offs
(recoveries) to average loans,
net of unearned income and
deferred fees(1) .31% .06% .17% .28%
======== ======== ========= =========
Ratio of allowance for loan
losses to nonperforming
loans(2) 4,421.21% 6,647.50% 9,567.86% 2,802.30%
======== ======== ========= =========
(1) Net charge-offs are on an annualized basis.
(2) The Company defines nonperforming loans as total nonaccrual and
restructured loans. Loans 90 days past due and still accruing are
excluded.
September 30, December 31,
($000's, except for % data) 1999 1998 1998 1997
======== ======== ======== ========
Nonperforming Assets
Nonaccrual loans $ 67 40 28 87
Restructured loans --- --- --- ---
------ ------ ------ ------
Total nonperforming loans 67 40 28 87
Foreclosed property 340 286 628 421
------ ------ ------ ------
Total nonperforming assets $ 407 326 656 508
====== ====== ====== ======
Ratio of nonperforming assets to
loans, net of unearned income and
deferred fees, plus other real
estate owned .14% .14% .27% .23%
====== ====== ====== ======
-13-<PAGE>
Accruing Loans Past Due 90 Days or More
---------------------------------------
Past due 90 days or more and
still accruing $2,755 899 550 672
====== ====== ====== ======
Ratio of loans past due 90 days or
more to loans, net of unearned
income and deferred fees .96% .39% .23% .31%
====== ====== ====== ======
Impaired Loans
--------------
Total impaired loans $ 67 600 373 177
====== ====== ====== ======
Impaired loans with a
valuation allowance $ --- 284 145 53
Valuation allowance --- (52) (145) (53)
------ ------ ------ ------
Impaired loans net of allowance $ --- 232 --- ---
====== ====== ====== ======
Impaired loans with no
valuation allowance $ 67 316 228 124
====== ====== ====== ======
Average recorded investment
in impaired loans $ 107 360 387 458
====== ====== ====== ======
Income recognized on impaired
loans $ --- 49 32 23
====== ====== ====== ======
Amount of income recognized
on a cash basis $ --- --- --- 12
====== ====== ====== ======
-14-<PAGE>
Note (3) Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for sale by major security type as of
September 30, 1999 are as follows:
September 30, 1999
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
--------- ---------- ---------- ------
Available for sale:
U.S. Treasury $ 7,249 53 42 7,260
U.S. Government
agencies and
corporations 50,870 24 2,171 48,723
States and political
subdivisions 32,894 192 1,086 32,000
Mortgage-backed
securities 13,895 14 180 13,729
Corporate debt
securities 14,352 26 603 13,775
Federal Home Loan
Bank stock 1,328 --- --- 1,328
Other securities 459 --- --- 459
-------- -------- -------- --------
Total securities
available for sale $121,047 309 4,082 117,274
======== ======== ======== ========
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of
September 30, 1999 are as follows:
September 30, 1999
Gross Gross
Amortized Unrealized Unrealized Fair
($ in thousands) Costs Gains Losses Values
--------- ---------- ---------- ------
Held to maturity:
U.S. Treasury $ 502 --- --- 502
U.S. Government
agencies and
corporations 5,499 5 213 5,291
States and political
subdivisions 18,792 198 29 18,961
Mortgage-backed
securities 392 11 --- 403
-------- -------- -------- -------
Total securities
held to maturity $25,185 214 242 25,157
======== ======== ======== =======
-15-<PAGE>
Note (4) Restrictions on Dividend Payments and Capital Requirements
Bankshares' and its subsidiaries' actual regulatory capital amounts and
ratios are also presented in the following tables:
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
($ in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
September 30, 1999:
Total capital(1)
Bankshares
consolidated $57,720 18.56% 24,883 8.00% N/A N/A
NBB 28,751 13.90% 16,552 8.00% 20,691 10.00%
BTC 26,475 24.77% 8,551 8.00% 10,689 10.00%
Tier I capital(1)
Bankshares
consolidated $54,802 17.62% 12,441 4.00% N/A N/A
NBB 26,761 12.93% 8,276 4.00% 12,414 6.00%
BTC 25,547 23.90% 4,275 4.00% 6,413 6.00%
Tier I capital(2)
Bankshares
consolidated $54,802 12.06% 18,170 4.00% N/A N/A
NBB 26,761 9.70% 11,037 4.00% 16,556 5.00%
BTC 25,547 14.09% 7,253 4.00% 10,879 5.00%
(1) To Risk Weighted Assets
(2) To Average Assets
-16-<PAGE>
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
($ in thousands) Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 1998:
Total capital(1)
Bankshares
consolidated $61,216 22.4% 21,819 8.0% N/A N/A
NBB 30,411 16.5% 14,747 8.0% 18,433 10.0%
BTC 28,284 31.8% 7,112 8.0% 8,890 10.0%
Tier I capital(1)
Bankshares
consolidated $58,537 21.5% 10,910 4.0% N/A N/A
NBB 28,511 15.5% 7,373 4.0% 11,060 6.0%
BTC 27,505 30.9% 3,536 4.0% 5,334 6.0%
Tier I capital(2)
Bankshares
consolidated $58,537 13.4% 17,457 4.0% N/A N/A
NBB 28,511 11.1% 10,292 4.0% 12,865 5.0%
BTC 27,505 15.6% 7,068 4.0% 8,835 5.0%
(1) To Risk Weighted Assets
(2) To Average Assets
Substantially all of Bankshares' retained earnings are undistributed
earnings of its banking subsidiaries, which are restricted by various
regulations administered by federal and state bank regulatory agencies. Bank
regulatory agencies restrict, without prior approval, the total dividend
payments of a bank in any calendar year to the bank's retained net income of
that year to date, as defined, combined with its retained net income of the
preceding two years, less any required transfers to surplus. At September 30,
1999, retained net income from the Company's NBB affiliate which was free of
such restriction amounted to approximately $2,506.
At present, no dividends are available from the Company's BTC affiliate
without prior regulatory approval. BTC remains well capitalized and management
does not believe that such approvals will be withheld.
Note (5) Stock Option Plan
In April 1999, the National Bankshares, Inc. 1999 Stock Option Plan was
approved by the Company's shareholders. The purpose of the Stock Option Plan
is to provide additional incentive to key employees in the form of stock
options. The determination of key employees and the amount of awards will be
determined by the Stock Option Committee of the Board of Directors. On June 4,
1999, Form S-8 was filed with the Securities and Exchange Commission
registering 250,000 shares under the Plan. To date, no stock option awards
have been granted.
-17-<PAGE>
National Bankshares, Inc. and Subsidiaries
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (In thousands, except for per share data)
The purpose of this discussion is to provide information about the
financial condition and results of operations of National Bankshares, Inc. and
its wholly-owned subsidiaries (the Company), which are not otherwise apparent
from the consolidated financial statements and other information included in
this report. Reference should be made to the financial statements and other
information included in this report as well as the 1998 Annual Report and Form
10-K for an understanding of the following discussion and analysis.
This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. The Company's actual results could
differ materially from those set forth in the forward-looking statements.
Analysis of Financial Condition and Results of Operations for the Nine Months
Ended September 30, 1999
- -------------------------------------------------------------------------------
Net income for the nine months ended September 30, 1999 was $5,283 which
represents an increase of $302 or 6.06% over the first nine months of 1998.
The return on average assets for the nine months ended September 30, 1999 was
1.59% and 1.60% for the period ended September 30, 1998. The return on average
equity was 12.36% for the period ended September 30, 1999 and 11.58% for the
period ended September 30, 1998.
Earnings per share for the period ended September 30, 1999 was $1.45 per
share, an increase of $0.14 per share over the same period in 1998.
The following table provides selected consolidated financial data.
September 30, December 31,
($000's, except per share and 1999 1998 1998 1997
percent data) ====== ====== ============ ============
Interest income $24,601 23,644 31,828 29,797
Interest expense 10,260 10,344 13,928 13,106
Net interest income 14,341 13,300 17,900 16,691
Provision for loan losses 840 319 624 435
Noninterest income 2,578 2,246 3,174 2,834
Noninterest expense 8,897 8,326 11,061 10,031
Income taxes 1,899 1,920 2,591 2,499
Net income $ 5,283 4,981 6,798 6,560
Return on average assets 1.59% 1.60% 1.61% 1.66%
Return on average equity (1) 12.36% 11.58% 11.66% 12.21%
Basic net income per share $ 1.45 1.31 1.79 1.73
Book value per share (1) $ 15.16 15.88 16.00 14.73
(1) Includes amount related to common stock subject to ESOP put option
excluded from stockholders' equity on the Consolidated Balance Sheets.
-18-<PAGE>
Net Interest Income
- -------------------
Net interest income at the end of the first nine months of 1999 was
$14,341, an increase of $1,041 or 7.83% over the same period in 1998.
The net interest margin is one of the primary ratios used by banks to
measure net interest income. The net interest margin is composed of the yield
on earning assets on a fully tax equivalent basis less the cost to fund earning
assets. The funding cost factors in interest bearing deposits as well as
capital and demand deposits. The following table sets forth the Company's net
interest margin for the period specified.
September 30, December 31,
1999 1998 1998 1997
--------- --------- ------------------------
Yield on earning assets 8.12% 8.32% 8.25% 8.24%
Cost to fund earning assets 3.25% 3.52% 3.50% 3.50%
-------- ------- ------- -------
Net interest margin 4.87% 4.80% 4.75% 4.74%
======== ======= ======= =======
As can be seen by the table shown above, the yield on earning assets for
the nine months ended September 30, 1999 has decreased by 13 basis points from
the year-ended 1998. The cost to fund earning assets decreased by 25 basis
points. These elements combined to produce a 12 basis point increase in the
net interest margin.
A second measure of net interest income is the net interest spread. The
ratio consists of the yield on earning assets on a fully tax equivalent basis
less the cost of interest bearing liabilities. It does not reflect the benefit
received from "free funds" provided by demand deposits and capital. The
following table sets forth the Company's net interest spread for the periods
shown.
September 30 December 31,
1999 1998 1998 1997
--------- --------- ------------ ------------
Yield on earning assets 8.12% 8.32% 8.25% 8.24%
Cost of interest-bearing
liabilities 4.15% 4.51% 4.48% 4.43%
-------- ------- ------- -------
Net interest spread 3.97% 3.81% 3.77% 3.81%
======== ======= ======= =======
Provision and Allowance for Loan Losses
- ---------------------------------------
The adequacy of the allowance for loan losses is based on management's
judgement and analysis of current and historical loss experience, risk
characteristics of the loan portfolio, concentrations of credit and asset
quality, as well as other internal and external factors such as general
economic conditions.
-19-<PAGE>
An internal credit review department performs pre-credit analyses of large
credits and also conducts credit review activities that provide management with
an early warning of asset quality deterioration. Changing trends in the loan
mix are also evaluated in determining the adequacy of the allowance for loan
losses.
It should be noted that loans past due 90 days or more have increased when
compared to prior period data. Included in loans past due 90 days or more are
two credits with the same borrower totaling approximately $1.7 million. As of
September 30, 1999, these loans are well collaterialized and currently in a
work-out process. Management believes the work-out will be completed during
the fourth quarter. However, should circumstances change and consumation not
occur as expected, these loans may be placed on nonaccrual status.
Overall, it is expected that provisions for loan loss expense will be
higher in 1999. Such expense will be required by strong loan growth and the
need to maintain an adequate overall allowance.
Noninterest Income
- ------------------
Noninterest income is an important source of the Company's income. This
category is comprised of service charges on deposit accounts, other service
charges and fees, credit card fees, trust income and other income. Net
securities gains and losses are also included in this category.
Noninterest income for the period ended September 30, 1999 was $2,578, an
increase of $332 or 14.78% over the same period in 1998.
Service charges on deposit accounts were $999 at September 30, 1999, an
increase of $121 or 13.78% from the same period in 1998. This was primarily
due to an increase in the level of account service charges, return check and
overdraft fees and ATM transaction fees.
Other service charges increased by $33 when September 30, 1999 and 1998
are compared.
Credit card fees increased by $106 or 21.72% when the first nine months of
1999 and 1998 are compared. Continued growth in volume was the primary cause
of this increase.
Trust income increased by 27.08% when compared to the first nine months of
1998. Trust income is dependent on market conditions as well as the types of
accounts being handled at any given point in time. The level of estate
business, for example, cannot be predicted with any degree of preciseness.
Other income, which is comprised of various miscellaneous types of income,
decreased by $6 for the first nine months of 1999.
Net securities gains and losses decreased $75 when 1999 and 1998 are
compared. The income in this category primarily reflects gains and losses on
securities called prior to maturity.
-20-<PAGE>
Noninterest Expense
- -------------------
Noninterest expenses for the first nine months of 1999 were $8,897, an
increase of $571 or 6.86% over the first nine months of 1998.
Salaries and fringe benefits were $4,552 at the end of the first nine
months of 1999. This represents an increase of $234 or 5.42% over the first
nine months of 1998. A portion of this increase was due to the acquisition of
the Galax branch. This facility was acquired in the second quarter of 1998.
Accordingly, 1998 data contains only a lesser amount of salaries expense
associated with the acquisition. The remainder of the increase was due to
normal merit increases and other personnel related costs.
Occupancy expenses increased by $99 or 13.36% when the first nine months
of 1999 and 1998 are compared. Acquisition of the previously mentioned Galax
Branch contributed to this increase. Occupancy expenses are expected to
increase with the addition of a new facility in the third quarter of 1999.
This addition was built to serve as a corporate headquarters and to provide
office space to replace leased properties. The facility also contains a branch
bank of NBB.
Data processing expense increased by $54 or 8.96%.
Credit card expense increased by $92 or 20.63% in the first nine months of
1999. Increases in overall volume contributed to this increase. Included in
the category was approximately $4 in expense related to the reissuance of debit
cards. The next scheduled reissuance will be in four years.
Other expenses at September 30, 1999 were $2,222, which represents an
increase of $88 or 4.12% over the same period in 1998. Other expenses include
various types of costs. Examples of expense accounts included are telephone,
franchise taxes, stationary and supplies, market expense, correspondent charges
and numerous others. Some expenses included in this area represent accrued
expense for anticipated expenditures, while others are on a cash or pay as
incurred basis. Some categories are within management's ability to control
while others can only be controlled to a degree.
-21-<PAGE>
Balance Sheet
- -------------
The following table sets forth selected consolidated balance sheet data.
September 30, December 31,
1999 1998 1998 1997
========= ========= ============ ============
($000's)
Selected Period-End Data
- ------------------------
Loans, net $283,711 230,570 236,578 214,552
Total Securities 142,459 156,953 166,754 149,974
Total Assets 462,673 430,631 445,166 402,907
Total Deposits 406,985 367,902 382,696 344,867
Stockholders' Equity 51,142 58,416 58,503 54,029
Selected Daily Averages Data
- ----------------------------
Loans, net $259,934 222,538 225,613 204,540
Total securities 155,252 149,606 152,432 157,179
Interest-earning assets 421,457 392,998 398,340 374,478
Total assets 445,384 415,109 420,988 395,932
Total deposits 385,959 354,830 359,970 339,439
Interest-bearing liabilities 330,576 306,855 310,634 295,565
Stockholders' equity 54,944 55,449 58,282 53,712
Total average assets at September 30, 1999 were $445,384, an increase of
$30,275 or 7.29% from September 30, 1998. A portion of this increase was due
to the acquisition of the Galax branch in the third quarter of 1998. The
Company also continues to experience satisfactory growth in deposits from
nonacquisition related sources.
In the third quarter of 1999, the Office of the Controller Currency
announced the closure of a National Banking Institution in Keystone, West
Virginia. As a result of the closure, depositors in that area were forced to
seek banking relationships with other institutions in the general area. The
Company's BTC affiliate was a benefactor of this event.
-22-<PAGE>
The following table sets forth selected balance sheet caption as a
percentage of total assets at the dates shown.
September 30, December 31,
1999 1998 1998 1997
========= ========= ========================
Assets
- ------
Interest bearing-deposits 1.58% 3.75% 1.58% 2.41%
Federal funds sold .03% .98% 1.14% 1.07%
Securities available for sale 25.35% 23.45% 30.57% 16.28%
Securities held to maturity 5.44% 13.00% 6.89% 20.95%
Mortgage loans held for sale .12% .12% .49% .10%
Real estate construction
loans 3.77% 2.33% 2.88% 2.11%
Real estate mortgage loans 11.93% 10.83% 10.95% 10.66%
Commercial and industrial
loans 30.88% 25.71% 24.82% 25.16%
Loans to individuals 15.81% 15.86% 15.61% 16.54%
Liabilities
- -----------
Noninterest-bearing demand
deposits 12.42% 12.31% 12.46% 11.19%
Interest-bearing demand
deposits 17.94% 17.86% 18.94% 19.33%
Savings deposits 10.16% 11.08% 10.42% 11.61%
Time deposit 47.44% 44.19% 44.14% 43.47%
Other borrowed funds .12% .04% .05% .12%
A comparison of the loan portfolio at September 30, 1999 and 1998
indicates that construction and commercial loans have experienced the greatest
increase followed by real estate. Loans to individuals have declined slightly
as part of total assets.
-23-<PAGE>
As shown by the above table, management has shifted a substantial portion
of its investment portfolio to the available for sale category. A portion of
this shift was accomplished through calls, maturities of bonds and their
subsequent reinvestment. In the fourth quarter of 1998, the Company adopted
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and hedging Activities". The statement allowed, upon adoption, the
transfer of securities from the held to maturity classification to the
available for sale without calling into question management's intent to hold
its remaining securities until maturity. The Company used this opportunity to
transfer approximately $20,516 in securities to held for sale category.
The overall mix of loan and deposits has remained roughly the same.
Liquidity
- ---------
Liquidity is the ability to provide sufficient cash levels to meet
financial commitments and to fund loan demand and deposit withdrawals. Net
cash provided by operating activities was $8,756 for the nine months ended
September 30, 1999. Net cash used in investing activities was $26,779 with the
majority of that cash invested in securities and loans. Net cash used in
financing activities was $15,501. Net cash decreased $2,522 from December 31,
1998.
During the first nine months of 1999 the Company repurchased 275,856 of
its common shares at $28.00 per share. Cash used for the purchase and related
expenses was $7,761.
The Company actively manages its liquidity position through its investing
activities. In addition, securities with a remaining maturity of less than one
year totaled $8,191. Liquidity is also managed through the management of
deposit liabilities, in particular, volatile funds such as time deposits over
$100. The amount of such deposits is largely dependent on the rate of interest
offered. The Company had approximately $35,060 in such deposits due within
twelve months. Other types of deposits such as interest-bearing demand,
savings and time deposits less than $100 are less volatile and less rate
dependent historically.
Short-term liquidity needs can also be satisfied by way of credit
facilities established with correspondent banks, the Federal Home Loan Bank and
Federal Reserve. Longer term borrowings, if necessary, can be obtained through
the Federal Home Loan Bank.
At present the Company is relying on short-term borrowings for liquidity.
While the procurement of additional deposits remains an option, increased
interest expense would likely result, as interest rates would have to be
increased to attract new deposits. The increase in interest rates would
eventually affect the existing deposit base creating additional interest
expense.
The Company completed construction of a new office building in the third
quarter. This facility will serve as corporate headquarters, provide
additional office space to replace existing leased properties and also add a
branch facility. This project did not have a material impact on the Company's
liquidity.
-24-<PAGE>
The Year 2000 also has liquidity implications. Management is fully aware
of customer apprehension associated with the Year 2000 date change.
Accordingly, it is management's plan to provide for additional liquidity as
part of its contingency planning processes. Please refer to the above
information related to the establishment of credit facilities and the Year 2000
discussion which follows for the steps the Company is taking to allay
unwarranted customer concerns.
Management is not aware of any other events that will result in or that
are reasonably likely to result in a decrease in liquidity that would be
adverse and to a degree that operations would be materially impaired.
Capital Resources
- -----------------
Total stockholders' equity decreased $7,361 or 12.58% from December 31,
1998. During the first nine months of 1999, retained earnings decreased by
$3,160. Retained earnings experienced this net decrease due to the payment of
a dividend ($1,372), the repurchase of 275,856 shares of common stock ($7,071)
offset by earnings of $5,283. Accumulated comprehensive income decreased
stockholders' equity by $3,509. This category is comprised solely of changes
in the net unrealized gains (losses) on securities available for sale. Common
stock subject to put option increased by $2. The common stock subject to put
option is affected by the current market price of the Company's common stock as
well as the number of shares outstanding. See Note (4) for the Company's Risk
Based Capital Ratio's.
Tender Offer
- ------------
On March 15, 1999, the Company announced a stock tender offer. The
Company sought to repurchase 200,000 shares, but reserved the right to purchase
an additional two percent of its outstanding shares of common stock. The
tender off closed on April 30, 1999. The offer resulted in the repurchase of
275,856 shares. The Company's Form 13E-4 filed March 15, 1999, amended 13E-4
filed March 31, 1999 and the Final Amendment filed May 24, 1999 are
incorporated herein.
Selected Affiliate Bank Data
- ----------------------------
The following table sets forth selected data for NBB and BTC:
September 30, 1999
------------------
(000's, except for % data) NBB BTC
--- ---
Assets $278,311 196,482
Deposits 235,987 171,096
Net Income 3,608 1,665
Return on Average Assets 1.79% 1.25%
Return on Average Equity 16.89% 8.55%
-25-<PAGE>
Year 2000
- ---------
The Company recognizes the risks and challenges presented by the impact of
the century date change on information processing and other microchip
controlled systems. The Year 2000 ("Y2K") involves several issues for
financial institutions. The Company's own internal information processing and
microchip controlled systems, as well as those of its major service vendors,
must be Y2K compliant. Banks face credit, earnings and liquidity risk should
commercial loan customers or large depositors suffer significant business
disruptions as a result of the impact of computer failures in their own
operations or in those of their suppliers or customers. Banks could encounter
temporary funding shortages if customers withdraw unusually large sums of cash
because they are unduly concerned about the effects of Y2K. And, although
management believes the level of counterpart trading risk is low, there could
be a temporary or permanent effect on the investment portfolio resulting from
the negative impact of Y2K on the underlying entities.
Both of the Company's bank subsidiaries have established Y2K project
management teams that have developed Y2K plans with assessment, testing, and
remediation phases. The internal audit department is conducting Y2K audits,
and both banks are subject to the guidelines promulgated by the Federal
Financial Institutions Examination Counsel (FFIEC) and to regular Year 2000
compliance examinations by their respective federal regulators.
The assessment phase outlined in both NBB's and BTC's Y2K plans has been
completed. The banks have identified all internal mission critical information
technology and microchip controlled systems. Outside vendors that provide
mission critical service to the institutions have also been identified.
Because of their importance to daily business operations, substantial
attention has been focused on the banks' customer information processing
hardware and software. In 1997, in the normal course of business, NBB
purchased a new Unisys host computer and peripherals and installed the latest
version of its Information Technology, Inc. (ITI) software. In the last
quarter of 1998, BTC converted from its previous in-house information
processing system. BTC is now processed using NBB's hardware and software.
The NBB system has been tested, including century date rollover and other
critical dates, and validation of the ITI application is complete.
Each bank has identified as mission critical independent information
technology systems in their Trust Departments. NBB has successfully completed
proxy testing of its external service provider, and BTC has successfully tested
its internal system. Microchip controlled bank security systems are also
mission critical. Testing of these systems at both banks determined that minor
renovations were necessary at three offices. Those renovations are now
complete.
The Federal Reserve Bank of Richmond has provided comprehensive procedures
and instructions for interface testing. During the first quarter of 1999, NBB
and BTC successfully tested all utilized services, including wire transfer,
automated clearing house and savings bonds.
Both NBB and BTC deal with outside vendors that provide mission critical
support for bank card processing and ATM servicing. The banks are monitoring
these vendors' progress to assure their Y2K readiness. The vendors regularly
provide status reports and testing criteria. In the first quarter of 1999,
both BTC and NBB converted to a new ATM servicer. Testing of that application
was successfully concluded.
-26-<PAGE>
Each bank has developed and implemented programs to assess the level of
Y2K risk among large loan customers. NBB's Credit Review department performs a
precredit analysis of all new large loans made by both banks. An assessment of
the potential effects of the Year 2000 on the credit-worthiness of borrowers is
a part of this analysis. BTC is asking new commercial borrowers to sign an
agreement to insure compliance with minimum standards with regard to Y2K
issues. That bank is also following up with these borrowers to insure that
promised deadlines are met. Both NBB and BTC have also completed assessments
of Year 2000 preparedness among existing large commercial loan customers.
The banks have ongoing initiatives designed to educate customers about Y2K
issues and to allay any unwarranted concerns about the safety and soundness of
the institutions. Leaflets discussing the topic were sent to all customers,
and the banks have posted information on their Web sites. NBB held a public
forum directed at small businesses and has established a toll free information
hotline. Employee training and awareness campaigns have been completed.
Additional employee training and public education efforts are planned
throughout the rest of 1999.
Contingency plans have been drafted by NBB and BTC to 1) identify
alternatives if mission critical applications do not meet the banks' readiness
plan, and 2) develop a course of action to assure business continuity in the
event there are system failures on critical dates. Both institutions are
providing their Boards of Directors with regular reports on Y2K initiatives and
preparedness, and both Boards have approved bank contingency plans.
At this time, National Bankshares, Inc. believes that in the most likely
worst-case scenarios, Y2K will not have a material effect on the Company's
operations, liquidity or financial condition. Although contingency plans
address multiple alternative scenarios, the Company believes it is impossible
for any business to address the potentially unlimited number of possible
circumstances relating to Y2K issues. Even though it is highly unlikely,
National Bankshares recognizes that if its Y2K assessment, remediation or
contingency plans prove to be inadequate, this could have a material impact on
its operations and therefore result in a material adverse effect on the
Company's results of operations and financial condition.
The Company's recently completed upgrade of internal processing systems
does enhance Y2K preparedness. However, the major goals of the upgrade were to
provide a shared information processing system for affiliates and to provide
additional processing capacity and the ability to use the most advanced version
of software available. The costs of the upgrade were substantial, but the
total of costs of the upgrade directly related to the Y2K component was not
material.
-27-<PAGE>
<TABLE>
Analysis of Financial Condition and Results of Operations for the Three Months Ended September 30, 1999
- --------------------------------------------------------------------------------------------------------
The following table sets forth selected quarterly consolidated financial data.
<CAPTION>
For the Quarter-Ended
($000's, except per share September 30, June 30, March 31, December 31, September 30,
and percent data) 1999 1999 1999 1998 1998
------------- -------- --------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Interest income $8,416 8,170 8,089 8,184 8,150
Interest expense 3,506 3,392 3,436 3,584 3,590
Net interest income 4,910 4,778 4,653 4,600 4,560
Provision for loan loss 371 237 232 305 225
Noninterest income 956 856 766 928 754
Noninterest expense 3,025 2,946 2,926 2,735 2,780
Income taxes 666 651 582 671 638
Net income $1,804 1,800 1,679 1,817 1,671
Return on average assets 1.60% 1.61% 1.54% 1.65% 1.56%
Return on average equity 13.64% 12.55% 11.12% 11.80% 11.37%
Basic net income per share $ 0.51 0.50 0.44 0.48 0.44
</TABLE>
<TABLE>
Daily Averages for the Quarter Ended
<CAPTION>
($000's, except per share September 30, June 30, March 31, December 31, September 30,
and percent data) 1999 1999 1999 1998 1998
------------- -------- --------- ------------ -------------
<S> <C> <C> <C> <C> <C>
Loans, net $277,588 260,077 241,788 234,817 226,338
Total securities 145,064 153,227 167,828 161,873 155,884
Total assets 452,176 447,683 442,926 439,469 427,725
Total deposits 392,710 385,610 379,465 375,607 366,490
Stockholders' equity 52,908 57,361 61,338 61,596 58,778
Net Income for the third quarter of 1999 was $1,804 which represents an increase of $133 or 7.96%
over the third quarter of 1998.
The return on average assets for the quarter-ended September 30, 1999 and September 30, 1998 was
1.60% and 1.56%, respectively. The return on average equity for the third quarter of 1999 was 13.64%
and 11.37% for the third quarter of 1998.
The improvement in the return on average equity was in part due to an increase in net income and to
a reduction in average equity as a result of a tender offer completed in the second quarter of 1999.
Earnings per share for the third quarter of 1999 was $0.51, an increase of $0.07 over the third
quarter in 1998.
</TABLE>
-28-<PAGE>
Net Interest Income
- -------------------
Net interest income for the third quarter of 1999 was $4,910 an increase
of $350 over the third quarter of 1998. The principal cause of this net
increase was loan volume.
Provision for Loan Losses
- -------------------------
The provision for loan losses for the third quarter was $371 compared to
$225 in 1999. As previously mentioned, it is expected that bad debts expense
will continue to increase in 1999 due to loan growth and the need to maintain
an adequate overall allowance.
Noninterest Income
- ------------------
Noninterest income for the third quarter of 1999 was $956, an increase of
$202 or 26.79% over the same period last year. While most categories
experienced increases, securities gains and losses declined substantially.
Such gains and losses are dependent primarily on securities with call features.
Noninterest Expense
- -------------------
Noninterest expense for the quarter ended September 30, 1999 was $3,025,
an increase of $245 or 8.81% over the same period in 1998. Occupancy expenses
increased by $63 when compared to the third quarter of 1998. In the third
quarter 1999 the Company opened a new facility to serve as a corporate
headquarters and an additional NBB branch, which contributed to the increase.
It is expected that this category will increase further as a result of that
addition.
Data processing expense also showed an increase. In the fourth quarter of
1998 the Company updated its computer mainframe and converted its BTC affiliate
to the same system utilized by NBB. Accordingly, additional costs related to
this project are included in 1999 third quarter income only.
Balance Sheet
- -------------
Total average quarterly assets for the three months ended September 30,
1999 were $452,176 an increase of $24,451 or 5.72% over the third quarter of
1998. Total average quarterly deposits increased $26,220 or 7.15% when the two
periods are compared. Reference is made to previous comments related to
deposit growth at the Company's BTC affiliate.
-29-<PAGE>
Banking Terms
Basis Point - a deposits in other borrowed funds.
measure-ment unit banks.
defined as one Net Interest Margin -
hundredth of one net taxable-equivalent
percent; it usually Earnings Per Share- interest income divided
refers to an interest Basic - net income, by average earning
rate. reduced by dividends on assets.
preferred stock,
Book Value Per Share - divided by the weighted Nonperforming Assets -
the value of a share of average number of the sum of loans on
common stock determined common shares which interest income
b y d i v i d i n g outstanding in the is not being accrued,
shareholders' equity at period. restructured loans on
the end of a period, which the interest
excluding preferred Equity Capital/Share- rates or terms of
stock, by the number of holders' Equity - a repayment have been
common shares balance sheet amount materially revised and
outstanding at the end that represents the real estate that has
of the same period. total investment in the been acquired through
corporation by holders foreclosure.
Core Deposits - demand of common and preferred
deposits, savings stock; it includes Rate-Sensitive Assets/
accounts, interest amounts added through Liabilities - earning
checking accounts, the retention of assets and interest-
insured money market earnings. bearing liabilities
a c c o u n t s a n d that can be repriced or
certificates of deposit Interest-Bearing replaced at a different
under $100,000. This Liabil-ities - deposits interest rate, within a
is a more stable source and borrowed funds on specific period, due to
of funds than funds which the corporation rate changes or
purchased on the basis pays interest; includes maturity.
of rate only. interest checking
accounts, money market Return on Average
Cost of Funds - accounts, certificates Assets (ROA) - net
interest on deposits of deposit, short-term income as a percentage
and borrowed funds borrowings and long- of average total
divided by the average term debt. assets. It is a key
balance of such funds. profitability ratio
Leverage Capital that indicates how
Comprehensive Income - Ratio - the total of effectively a bank has
net income plus the Tier 1 capital less used its total
change in unrealized certain intangible resources.
gains and losses, net assets such as
of tax, plus certain goodwill, divided by Return on Average
reclassification quarterly average Equity (ROE) - net
adjustments on assets. A key income as a percentage
securities available regulatory capital of total average
for sale for the requirement with the shareholders' equity.
period. minimum amount allowed Provides a measure of
of 4%. how productively a
Earning Assets - loans bank's equity has been
(net of unearned Net Interest Income - employed.
income), investment the difference between
securities, money income from earning Risk-Based Assets - a
market investments and assets and interest regulatory method of
interest-bearing paid on deposits and classifying assets
-30-<PAGE>
based on their the effective pretax
potential risk of loss, yields on different
used in calculating mixes of taxable and
various capital ratios. tax-exempt assets.
Assets are classified
in one of four Tier 1 Risk-Based Capi-
categories based tal Ratio - common
primarily on credit shareholders' equity
risk and are adjusted less certain intangible
to reflect the relative assets, such as
riskiness of that goodwill, divided by
category. risk-based assets.
Current regulatory
Securities Available minimum requires that
for Sale - securities at least a 4% ratio be
that will be held for maintained.
indefinite periods of
time and that may be Total Risk-Based
sold as part of the Capital Ratio - total
bank's asset/liability capital divided by
strategy. These risk-based assets.
securities are recorded Total capital consists
at their current market of common shareholders'
value rather than at equity, the allowance
their historical for loan losses,
amortized cost. certain components of
nonpermanent preferred
Securities Held to stock and subordinated
Maturity - securities debt less certain
that the bank has the intangible assets, such
ability and the intent as goodwill. Current
to hold to maturity. regulatory minimum
These securities are requires that at least
recorded at their an 8% ratio be
original cost, adjusted maintained.
for amortization of
premium or discount Yield on Earning Assets
accretion. - total taxable-
equivalent interest
Spread or Interest-Rate income dividend by the
Differential - the average balance of
difference between the earnings assets.
average interest rates
received on earning
assets and the average
interest rates paid for
interest-bearing
liabilities.
Taxable-Equivalent In-
come - income that has
been adjusted by
increasing tax-exempt
interest income to an
equivalent pretax
amount of taxable
income. This
adjustment allows
corporations to compare
-31-<PAGE>
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Derivatives
The Company is not a party to derivative financial instruments with off-
balance sheet risks such as futures, forwards, swaps and options. The Company
is a party to financial instruments with off-balance sheet risks such as
commitments to extend credit, standby letters of credit, and recourse
obligations in the normal course of business to meet the financing needs of its
customers. Management does not plan any future involvement in high risk
derivative products. The Company has investments in mortgage-backed
securities, collateralized mortgage obligations, structured notes and other
similar instruments which are included in securities available for sale and
securities held to maturity. The fair value of these investments at September
30, 1999 approximated $6,463.
Interest Rate Sensitivity
The Company's securities and loans and its deposits are subject to
interest rate risk. The Company's profitability in the near term may
temporarily be affected, either positively by a falling interest rate scenario
or negatively by a period of rising rates. The table below sets forth, as of
September 30, 1999, the distribution of repricing opportunities of the
Company's interest-earning assets and interest-bearing liabilities, the
interest rate sensitivity gap (i.e., interest rate sensitive assets less
interest rate sensitive liabilities), and the cumulative interest rate
sensitivity gap. The table sets forth the time periods during which interest-
earning assets and interest-bearing liabilities will mature or may reprice in
accordance with their contracted terms.
The method of analysis presented in the following table has certain
inherent shortcomings. For example, although certain assets and liabilities
may have similar maturities or periods of repricing, they may react in
different degrees and at different times to changes in market interest rates.
In addition, loan prepayments and early withdrawals of certificates of deposit
could cause the interest sensitivities to vary from those which appear on the
table. The classification of securities as held to maturity or available for
sale also effects rate sensitivity. Available for sale securities which may be
sold can be used to adjust the Company's interest rate sensitivity position.
Finally, call features in the investment portfolio can have a considerable
effect. Since the call decision is dependent on interest rate levels at a
future point in time, the ultimate effect on interest rate sensitivity cannot
be precisely determined. A substantial number of bonds in the investment
portfolio contain these features.
-32-<PAGE>
<TABLE>
<CAPTION>
Interest Rate September 30, 1999
Sensitivity Table (1) Interest-sensitive (days)
1-5 >5
($ in thousands) 1-90 91-180 181-365 Years Years Total
--------- -------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Interest-earning assets:
Loans, net of unearned income (2) $ 39,837 28,904 27,169 128,590 62,062 286,562
Federal funds sold 150 --- --- --- --- 150
Interest bearing deposits 7,320 --- --- --- --- 7,320
Securities available for sale (3) 3,464 2,017 3,125 26,313 86,128 121,047
Securities held to maturity (3) 2,368 1,491 1,699 16,544 3,083 25,185
Mortgage loans held for sale 570 --- --- --- --- 570
Total interest-earning assets $ 53,776 32,412 31,993 171,447 151,274 440,902
Interest-bearing liabilities:
Interest-bearing demand deposits $ 83,001 --- --- --- --- 83,001
Savings deposits 47,012 --- --- --- --- 47,012
Time deposits 37,462 47,883 63,882 70,258 --- 219,485
Other borrowed funds 559 --- --- --- --- 559
Total interest-bearing liabilities $ 168,034 47,883 63,882 70,258 --- 350,057
Cumulative ratio of interest-
sensitive assets to interest-
sensitive liabilities $(114,258) (129,729) (161,618) (60,429) 90,845 90,845
Cumulative interest-sensitivity gap $ .32 .40 .42 .83 1.26 ---
(1) The Company is sensitive to interest rate changes, as liabilities generally reprice or mature
before interest-earning assets. The above gap table reflects the Company's rate-sensitive
position at September 30, 1999, and is not necessarily reflective of its position throughout
the year. The carrying amounts of interest-rate sensitive assets and liabilities are
presented in the periods in which they reprice to market rates or mature and are summed to
show the interest-rate sensitivity gap.
(2) Excludes nonaccrual loans.
(3) Call features on certain securities, if exercised could have the effect of materially shortening
the average life of the investment portfolio. The exercise of a call feature is dependent upon the
rate environment. The call decision is at the issuers discretion and ultimate benefit. Securities
available for sale are shown at amortized cost.
</TABLE>
-33-<PAGE>
The Company also uses simulation analysis to forecast its balance sheet
and monitor interest rate sensitivity. One test used by the Company is shock
analysis, which measures the effect of a hypothetical, immediate and parallel
shift in interest rates. The following table shows the results of a rate shock
of 100, 200, and 300 basis points and the effects on net income and return on
average assets and return on average equity for the nine months ended September
30, 1999.
($000's, except for percent data)
Return on Return on
Rate Shift Net Income Average Equity Average Assets
========== ========== ============== ==============
300 $4,935 8.61% 1.03%
200 5,742 10.10% 1.22%
100 6,544 11.55% 1.40%
(-)100 8,133 14.35% 1.77%
(-)200 8,921 15.70% 1.95%
(-)300 9,255 16.29% 2.03%
Simulation analysis allows the Company to test asset and liability
management strategies under rising and falling rate conditions. As a part of
simulation process, certain estimates and assumptions must be made dealing
with, but not limited to, asset growth, the mix of assets and liabilities, rate
environment, and local and national economic conditions. Asset growth and the
mix of assets can to a degree be influenced by management. Other areas such as
the rate environment and economic factors cannot be controlled. For this
reason actual results may vary materially from any particular forecast or shock
analysis.
This shortcoming is offset to a degree by the periodic re-forecasting of
the balance sheet to reflect current trends and economic conditions. Shock
analysis must also be updated periodically as a part of the asset and liability
management process.
-34-<PAGE>
National Bankshares, Inc. and Subsidiaries
Part II
Other Information
Items 1-3. Legal Proceedings; Changes in Securities and Use of Proceeds;
Defaults Upon Senior Securities
None for the three months ended
September 30, 1999.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 27 - Financial Data Schedule
(b) Reports on Form 8-K filed during the three months ended
September 30, 1999:
-- None
-35-<PAGE>
National Bankshares, Inc. and Subsidiaries
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
National Bankshares, Inc.
(Registrant)
Date: 11/12/1999 /s/James G. Rakes
------------- -------------------------------------
James G. Rakes, Chairman
President and Chief Executive Officer
Date: 11/12/1999 /s/J. Robert Buchanan
------------- -------------------------------------
J. Robert Buchanan, Treasurer
(principal financial officer)
-36-<PAGE>
<TABLE> <S> <C>
<ARTICLE> 9
<LEGEND>
THIS SCHEDULE OF FINANCIAL INFORMATION IS EXTRACTED FROM THE SEPTEMBER 30,
1999 10-Q AND QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<CASH> 11,899
<INT-BEARING-DEPOSITS> 7,320
<FED-FUNDS-SOLD> 150
<TRADING-ASSETS> 0
<INVESTMENTS-HELD-FOR-SALE> 117,274
<INVESTMENTS-CARRYING> 25,185
<INVESTMENTS-MARKET> 25,157
<LOANS> 286,629
<ALLOWANCE> 2,918
<TOTAL-ASSETS> 462,673
<DEPOSITS> 406,985
<SHORT-TERM> 559
<LIABILITIES-OTHER> 3,987
<LONG-TERM> 0
0
0
<COMMON> 8,792
<OTHER-SE> 42,350
<TOTAL-LIABILITIES-AND-EQUITY> 462,673
<INTEREST-LOAN> 17,612
<INTEREST-INVEST> 6,901
<INTEREST-OTHER> 88
<INTEREST-TOTAL> 24,601
<INTEREST-DEPOSIT> 10,254
<INTEREST-EXPENSE> 10,260
<INTEREST-INCOME-NET> 14,341
<LOAN-LOSSES> 840
<SECURITIES-GAINS> 24
<EXPENSE-OTHER> 8,897
<INCOME-PRETAX> 7,182
<INCOME-PRE-EXTRAORDINARY> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,283
<EPS-BASIC> 1.45
<EPS-DILUTED> 1.45
<YIELD-ACTUAL> 0
<LOANS-NON> 0
<LOANS-PAST> 0
<LOANS-TROUBLED> 0
<LOANS-PROBLEM> 0
<ALLOWANCE-OPEN> 0
<CHARGE-OFFS> 0
<RECOVERIES> 0
<ALLOWANCE-CLOSE> 0
<ALLOWANCE-DOMESTIC> 0
<ALLOWANCE-FOREIGN> 0
<ALLOWANCE-UNALLOCATED> 0
</TABLE>
