--------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR
15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2006.
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OR THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ________.
Commission file number 0-15204
NATIONAL BANKSHARES, INC.
(Exact name of Registrant as specified in its Charter)
Virginia 54-1375874
(State of incorporation) (I.R.S. Employer Identification No.)
101 Hubbard Street
P.O. Box 90002
Blacksburg, VA 24062-9002
(540) 951-6300
(Address and telephone number of principal executive offices)
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 by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b - 2 of the Exchange
Act.
Large accelerated filer |_| Accelerated filer |X| Non-accelerated filer |_|
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12b - 2 of the Exchange Act). Yes |_| No |X|
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 July 31, 2006
----- ----------------------------
Common Stock, $1.25 Par Value 6,996,284
(This report contains 34 pages)
10 NATIONAL BANKSHARES, INC. AND SUBSIDIARIES
Form 10-Q
Index
Part I Financial Information Page
----------------------------
Item 1 Financial Statements
Consolidated Balance Sheets, June 30, 2006 (Unaudited) 3-4
and December 31, 2005
Consolidated Statements of Income for the Three Months Ended June 30, 5-6
2006 and 2005 (Unaudited)
Consolidated Statement of Income for the Six Months ended 7-8
June 30, 2006 and 2005 (Unaudited)
Consolidated Statements of Changes in 9
Stockholders' Equity, Six Months Ended
June 30, 2006 and 2005 (Unaudited)
Consolidated Statements of Cash Flows, 10-11
Six Months Ended June 30, 2006 and 2005 (Unaudited)
Notes to Consolidated Financial Statements 12-18
Item 2 Management's Discussion and Analysis of 18-27
Financial Condition and Results of Operations
Item 3 Quantitative and Qualitative Disclosures About 27
Market Risk
Item 4 Controls and Procedures 28
Part II Other Information
--------------------------
Item 1 Legal Proceedings 28
Item 1A Risk Factors 28
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 28
Item 3 Defaults Upon Senior Securities 29
Item 4 Submission of Matters to a Vote of Security Holders 29
Item 5 Other Information 29
Item 6 Exhibits 29
Signatures 30
----------
Index of Exhibits 30-31
-----------------
2
Part I
Financial Information
Item 1. Financial Statements
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets
(Unaudited)
June 30, December 31,
($ In thousands, except share and per share data) 2006 2005
================== ===================
Assets:
Cash and due from banks $19,037 $20,115
Interest-bearing deposits 13,966 10,279
Securities available for sale, at fair value 162,813 162,833
Securities held to maturity (fair value
approximates $102,747 at June 30, 2006 and $109,513
at December 31, 2005) 104,864 109,708
Mortgage loans held for sale 222 ---
Loans:
Real estate construction loans 30,177 27,116
Real estate mortgage loans 123,688 117,421
Commercial and industrial loans 209,667 205,978
Loans to individuals 132,944 143,009
------------------ -------------------
Total loans 496,476 493,524
Less unearned income and deferred fees (976) (913)
------------------- -------------------
Loans, net of unearned income
and deferred fees 495,500 492,611
Less: allowance for loan losses (5,340) (5,449)
------------------- -------------------
Loans, net 490,160 487,162
------------------- -------------------
Bank premises and equipment, net 12,777 12,808
Accrued interest receivable 5,301 5,145
Other real estate owned, net 390 376
Intangible assets and goodwill, net 16,544 17,113
Other assets 17,333 15,959
------------------- -------------------
Total assets $843,407 $841,498
=================== ===================
Liabilities and Stockholders' Equity:
Noninterest-bearing demand deposits $108,252 $112,445
Interest-bearing demand deposits 241,664 225,611
Savings deposits 53,518 54,505
Time deposits 343,147 353,088
------------------ -------------------
Total deposits 746,581 745,649
------------------ -------------------
Other borrowed funds 78 357
Accrued interest payable 688 725
Other liabilities 2,887 2,828
------------------ -------------------
Total liabilities 750,234 749,559
------------------ -------------------
3
Stockholders' Equity Preferred stock of no par value.
Authorized 5,000,000 shares; none
issued and outstanding --- ---
Common stock of $1.25 par value.
Authorized 10,000,000 shares; issued and
outstanding 6,999,284 shares in 2006 and
7,019,874 in 2005 8,749 8,775
Retained earnings 87,723 84,610
Accumulated other comprehensive income (loss), net (3,299) (1,446)
------------------ -------------------
Total stockholders' equity 93,173 91,939
------------------ -------------------
Total liabilities and
stockholders' equity $843,407 $841,498
================== ===================
See accompanying notes to the consolidated financial statements.
4
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended June 30, 2006 and 2005
(Unaudited)
June 30, June 30,
($ In thousands, except share and per share data) 2006 2005
================== =================
Interest income:
Interest and fees on loans $8,637 $8,260
Interest on interest-bearing deposits 102 64
Interest on Federal funds sold --- 1
Interest on securities - taxable 1,893 1,660
Interest on securities - nontaxable 1,217 1,283
------------------ -----------------
Total interest income 11,849 11,268
------------------ -----------------
Interest expense:
Interest on time deposits $100,000 or more 1,103 931
Interest on other deposits 3,259 2,282
Interest on borrowed funds 12 13
------------------ -----------------
Total interest expense 4,374 3,226
------------------ -----------------
Net interest income 7,475 8,042
Provision for loan losses 7 198
------------------ -----------------
Net interest income after
provision for loan losses 7,468 7,844
------------------ -----------------
Noninterest income:
Service charges on deposit accounts 855 801
Other service charges and fees 104 69
Credit card fees 636 578
Trust income 365 328
Other income 250 122
Realized securities gains, net 2 29
------------------ -----------------
Total noninterest income 2,212 1,927
------------------ -----------------
Noninterest expense:
Salaries and employee benefits 2,929 2,850
Occupancy, furniture and fixtures 472 480
Data processing and ATM 327 435
Credit card processing 469 463
Intangibles amortization 285 283
Net costs of other real estate owned --- 73
Other operating expenses 919 1,007
------------------ -----------------
Total noninterest expense 5,401 5,591
------------------ -----------------
Income before income tax expense 4,279 4,180
Income tax expense 1,052 1,028
------------------ -----------------
Net income $3,227 $3,152
================== =================
5
Net income per share - basic $0.46 $0.45
================= ===================
- diluted $0.46 $0.45
================= ===================
Weighted average number of common
shares outstanding - basic 7,011,581 7,033,212
================= ===================
- diluted 7,033,626 7,071,996
================= ===================
Dividends declared per share $0.36 $0.35
================= ===================
See accompanying notes to consolidated financial statements.
6
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Six Months Ended June 30, 2006 and 2005
(Unaudited)
June 30, June 30,
($ In thousands, except share and per share data) 2006 2005
================== =================
Interest income:
Interest and fees on loans $16,998 $16,327
Interest on interest-bearing deposits 260 145
Interest on Federal funds sold --- 1
Interest on securities - taxable 3,696 3,251
Interest on securities - nontaxable 2,478 2,579
------------------ -----------------
Total interest income 23,432 22,303
------------------ -----------------
Interest expense:
Interest on time deposits $100,000 or more 2,191 1,804
Interest on other deposits 6,407 4,447
Interest on borrowed funds 14 18
------------------ -----------------
Total interest expense 8,612 6,269
------------------ -----------------
Net interest income 14,820 16,034
Provision for loan losses 24 388
------------------ -----------------
Net interest income after
provision for loan losses 14,796 15,646
------------------ -----------------
Noninterest income:
Service charges on deposit accounts 1,670 1,476
Other service charges and fees 213 156
Credit card fees 1,160 1,072
Trust income 745 736
Other income 517 259
Realized securities (losses), net (34) (4)
------------------ -----------------
Total noninterest income 4,271 3,695
------------------ -----------------
Noninterest expense:
Salaries and employee benefits 5,840 5,712
Occupancy, furniture and fixtures 1,005 959
Data processing and ATM 628 902
Credit card processing 882 839
Intangibles amortization 569 549
Net costs of other real estate owned 14 181
Other operating expenses 1,962 2,138
------------------ -----------------
Total noninterest expense 10,900 11,280
------------------ -----------------
Income before income tax expense 8,167 8,061
Income tax expense 1,937 1,916
------------------ -----------------
Net income $6,230 $6,145
================== =================
7
Net income per share - basic $0.89 $0.88
================= ===================
- diluted $0.89 $0.87
================= ===================
Weighted average number of common
shares outstanding - basic 7,013,311 7,035,652
================= ===================
- diluted 7,039,303 7,071,996
================= ===================
Dividends declared per share $0.36 $0.35
================= ===================
See accompanying notes to consolidated financial statements.
8
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders' Equity
Six Months Ended June 30, 2006 and 2005
(Unaudited)
Accumulated
Other
($ In thousands) Common Retained Comprehensive Comprehensive
Stock Earnings Income (Loss) Income Total
============ ============== ================ ================ ===========
Balances, December 31, 2004 $8,797 $77,735 $556 $87,088
Net income --- 6,145 $6,145 6,145
---
Dividends ($0.35 per share) (2,464) (2,464)
Other comprehensive loss, net of tax:
Unrealized loss
on securities
available for sale, net
of income tax $(185) --- --- --- (343) ---
Reclass adjustment, net
of tax $(64) --- --- --- (119) ---
------------ -------------- ---------------- ---------------- -----------
Other comprehensive loss --- --- (462) (462) (462)
------------ -------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- $5,683 ---
------------ -------------- ---------------- ---------------- -----------
Exercise of stock options 5 42 --- --- 47
Stock repurchased (29) (504) (533)
------------ -------------- ---------------- ---------------- ------------
Balances, June 30, 2005 $8,773 $80,954 $94 --- $89,821
============ ============== ================ ================ ===========
Balances, December 31, 2005 $8,775 $84,610 $(1,446) $91,939
Net income --- 6,230 --- $6,230 6,230
Dividends ($0.36 per share) (2,524) (2,524)
Other comprehensive loss, net of tax:
Unrealized loss
on securities
available for sale, net
of income tax $(1,011) --- --- --- (1,878) ---
Reclass adjustment, net
of tax $13 --- --- --- 25 ---
------------ -------------- ---------------- ---------------- -----------
Other comprehensive loss --- --- (1,853) (1,853) (1,853)
------------ -------------- ---------------- ---------------- -----------
Comprehensive income --- --- --- 4,377 ---
------------ -------------- ---------------- ---------------- -----------
Exercise of stock options 13 108 --- --- 121
Stock repurchased (39) (701) (740)
------------ -------------- ---------------- ---------------- -----------
Balances, June 30, 2006 $8,749 $87,723 $(3,299) $93,173
============ ============== ================ ================ ===========
See accompanying notes to consolidated financial statements.
9
National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Six Months Ended June 30, 2006 and 2005
(Unaudited)
June 30, June 30,
($In thousands) 2006 2005
================== =================
Cash flows from operating activities:
Net income $6,230 $6,145
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 24 388
Depreciation of bank premises and equipment 506 505
Amortization of intangibles 569 549
Amortization of premiums and accretion of
discount, net 124 236
(Gains) on disposal of fixed assets (2) (4)
(Gains)losses on sales and calls of securities
available for sale, net 40 (183)
(Gains)losses on calls of securities held to maturity (3) 187
Losses and writedowns on other real estate owned 10 106
Increase(decrease) in:
Mortgage loans held for sale (222) (309)
Accrued interest receivable (156) (382)
Other assets (376) (1,510)
Increase in:
Accrued interest payable (37) 105
Other liabilities 59 242
------------------ -----------------
------------------ -----------------
Net cash provided by operating
activities $6,766 $6,075
------------------ -----------------
------------------ -----------------
Cash flows from investing activities
Net (increase) in federal funds sold $--- $(300)
Net (increase) decrease in interest-bearing deposits (3,687) 9,962
Proceeds from calls, principal payments, sales and maturities of
securities available for sale 7,847 10,401
Proceeds from calls, principal payments and maturities of
securities held to maturity 6,261 3,064
Proceeds from the sale of securities held to maturity --- 3,123
Purchases of securities available for sale (10,798) (15,582)
Purchases of securities held to maturity (1,458) (10,634)
Purchases of loan participations (2,232) (2,891)
Collections of loan participations 4,084 1,624
Net (increase) in loans to customers (4,974) (10,224)
Acquisitions, net of cash received --- 13,178
Proceeds from disposal of other real estate owned --- 457
Recoveries on loans charged off 76 100
Purchase of bank premises and equipment (475) (1,153)
Proceeds from disposal of bank premises and equipment 2 4
------------------ -----------------
------------------ -----------------
Net cash provided by(used in) investing
activities $(5,354) $1,129
------------------ -----------------
10
Cash flows from financing activities
Net increase (decrease) in other deposits $10,873 $(4,038)
Net increase (decrease) in time deposits (9,941) 2,094
Net increase (decrease) in other borrowed funds (279) 275
Stock options exercised 121 47
Cash dividends (2,524) (2,464)
Stock repurchased (740) (533)
------------------ -----------------
Net cash used in financing
activities $(2,490) $(4,619)
------------------ -----------------
Net increase (decrease) in cash and due from banks (1,078) 2,585
Cash and due from banks at beginning of period 20,115 12,493
------------------ -----------------
Cash and due from banks at end of period $19,037 $15,078
================== =================
Supplemental disclosure of cash flow information:
Cash paid for interest $8,649 $6,164
================== =================
Cash paid for income taxes $1,741 $2,017
================== =================
Loans charged to the allowance for loan losses $209 $585
================== =================
Loans transferred to other real estate owned $24 $151
================== =================
Unrealized (losses) on securities available for sale $(2,851) $(711)
================== =================
Transactions related to acquisition of branches:
Increase in assets and liabilities:
Investments $--- $---
Loans $--- $8,831
Deposits $--- $22,009
Fixed assets $--- $311
See accompanying notes to consolidated financial statements.
11
National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
June 30, 2006
(Unaudited)
($ In thousands, except share and per share data)
Note (1)
The consolidated financial statements of National Bankshares, Inc.
(Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg
(NBB and National Bankshares Financial Services, Inc. (NBFS), (the Company),
conform to accounting principles generally accepted in the United States of
America and to general practices within the banking industry. The accompanying
interim period consolidated financial statements are unaudited; however, in the
opinion of management, all adjustments consisting of normal recurring
adjustments, which are necessary for a fair presentation of the consolidated
financial statements, have been included. The results of operations for the six
months ended June 30, 2006 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 in this
Form 10-Q should be read in conjunction with the notes to consolidated financial
statements included in the Company's 2005 Form 10-K. The Company posts all
reports required to be filed under the Securities and Exchange Act of 1934 on
its web site at www.nationalbankshares.com.
Note (2) Stock-Based Compensation
The Company adopted the National Bankshares, Inc. 1999 Stock Option Plan
to give key employees of Bankshares and its subsidiaries an opportunity to
acquire shares of National Bankshares, Inc. common stock. The purpose of the
1999 Stock Option Plan is to promote the success of Bankshares and its
subsidiaries by providing an incentive to key employees that enhances the
identification of their personal interest with the long term financial success
of the Company and with growth in stockholder value. Under the 1999 Stock Option
Plan, up to 250,000 shares of Bankshares common stock may be granted. The 1999
Stock Option Plan is administered by the Stock Option Committee, which is the
NBI Board of Directors' Compensation Committee, made up entirely of independent
directors of National Bankshares, Inc. The Stock Option Committee may determine
whether options are incentive stock options or nonqualified stock options and
may determine the other terms of grants, such as number of shares, term, a
vesting schedule, and the exercise price. The 1999 Stock Option Plan limits the
maximum term of any option granted to ten years, states that options may be
granted at not less than fair market value on the date of the grant and contains
certain other limitations on the exercisability of incentive stock options. The
options generally vest 25% after one year, 50% after two years, 75% after three
years and 100% after four years. On December 29, 2005, the Company's Board of
Directors passed a resolution stating that all 142,000 previously granted, but
unvested, stock options be immediately vested. The vesting was made subject to
the provision that any shares of NBI common stock obtained by an option grantee
by exercise of an option subject to accelerated vesting may not be sold or
otherwise transferred prior to the expiration of the option's original vesting
period. This action was taken to reduce the impact of the "Statement of
Financial Accounting Standards No. 123R, Share-Based Payment" on the Company's
earnings over the remaining vesting period of the stock options. At the
discretion of the Stock Option Committee options may be awarded with the
provision that they may be accelerated upon a change of control, merger,
consolidation, sale or dissolution of National Bankshares, Inc. At June 30,
2006, there were 286,000 additional shares available for grant under the plan.
Compensation expense is calculated using the Black-Scholes model and is
amortized over the requisite service period using the straight-line method.
Please refer to the Company's Form 10-K dated December 31, 2005 for assumptions
used. There have been no grants of stock options in 2006.
12
Weighted
Weighted- -Average Aggregate
Average Remaining Intrinsic
Exercise Contractual Value
Options Shares(1) Price Term ($000)
------------------------------------------- ------------ ------------ --------------- ------------
Outstanding at January 1, 2006 172,500 $19.90
Granted ---
Exercised (10,710) $11.24
Forfeited or expired ---
---
Outstanding at June 30, 2006 161,790 $20.48 7.5 $442
======= ====== === ====
Exercisable at June 30, 2006 161,790 $20.48 7.5 $442
======= ====== === ====
1. Outstanding shares at January 1, 2006 have been adjusted to reflect a
2-for-1 stock split effective March 31, 2006.
Because no options were granted in 2006, there is no expense included in
net income.
----------------- ----------------
Six months Three months
ended ended
June 30, June 30,
----------------- ----------------
($ In thousands, except per share data) 2005 2005
----------------- ----------------
Net income, as reported $6,145 $3,152
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards (73) (37)
----------------- ----------------
Pro forma net income $6,072 $3,115
----------------- ----------------
Earnings per share:
Basic - as reported $0.88 $0.45
----------------- ----------------
Basic - pro forma $0.87 $0.45
----------------- ----------------
Diluted - as reported $0.87 $0.45
----------------- ----------------
Diluted - pro forma $0.86 $0.45
----------------- ----------------
During the six months ended June 30, 2006, there were no stock options
granted and 10,710 stock options were exercised with an intrinsic value of
$128,000. For the six months ended June 30, 2005 there were no stock options
granted and 1,250 options were forfeited.
For and 2004, 36,000 shares and 16,500 shares were excluded.
13
Note (3) Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
For the periods ended
----------------------
June 30, December 31,
----------------------------- -----------------
2006 2005 2005
-------------- -------------- -----------------
($ In thousands, except % data)
Balance at beginning of period $5,449 $5,729 $5,729
Provision for loan losses 24 388 567
Loans charged off (209) (585) (1,101)
Recoveries 76 100 254
-------------- -------------- -----------------
Balance at the end of period $5,340 $5,632 $5,449
============== ============== =================
Ratio of allowance for loan losses to the
end of period loans, net of unearned income
and deferred fees 1.08% 1.13% 1.11%
============== ============== =================
Ratio of net charge-offs to average
loans, net of unearned income and deferred
fees(1.) 0.05% 0.21% 0.17%
============== ============== =================
Ratio of allowance for loan losses to
nonperforming loans(2.) --- 2,234.92% 3,061.24%
============== ============== =================
1. Net charge-offs are on an annualized basis.
2. The Company defines nonperforming loans as total nonaccrual and
restructured loans. Loans 90 days past due and still accruing are
excluded.
June 30, December 31,
-------------------------- --------------
2006 2005 2005
------------- ------------ ----------------
($ In thousands, except % data)
Nonperforming Assets:
Nonaccrual loans $--- $252 $178
Restructured loans --- --- ---
------------- ------------ ----------------
Total nonperforming loans --- 252 178
Foreclosed property 390 483 376
------------- ------------ ----------------
Total nonperforming assets $390 $735 $554
============= ============ ================
Ratio of nonperforming assets to loans, net of
unearned income and deferred fees, plus
other real estate owned 0.08% 0.15% 0.11%
============= ============ ================
14
June 30, December 31,
-------------------------- ---------------
2006 2005 2005
------------- ------------ ---------------
Loans Past due 90 days or more and
still accruing $362 $526 $546
============= ============ ===============
Ratio of loans past due 90 days or
more and still accruing to loans, net
of unearned income and deferred fees 0.07% 0.11% 0.11%
============= ============ ===============
Impaired loans:
Total impaired loans $--- $252 $174
============= ============ ===============
Impaired loans with a
valuation allowance --- --- ---
Valuation allowance --- --- ---
------------- ------------ ---------------
Impaired loans, net of allowance --- --- ---
============= ============ ===============
Impaired loans with no
valuation allowance $--- $252 $174
============= ============ ===============
Average recorded investment
in impaired loans $232 $316 $274
============= ============ ===============
Income recognized on impaired
loans $--- --- ---
============= ============ ===============
Amount of income recognized
on a cash basis $--- --- $11
============= ============ ===============
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 at June
30, 2006 were $0.
15
Note (4) Securities
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities available for the sale by major security type as of
June 30, 2006 are as follows:
June 30, 2006
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Available for sale:
U.S. Treasury $3,035 --- $216 $2,819
U.S. Government
Agencies and
Corporations 28,784 --- 685 28,099
State and political
subdivisions 70,641 591 1,163 70,069
Mortgage-backed
securities 28,962 51 919 28,094
Corporate debt
securities 32,052 15 1,945 30,122
Federal Reserve Bank stock-
restricted 91 --- --- 91
Federal Home Loan
Bank stock-restricted 1,732 --- --- 1,732
Other securities 1,640 147 --- 1,787
----------------- ----------------- ----------------- ------------------
Total securities
available for sale $166,937 $804 $4,928 $162,813
================= ================= ================= ==================
The amortized costs, gross unrealized gains, gross unrealized losses and
fair values for securities held to maturity by major security type as of June
30, 2006 are as follows:
June 30, 2006
Gross Gross
Amortized Unrealized Unrealized Fair
($ In thousands) Costs Gains Losses Values
----------------- ----------------- ----------------- ------------------
Held to Maturity:
U.S. Government
Agencies and
Corporations $28,609 --- $1,235 $27,374
State and political
subdivisions 53,483 433 558 53,358
Mortgage-backed
securities 3,577 18 88 3,507
Corporate securities 19,195 130 817 18,508
----------------- ----------------- ----------------- ------------------
Total securities
held to maturity $104,864 $581 $2,698 $102,747
================= ================= ================= ==================
16
Information pertaining to securities with gross unrealized losses at
June 30, 2006 and December 31, 2005, aggregated by investment category and
length of time that individual securities have been in a continuous loss
position, follows:
June 30, 2006
-------------
Less Than 12 Months 12 Months or More
----------------------------- ------------------------------
Fair Value Unrealized Loss Fair Value Unrealized Loss
----------------------------- ------------------------------
U.S. Government agencies and
corporations $39,480 $1,055 $18,812 $1,081
State and political subdivisions 36,444 751 19,239 969
Mortgage-backed securities 18,608 544 10,546 464
Corporate debt securities 12,447 489 26,840 2,273
------ --- ------ -----
Total temporarily impaired
securities $106,979 $2,839 $75,437 $4,787
======== ====== ======= ======
December 31, 2005
-----------------
Less Than 12 Months 12 Months or More
----------------------------- ------------------------------
Fair Value Unrealized Loss Fair Value Unrealized Loss
----------------------------- ------------------------------
U.S. Government agencies and
corporations $38,913 541 $11,698 485
State and political subdivisions 28,660 429 15,625 601
Mortgage-backed securities 22,169 333 3,132 76
Corporate debt securities 12,052 200 25,881 1,482
------ --- ------ -----
Total temporarily impaired
securities $101,794 $1,503 $56,336 $2,644
======== ====== ======= ======
The Company had 304 securities with a fair value of $182,416 which were
temporarily impaired at June 30, 2006. The total unrealized loss on these
securities was $7,626. Losses are attributed to interest rate movements. Credit
quality of the securities portfolio is continuously monitored by management, and
there is no present concern with that quality. The Company has the ability and
intent to hold these securities until maturity. Therefore, the losses associated
with these securities are considered temporary at June 30, 2006. All securities
shown are above investment grade.
Note (5) Recent Accounting Pronouncements
In March 2006, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 156, "Accounting for Servicing of
Financial Assets an amendment of FASB Statement 140" (Statement 156). Statement
156 amends Statement 140 with respect to separately recognized servicing assets
and liabilities. Statement 156 requires an entity to recognize a servicing asset
or liability each time it undertakes an obligation to service a financial asset
by entering into a servicing contract and requires all servicing assets and
liabilities to be initially measured at fair value, if practicable. Statement
156 also permits entities to subsequently measure servicing assets and
liabilities using an amortization method or fair value measurement method. Under
the amortization method, servicing assets and liabilities are amortized in
proportion to and over the estimated period of servicing. Under the fair value
measurement method, servicing assets are measured at fair value at each
reporting date and changes in fair value are reported in net income for the
period the change occurs.
Adoption of Statement 156 is required as of the beginning of fiscal
years beginning subsequent to September 15, 2006. Earlier adoption is permitted
as of the beginning of an entity's fiscal year, provided the entity has not yet
issued financial statements, including interim financial statements.
17
The Company does not expect the adoption of Statement 156 at the
beginning of 2007 to have a material impact.
Note (6) Defined Benefit Plan
Components of Net Periodic Benefit Cost
Pension Benefits
-----------------------
Six Months Ended
June 30,
-----------------------
($ in Thousands)
2006 2005
Service cost $ 286 $ 280
Interest cost 322 306
Expected return on plan assets (286) (290)
Amortization of prior service cost (6) 4
Recognized net actuarial loss 106 92
Amortization of transition cost 4 (6)
---------- ------------
Net periodic benefit cost $ 426 $ 386
========== ============
Employer Contributions
Bankshares expects to contribute a total of $698, paid in quarterly
installments, to the pension plan for 2006. Contributions through June 30, 2006
totaled $349, and Bankshares anticipates making all required contributions prior
to the end of 2006.
Note (7) Stock Split
Bankshares' Board of Directors approved a 2-for-1 stock split of
Bankshares' common stock effective March 31, 2006. All per share information for
prior periods presented has been restated to reflect the stock split.
National Bankshares, Inc. and Subsidiaries
(In thousands, except per share data)
Item 2. Management's Discussion and Analysis of Financial Condition
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. Refer to the financial statements and other information included in
this report as well as the 2005 Annual Report on Form 10-K for an understanding
of the following discussion and analysis.
This Quarterly Report on Form 10-Q contains forward-looking statements
as described in the Securities Exchange Act of 1934. The Company's actual
results could differ materially from those set forth in the forward-looking
statements.
Critical Accounting Policies
General
The Company's financial statements are prepared in accordance with
accounting principles generally accepted in the United States (GAAP). The
financial information contained within our statements is, to a significant
extent, financial information that is based on measures of the financial effects
of transactions and events that have already occurred. A variety of factors
could affect the ultimate value that is obtained when earning income,
recognizing an expense, recovering an asset or relieving a liability. We use
18
historical loss factors as one element in determining the inherent loss that may
be present in our loan portfolio. Actual losses could differ significantly from
the historical factors that we use. In addition, GAAP itself may change from one
previously acceptable method to another method. Although the economics of our
transactions would be the same, the timing of events that would impact our
transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be
sustained in our loan portfolio. The allowance is based on two basic principles
of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that
losses be accrued when they are probable of occurring and estimable and (ii)
SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that
losses be accrued based on the differences between the value of collateral,
present value of future cash flows or values that are observable in the
secondary market and the loan balance.
Our allowance for loan losses has three basic components; the formula
allowance, the specific allowance and the unallocated allowance. Each of these
components is determined based upon estimates that can and do change when actual
events occur. The formula allowance uses a historical loss view and certain
qualitative factors as an indicator of future losses and, as a result, could
differ from the loss incurred in the future. However, since this history is
updated with the most recent loss information, the errors that might otherwise
occur are mitigated. The specific allowance uses various techniques to arrive at
an estimate of loss. Expected cash flows and fair market value of collateral are
used to estimate these losses. The use of these values is inherently subjective
and our actual losses could be greater or less than the estimates. The
unallocated allowance captures losses that are attributable to various economic
events, industry or geographic sectors, whose impact on the portfolio have
occurred but have yet to be recognized in either the formula or specific
allowance.
Core deposit intangibles
Effective January 1, 2002, the Corporation adopted Financial Accounting
Standards Board Statement No. 142, Goodwill and Other Intangible Assets.
Accordingly, goodwill is no longer subject to amortization over its estimated
useful life, but is subject to at least an annual assessment for impairment by
applying a fair value based test. Additionally, Statement 142 requires that
acquired intangible assets (such as core deposit intangibles) be separately
recognized if the benefit of the asset can be sold, transferred, licensed,
rented, or exchanged and amortized over its estimated useful life. Branch
acquisition transactions were outside the scope of the Statement and therefore
any intangible asset arising from such transactions remained subject to
amortization over their estimated useful life.
In October 2002, the Financial Accounting Standards Board issued
Statement No. 147, Acquisitions of Certain Financial Institutions. The Statement
amends previous interpretive guidance on the application of the purchase method
of accounting to acquisitions of financial institutions, and requires the
application of Statement No. 141, Business Combinations, and Statement No. 142
to branch acquisitions if such transactions meet the definition of a business
combination. The provisions of the Statement do not apply to transactions
between two or more mutual enterprises. In addition, the Statement amends
Statement No. 144, Accounting for the Impairment of Long-Lived Assets, to
include in its scope core deposit intangibles of financial institutions.
Accordingly, such intangibles are subject to a recoverability test based on
undiscounted cash flows, and to the impairment recognition and measurement
provisions required for other long-lived assets held and used. The Company has
determined that the acquisitions that generated the intangible assets and
goodwill on the consolidated balance sheets in the amount of $9,958 and $10,912
at December 31, 2003 and 2002, respectively, did not constitute the acquisition
of a business, and therefore will continue to be amortized.
19
Overview
National Bankshares, Inc. (NBI) is a financial holding company located in
Southwest Virginia. Until May 26, 2006, it conducted operations primarily
through two full-service banking affiliates, the National Bank of Blacksburg and
Bank of Tazewell County. On May 26, Bank of Tazewell County was merged with and
into the National Bank of Blacksburg, which does business as National Bank. It
also has one nonbanking affiliate, National Bankshares Financial Services, Inc.,
which offers investment and insurance products. Net income derived from the
nonbanking affiliate is not significant at this time or in the foreseeable
future. NBI is a community bank operation.
Performance Summary
The following table shows NBI's key performance ratios for the period ended
June 30, 2006 and 2005 and December 31, 2005. Per share data has been adjusted
to reflect the effects of the March 31, 2006 2-for-1 stock split.
June 30, June 30, December 31,
2006 2005 2005
----------------------------------------------- ------------------- ---------------------- -----------------------
Return on average assets 1.50% 1.53% 1.52%
----------------------------------------------- ------------------- ---------------------- -----------------------
Return on average equity 13.69% 13.90% 13.73%
----------------------------------------------- ------------------- ---------------------- -----------------------
Net interest margin (1) 4.22% 4.65% 4.45%
----------------------------------------------- ------------------- ---------------------- -----------------------
Noninterest margin (2) 1.59% 1.89% 1.74%
----------------------------------------------- ------------------- ---------------------- -----------------------
Basic net earnings per share $0.89 $0.88 $1.77
----------------------------------------------- ------------------- ---------------------- -----------------------
Fully diluted net earnings per share $0.89 $0.87 $1.76
----------------------------------------------- ------------------- ---------------------- -----------------------
(1) Net Interest Margin: Year-to-date tax-equivalent net interest income
divided by year-to-date average earning assets using a tax rate of 35%.
(2) Noninterest Margin: Noninterest income (including securities gains and
losses) less noninterest expense (excluding the provision for bad debts
and income taxes) divided by average year-to-date assets. This is a
non-GAAP financial measure of the level of noninterest income and
expense.
The return on average assets for the first half of 2006 was 1.50%, down
slightly from the 1.53% for the same period in the prior year and from the 1.52%
at December 31, 2005. The return on average equity also experienced a decline.
The net interest margin declined by 43 basis points when compared with June
30, 2005, and it is down 23 basis points when compared to year-end 2005. This
decrease was due to rising interest rates. Interest expense has continued to
grow at a faster pace than interest income.
Growth
The following table shows NBI's key growth indicators:
June 30, 2006 June 30, 2005 December 31, 2005
------------------- ---------------------------- --------------------- ----------------------
Securities $267,677 $259,385 $272,541
------------------- ---------------------------- --------------------- ----------------------
Loans, net 490,160 491,882 487,162
------------------- ---------------------------- --------------------- ----------------------
Deposits 746,581 725,997 745,649
------------------- ---------------------------- --------------------- ----------------------
Total assets 843,407 819,574 841,498
------------------- ---------------------------- --------------------- ----------------------
At June 30, 2006, total assets were $843,407, an increase of $23,833, or
2.91%, when compared to June 31, 2005, and total assets increased $1,909, or
0.23%, when compared to December 31, 2005.
In order to reduce the compression of the net interest margin,
management has exercised restraint when pricing large denomination time
deposits. This approach has had positive influence on profitability; however, it
has caused lower rates of deposit growth.
20
Asset Quality
Key asset quality indicators are shown below:
June 30, 2006 June 30,2005 December 31, 2005
--------------------------------------------- ----------------------- --------------------- ----------------------
Nonperforming loans $ --- $ 252 $ 178
--------------------------------------------- ----------------------- --------------------- ----------------------
Loans past due over 90 days 362 526 546
--------------------------------------------- ----------------------- --------------------- ----------------------
Other real estate owned 390 483 376
--------------------------------------------- ----------------------- --------------------- ----------------------
Allowance for loan losses to loans 1.08% 1.13% 1.11%
--------------------------------------------- ----------------------- --------------------- ----------------------
Net charge-off ratio 0.05% 0.20% 0.17%
--------------------------------------------- ----------------------- --------------------- ----------------------
This data indicates that the level of nonperforming loans has declined,
and at quarter-end there were no nonperforming loans. The level of loans past
due 90 days or more has also declined. Asset quality remains excellent.
Net Interest Income
Net interest income for the period ending June 30, 2006 was $14,820, a
decrease of $1,214 or 7.57%, from June 30, 2005.
The principal cause of the decline is rising interest rates.
Specifically, the Company's interest-bearing liabilities have repriced upward at
a faster pace than interest-earning assets. The yield on earning assets rose by
14 basis points, while the cost of interest-bearing liabilities increased by 67
basis points when the six months ended June 30, 2006 and 2005 are compared.
Net Interest Income - Trends and Future Expectations
Starting in mid-2004 and continuing through 2006, the Federal Reserve
Board initiated a series of interest rate increases. These increases were
designed to restore interest rates to historically more typical levels and to
prevent inflation. Rate increases have occurred at regular intervals, each at 25
basis points to date.
Rising energy costs coupled with high levels of government spending are
viewed as inflationary. Government expenditures are expected to remain high as a
result of natural disasters, conflict in the Middle East and new spending
programs such as the prescription drug benefit for senior citizens. This may
prompt future interest rate increases by the Federal Reserve Bank, unless the
national economy slows sufficiently to keep inflationary pressure in check.
As long as interest rates continue to rise the Company will experience
downward pressure on its net interest margin.
The general impact of a rising interest rate scenario on the Company's
balance sheet is described on page 15 of the Company's 2005 Form 10K, which is
incorporated by reference in this report.
Interest Expense
Interest expense for the six months ended June 30, 2006 was $8,612, an
increase of $2,343, or 37.37%, from the same period the prior year. As
previously discussed, rising interest rates have been the major contributor to
this increase.
During periods of rising interest rates, interest-bearing demand
deposits, and to a lesser degree savings deposits, migrate to higher rate,
longer-term time deposits. Generally, as rates climb, more migration occurs.
Given their re-pricing characteristics, interest-bearing demand deposits readily
respond to any interest rate movement. In other words, increases or decreases in
interest expense can occur quite quickly.
21
Provision and Allowance for Loan Losses
The provision for loan losses for the six-month period ended June 30,
2006 was $24, a $364 decrease from the same period ended June 30, 2005. The
ratio of the allowance for loan losses to total loans at the end of the first
six months of 2006 was 1.08%, which compares to 1.13% at the same period last
year. The net charge-off ratio at June 30, 2006 was .05%, and it was .20% at
June 30, 2005.
The Company regularly reviews asset quality and re-evaluates the
allowance for loan losses. An appropriate provision and allowance for loan
losses is established for the bank, depending upon the quality of its loan
portfolio. Because of the continued excellent overall quality of the loan
portfolio and somewhat slower loan growth, it is management's judgment that the
decrease in the provision for loan losses is justified and the allowance is
appropriate and adequate. (See "Allowance for Loan Losses" under "Critical
Accounting Policies".)
Noninterest Income
June 30, 2006 June 30, 2005
----------------------------------- ----------------------- -------------------
Service charges on deposits $1,670 $1,476
----------------------------------- ----------------------- -------------------
Other service charges and fees 213 156
----------------------------------- ----------------------- -------------------
Credit card fees 1,160 1,072
----------------------------------- ----------------------- -------------------
Trust fees 745 736
----------------------------------- ----------------------- -------------------
Other income 517 259
----------------------------------- ----------------------- -------------------
Realized securities gains (losses) (34) (4)
----------------------------------- ----------------------- -------------------
Noninterest income is made up of several categories. Following is a
description of each, as well as the factors that influence each.
Service charges on deposit accounts consist of a variety of charges
imposed on demand deposits, interest-bearing deposits and savings deposit
accounts. These include, but are not limited to, the following:
o Demand deposit monthly activity fees
o Service charges for checks for which there are non-sufficient funds or
overdraft charges
o ATM transaction fees
The principal factors affecting current or future levels of income from
this category are:
o Internally generated growth
o Acquisitions of other banks/branches or de novo branches
o Adjustments to service charge structures
Service charges on deposits were $1,670 at June 30, 2006, an increase
of $194 or 13.14%. Of that increase, approximately $188 was due to increases in
fees for overdrafts and returned checks. In early 2005 the Company increased its
charge for each overdrawn item, and the amount of daily maximum charges was
increased.
Other service charges and fees consist of several categories. The
primary categories are listed below.
o Fees for the issuance of official checks
o Safe deposit box rent
o Income from the sale of customer checks
o Income from the sale of credit life and accident and health insurance
Levels of income derived from other service charges and fees vary. Fees
for the issuance of official checks and customer check sales tend to grow as
the existing franchise grows and as new offices are added. Fee schedules, while
22
subject to change, generally do not by themselves yield a significant increase
in income when they change. The most significant growth in safe deposit box
rent also comes with an expansion of offices. Safe deposit box fee schedules,
which are already at competitive levels, are occasionally adjusted. Income
derived from the sale of credit life insurance and accident and health
insurance varies with loan volume.
Other service charges and fees at June 30, 2006 were $213, as compared
with $156 for the same period the prior year. Of the $57 increase,
approximately $10 was due to increases in fees associated with cashing income
tax refund checks. Another $19 came from increased fees for letters of credit.
The remainder of the increase were in the safe deposit box, and credit life
insurance categories.
Credit card fees consist of three types of revenues.
o Credit card transaction fees
o Debit card transaction fees
o Merchant fees
In all three cases volume is critical to growth in income. For debit and
credit cards the number of accounts, whether obtained from internal growth or
by acquisition, is the key factor. Merchant fees also depend on the number of
merchants in the Company's program, as well as the type of business and the
level of transaction discounts associated with them.
Credit card fees increased by $88 or 8.21% when June 30, 2006 and June
30, 2005 are compared. The increase was attributable to volume.
Trust income is somewhat dependent upon market conditions and the number
of estate accounts being handled at any given point in time. Financial market
conditions, which affect the value of trust assets managed, can vary, leading
to fluctuations in the related income. Over the past few years and into 2006,
the financial markets have experienced a degree of volatility. Income from
estates is also unpredictable. Trust income for the first six months of 2006
was $745, an increase of $9 from the previous year.
Other income is used for types of income that cannot be classified with
other categories of noninterest income. The category includes such things as:
o Net gains on the sale of fixed assets
o Rent on foreclosed property
o Income from cash value life insurance
o Other infrequent or minor forms of income
o Revenue from investment and insurance sales
Given the nature of the items included in this category, trends or
patterns are not identifiable. Other income increased $258 when June 30, 2006
and June 30, 2005 are compared. Of the $258 change, approximately $273 was
attributable to increases in cash value associated with bank owned life
insurance policies, offset by declines in other areas.
Realized net gains and losses on securities include write-downs in
certain investments in limited liability companies (LLC's) of which the Company
is part owner, as well as sales, maturities and calls of securities.
Realized gains and losses were ($34) for the period ended June 30, 2006.
The majority of this loss was attributable to write-downs in investments in
limited liability companies (LLC's).
Noninterest Expense
-------------------
June 30, 2006 June 30, 2005
----------------------------- --------------------------- ---------------------
Salaries and employee
benefits $5,840 $5,712
----------------------------- --------------------------- ---------------------
Occupancy and furniture and
fixtures 1,005 959
----------------------------- --------------------------- ----------------------
23
----------------------------- --------------------------- ---------------------
Data processing and ATM 628 902
----------------------------- --------------------------- ---------------------
Credit card processing 882 839
----------------------------- --------------------------- ---------------------
Intangibles and goodwill
amortization 569 549
----------------------------- --------------------------- ---------------------
Net costs of other real
estate owned 14 181
----------------------------- --------------------------- ---------------------
Other operating expenses 1,962 2,138
----------------------------- --------------------------- ---------------------
Noninterest expense includes several categories. A brief description of
the factors that affect each follows.
In addition to employee salaries, the salaries and benefits expense
category includes the costs of employment taxes and employee fringe benefits.
Certain of these are:
o Health insurance
o Employee life insurance
o Dental insurance
o Executive compensation plans (1)
o Qualified Pension plans (1)
o Supplemental retirement plan (salary continuation agreements)
o Employer FICA
o Unemployment taxes
(1) See the 2005 Form 10-K and the Proxy Statement for the 2006 Annual
Meeting of Stockholders for further information.
Salaries and employee benefits expense was $5,840 at June 30, 2006, an
increase of $128 or 2.24% when compared with the same period in 2005. Included
in the increase is an $180 expense associated with a supplemental retirement
plan that provides for salary continuation agreements with selected officers of
the Company and its affiliates. This expense was offset by income from bank
owned life insurance on the plan participants. (See the discussion of "Other
Income".) The Company employed 250.5 fulltime equivalent employees at June 30,
2006 and 275.5 at June 30, 2005.
Occupancy costs include such items as depreciation expense, maintenance
of the properties, repairs and real estate taxes. At June 30, 2006, occupancy
and furniture and fixture expense was $1,005, an increase of $46 or 4.80% over
the end of the first half of last year. The increase was due to fluctuation in
various accounts, none of which represent a material change.
Data processing and ATM expense decreased by $274 when compared to June
30, 2005. A decline in maintenance cost of approximately $116 and a decrease in
conversion expenses of $152 account for most of the decrease.
Credit card processing includes costs associated with the processing of
credit cards, debit cards and merchant transactions. These expenses are related
to credit card income previously discussed in "Noninterest Income", and the
comments in that section are applicable. Credit card processing expense was $882
for the six months ended June 30, 2006, an increase of $43 from the same period
in 2005. Volume accounted for the increase.
Intangible expense is influenced by acquisitions, amortization schedules
and impairment testing depending on the nature of the intangible. Core deposit
intangibles are amortized while goodwill is subject to testing for impairment.
Both generally increase with acquisitions. Intangibles amortization expense at
June 30, 2006 was $569, an increase of $20 over the same period the previous
year. The increase was associated with the acquisition of two branches acquired
in February 2005.
24
Net cost of other real estate owned consists of losses on disposal,
repairs, write-downs and other foreclosure costs. Net costs of other real estate
owned was down $167 when compared to the first half of last year. This category
can fluctuate substantially depending on the number of properties on hand, the
gains or losses on sale and the amount of write-downs.
Other operating expenses include all other forms of expense not
classified elsewhere in the Company's statement of income. Included in this
category are such items as stationery and supplies, franchise taxes,
contributions, telephone, postage and other operating costs. Other operating
expenses for the first half of 2006, at $1,962, were down $176 from the same
period in the prior year, largely due to cost containment measures.
Balance Sheet
Year-to-date daily averages for the major balance sheet categories are
as follows:
Assets June 30, 2006 December 31, 2005
------------------------------------------------ -------------------------- ----------------------
Federal funds sold $ 220 $ ---
Interest-bearing deposits 11,464 14,819
Securities available for sale 164,689 151,431
Securities held to maturity 107,462 110,312
Mortgage loans held for sale 337 609
Real estate construction loans 27,501 26,926
Real estate mortgage loans 118,113 117,855
Commercial and industrial loans 200,818 200,799
Loans to individuals 146,473 148,088
Total Assets $ 837,315 $ 819,341
Liabilities and stockholders equity
------------------------------------------------
Noninterest-bearing demand deposits $ 113,188 $114,186
Interest-bearing demand deposits 224,410 204,522
Savings deposits 53,930 57,836
Time deposits 348,770 347,471
Other borrowings 772 705
Shareholders' equity $91,754 $90,470
Loans
Total loans net of unearned income at June 30, 2006 were $495,500, an
increase of $2,889 or approximately .59% from December 31, 2005. This equates to
an annualized growth rate of approximately 1.18%.
Deposits
Total deposits at June 30, 2006 increased by $932 from December 31,
2005. Noninterest-bearing demand deposits decreased by $4,193 when June 30, 2006
is compared to December 31, 2005. During the same period, interest-bearing
demand deposits increased by $16,053, and time deposits decreased by $9,941.
Saving deposits during the period declined by $987.
Liquidity and Capital Resources
Net cash provided by operating activities was $6,776 for the period
ended June 30, 2006, which compares to $6,075 for the same period the previous
year.
Net cash used in investing activities was $5,354 for the period ended
June 30, 2006, and $1,129 was provided for the period ended June 30, 2005. Net
cash used by financing activities was $2,490 for the period ending June 30,
2006.
Management is unaware of any commitment that would have a material and
adverse effect on liquidity at June 30, 2006.
25
Total shareholders' equity grew by $1,234 from December 31, 2005 to June
30, 2006. Earnings, the changes in unrealized gains and losses for securities
available for sale and a dividend of $2,524 accounted for the net increase.
During the first half of 2006, the Company repurchased 31,300 shares of its own
stock for approximately $740 at an average price of $23.67 (including broker
commission). The Tier I and Tier II risk-based capital ratios at June 30, 2006
were 13.35% and 14.25%, respectively. The Company's leverage capital ratio was
9.76%
Interest Rate Sensitivity
Following is a table showing repricing and maturity data for the
Company's interest-earning assets and interest-bearing liabilities:
June 30, 2006
-----------------------------------------------
Assets < 1 Year 1-5 Years > 5 Years
------------------------------------------- -------------- ---------------- ---------------
Federal funds sold --- --- ---
Interest-bearing deposits 13,966 --- ---
Securities available for sale 25,422 86,862 50,529
Securities held to maturity 10,374 56,459 38,031
Mortgage loans held for sale 222 --- ---
Loans, net of unearned income
and deferred fees 173,630 259,668 62,202
-------------- ---------------- ---------------
Total assets repricing/maturing 223,614 402,989 150,762=
============== ================ ===============
Liabilities
-------------------------------------------
Interest-bearing demand deposits 241,664 --- ---
Savings deposits 53,518 --- ---
Time deposits 177,815 147,749 17,583
Other borrowings 78 --- ---
-------------- ---------------- ---------------
Total liabilities/maturing 473,075 147,749 17,583
============== ================ ===============
Gap (249,461) 255,240 133,179
============== ================ ===============
Cumulative repricing gap (249,461) 5,779 138,958
============== ================ ===============
Cumulative gap ratio 0.47 1.01 1.22
============== ================ ===============
As shown in the above table, the Company is liability sensitive. In
other words, the Company's interest-bearing liabilities reprice and/or mature at
a faster rate than its interest-earning assets. During periods of rising
interest rates, such as we have recently experienced, this causes the Company's
net interest margin to decrease. This in turn has a negative impact on overall
profitability.
Management's Discussion and Analysis of the Financial Condition
and Results of Operations for the Three Months ended June 30, 2006
Net income for the three months ended June 30, 2006 was $3,227, up $75
when compared to the same period the prior year. Basic earnings per share for
the second quarter of 2006 were $0.46 compared to $0.45 in the second quarter of
2005.
Earnings
Interest rates have been steadily rising throughout 2005 and 2006.
Because the Company is liability sensitive, the rising rates have had an adverse
impact on net interest income. As shown in the statement of profit and loss,
interest income increased by $581, while interest expense during the same period
increased by $1,148. This produced a decline in net interest income of $567,
when the second quarter of 2006 and 2005 are compared.
26
The provision for loan losses increased by $7 in the second quarter of
2006, a decrease from the $198 in the second quarter of 2005. Asset quality
remains excellent. Therefore, based upon current information, the Company does
not anticipate substantial additions to the allowance for loan losses.
Noninterest income increased by $285 when the second quarter of 2006 and
2005 are compared. With the exception of realized gains and losses on
securities, which declined by $27, all other categories improved. Comments made
in the year-to-date discussion apply. Other income was up significantly because
of income from bank-owned life insurance contracts.
Noninterest expense was $5,401 for the quarter ended June 30, 2006. This
represents a decrease of $190 from the same period last year. Comments made in
the year-to-date discussion apply. Data processing expense declined when
compared to 2005 because of acquisition-related computer conversion costs in
2005. The cost of other real estate owned has dropped substantially as
foreclosed properties have been liquidated.
In summary, the Company has experienced a decline in net interest income
due to rising interest rates. To date, increases in the noninterest income
areas, coupled with decreases in noninterest expense, have more than offset the
decline in net interest income. The extent to which noninterest income and
expense will continue to offset the decline in interest income is not currently
known. If interest rates continue to rise and the interest margin erodes
further, it would not be unreasonable to expect that net income could be
negatively impacted. However, if interest rates stabilize, the Company's
interest income could improve.
Derivatives and Off Balance Sheet Items
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's banking affiliate extends lines of credit to its customers
in the normal course of business. Amounts drawn upon these lines vary at any
given time depending on the business needs of the customers.
Standby letters of credit are also issued to the bank customers. There
are two types of standby letters of credit. The first is a guarantee of payment
to facilitate customer purchases. The second type is a performance letter of
credit that guarantees a payment if the customer fails to perform a specific
obligation.
While it would be possible for customers to draw in full on approved
lines of credit and letters of credit, historically this has not occurred. In
the event of a sudden and substantial draw on these lines, the Company has its
own lines of credit on which it could draw funds. Sale of the loans would also
be an option.
The Company also sells mortgages on the secondary market for which there
are recourse agreements should the borrower default.
During the first half of 2006, there have been no significant or unusual
changes in these types of off balance sheet contractual obligations.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The Company considers interest rate risk to be a significant market risk
and has systems in place to measure the exposure of net interest income to
adverse movement in interest rates. Interest rate shock analyses provides
management with an indication of potential economic loss due to future rate
changes. There have not been any changes which would significantly alter the
26
results disclosed as of December 31, 2005. (See "Interest Rate Sensitivity".)
Item 4. Controls and Procedures
Under the supervision and with the participation of management,
including the Company's principal executive officer and principal financial
officer, the Company has conducted an evaluation of the effectiveness of the
design and operation of its disclosure controls and procedures as of June 30,
2006. Based on that evaluation, the Company's principal executive officer and
principal financial officer have concluded that these controls and procedures
are effective to give reasonable assurance in alerting them in a timely fashion
to material information relating to the Company that is required to be included
in the reports the Company files under the Act. There were no changes in the
Company's internal controls over financial reporting during the period covered
by this report that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
Disclosure controls and procedures are the Company's controls and
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports it files or submits under the Exchange Act is
accumulated and communicated to allow timely decisions regarding its required
disclosure. The Company believes that a controls system, no matter how well
designed and operated, cannot provide absolute assurance that all control issues
have been detected.
Part II
Other Information
Item 1. Legal Proceedings
There were no material legal proceedings for the quarter ending
June 30, 2006.
Item 1A. Risk Factors
No material changes from risk factors as previously disclosed in
the Company's 2005 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information about our purchases
during the second quarter of 2006 of equity securities that are
registered by the Company pursuant to Section 12 of the Exchange
Act.
-------------------- -------------------- ----------------------- -------------------- -------------------------
Fiscal Period Total Number of Average Price Paid Total Number of Approximate Dollar
Shares Purchased per Share(1) Shares Purchased Value or Number of
as Part of Shares That May Yet Be
Publicly Announced Purchased Under the
Plans or Programs Plans or Programs(2)(3)
-------------------- -------------------- ----------------------- -------------------- -------------------------
April 1-30 4,100 $24.62 4,100 $205,112
-------------------- -------------------- ----------------------- -------------------- -------------------------
May 1-31 6,000 $24.07 6,000 $60,692
-------------------- -------------------- ----------------------- -------------------- -------------------------
June 1-30 10,500 $22.91 10,500 89,500
-------------------- -------------------- ----------------------- -------------------- -------------------------
1) Average price per share includes commissions.
2) On May 12, 2005 the Board approved the repurchase of up to $1 million
of common stock in the period from June 1, 2005 through May 31, 2006.
On May 9, 2006 the Board approved repurchase of up to 100,000 shares of
common stock in the period from June 1, 2006 through May 31, 2007.
27
3) Beginning in June of 2006 the units remaining to be repurchased are e
xpressed in shares.
Item 3. Defaults upon Senior Securities
None for the three months ended June 30, 2006.
Item 4. Submission of Matters to a Vote of Security Holders
Three Class 1 Directors of the Company were elected for a term
of three years each by a vote of the security holders.
(a) This matter was submitted to a vote at the Company's
Annual Meeting of Stockholders held on April 11, 2006.
(b) The name of each director elected at the meeting
follows:
Lawrence J. Ball
Mary G. Miller
Glenn P. Reynolds
The name of each director whose term of office
continued after the meeting is listed:
Jack H. Harry
Jack M. Lewis
William A. Peery
James G. Rakes
James M. Shuler
Jeffrey R. Stewart
(c) The number of votes cast for or against each nominee
is provided below. There were no abstentions and no
broker non-votes.
Election of Directors
Director Votes For Votes Against
--------------------------------------------------
Lawrence J. Ball 3,113,421 13,074
Mary G. Miller 3,111,955 14,540
Glenn P. Reynolds 3,114,655 11,840
Item 5. Other Information
None
Item 6. Exhibits
See Index of Exhibits.
28
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, National
Bankshares, Inc. has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
DATE: August 9, 2006 NATIONAL BANKSHARES, INC.
/s/ JAMES G. RAKES
-----------------------------
James G. Rakes
Chief Executive Officer
/s/ J. ROBERT BUCHANAN
-----------------------------
J. Robert Buchanan
Chief Financial Officer
(1) Index of Exhibits
Page No. in
Exhibit No. Description Sequential System
----------- ----------- -----------------
3(i) Articles of Incorporation, as amended, of National (incorporated herein by
Bankshares, Inc. reference to Exhibit 3(a) of
the Annual Report on
Form 10-K for fiscal year
ended December 31, 1993)
3(i) Articles of Amendment to Articles of Incorporation (incorporated herein by
of National Bankshares, Inc., dated April 8, 2003. reference to exhibit 3(i) of
the Annual Report on
Form 10-K for the fiscal year
ended December 31, 2003)
3(i) Amended and Restated Articles of Incorporation of (incorporated herein by
National Bankshares, Inc. reference to Exhibit 3.1 of
Form 8-K filed on March 16,
2006)
4(i) Specimen copy of certificate for National (incorporated herein by
Bankshares, Inc. common stock. reference to Exhibit 4(a) of
the Annual Report on Form 10-K
for fiscal year ended
December 31, 1993)
4(i) Article Four of the Articles of Incorporation of (incorporated herein by
National Bankshares, Inc. included in Exhibit No. reference to Exhibit 4(b) of
3(a) the Annual Report on orm 10-K
for fiscal year ended
December 31, 1993)
10(ii)(B) Computer software license agreement dated June 18, (incorporated herein by
1990, by and between Information Technology, Inc. reference to Exhibit 10(e) of
and The National Bank of Blacksburg the Annual Report on Form 10-K
for fiscal year ended
December 31, 1992)
30
*10(iii)(A) National Bankshares, Inc. 1999 Stock Option Plan (incorporated herein by
reference to Exhibit 4.3 of
the Form S-8, filed as
Registration No. 333-79979
with the Commission on June 4,
1999)
*10(iii)(A) Employment Agreement dated January 2002 between (incorporated herein by
National Bankshares, Inc. and James G. Rakes reference to Exhibit 10(iii)(A)
of Form 10-Q for the period
ended June 30, 2002)
*10(iii)(A) Employment Lease Agreement dated August 14, 2002 (incorporated herein by
between National Bankshares, Inc., The National reference to Exhibit
Bank of Blacksburg and James G. Rakes 10(iii)(A) of Form 10-Q for
the period ended June 30, 2002)
*10(iii)(A) Change in Control Agreement dated January 5, 2003, (incorporated herein by
between National Bankshares, Inc. and Marilyn B. reference to Exhibit 10 iii(A)
Buhyoff of Form 10-K for the
period ended December 31, 2002)
*10(iii)(A) Change in Control Agreement dated January 8, 2003, (incorporated herein by
between National Bankshares, Inc. and F. Brad reference to Exhibit 10 iii (A)
Denardo of Form 10-K for the
period ended December 31, 2002)
*10(iii)(A) Salary Continuation Agreement dated February 8, (incorporated herein by
2006, between the National Bank of Blacksburg and reference to Exhibit
James G. Rakes. 10(iii)(A) of Form 8-K
filed on February 8, 2006)
*10(iii)(A) Salary Continuation Agreement dated February 8, (incorporated herein by
2006, between the National Bank of Blacksburg and reference to Exhibit 10(iii)(A)
F. Brad Denardo. of Form 8-K filed
on February 8, 2006)
*10(iii)(A) Salary Continuation Agreement dated February 8, (incorporated herein by
2006, between Bank of Tazewell County and J. reference to Exhibit 10(iii)(A)
Robert Buchanan. of Form 8-K filed on February 8,
2006)
*10(iii)(A) Salary Continuation Agreement dated February 8, (incorporated herein by
2006, between Bank of Tazewell County and Marilyn reference to Exhibit 10(iii)(A)
B. Buhyoff. of Form 8-K filed on February 8,
2006)
31(i) Section 302 Certification of Chief Executive Officer Page 32
31(ii) Section 302 Certification of Chief Financial Officer Page 33
32(i) 18 U.S.C. Section 1350 Certification of Chief Page 34
Executive Officer
32(ii) 18 U.S.C. Section 1350 Certification of Chief Page 34
Financial Officer
* Indicates a management contract or compensatory plan required to be filed
herein.
31
Exhibit No. 31(i)
CERTIFICATIONS UNDER SECTION 906 OF THE SARBANES OXLEY ACT OF 2002
I, James G. Rakes, Chairman, President and Chief Executive Officer of
National Bankshares, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of National Bankshares,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a - 15 (e) and 15d - 15 (e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a - 15(f) and 15d -
15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluations; and
(d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: August 9, 2006
/s/ JAMES G. RAKES
-------------------------
James G. Rakes
Chairman
President and Chief Executive Officer
(Principal Executive Officer)
32
Exhibit 31(ii)
I, J. Robert Buchanan, Treasurer (Chief Financial Officer) of National
Bankshares, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of National Bankshares,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a - 15 (e) and 15d - 15 (e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a - 15(f) and 15d -
15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure
controls and procedures to be designed under our supervision, to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this report is being prepared; and
(b) Designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purpose in accordance
with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluations; and
(d) Disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal control
over financial reporting.
Date: August 9, 2006
/s/ J. ROBERT BUCHANAN
-----------------------------
J. Robert Buchanan
Treasurer
(Principal Financial Officer)
33
Exhibit 32 (i)
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
In connection with the Form 10-Q of National Bankshares, Inc. for the
quarter ended June 30, 2006, I, James G. Rakes, President and Chief Executive
Officer of National Bankshares, Inc. (Principal Executive Officer), hereby
certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, to the best of my knowledge and belief, that:
(1) such Form 10-Q for the quarter ended June 30, 2006, fully complies with the
requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934;
and
(2) the information contained in such Form 10-Q for the quarter ended
June 30, 2006, fairly presents, in all material respects, the financial
condition and results of operations of National Bankshares, Inc.
/s/ JAMES G. RAKES
----------------------
James G. Rakes
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
Exhibit 32 (ii)
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
In connection with the Form 10-Q of National Bankshares, Inc. for the
quarter ended June 30, 2006, I, J. Robert Buchanan, Treasurer (Principal
Financial Officer) of National Bankshares, Inc., hereby certify pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002, to the best of my knowledge and belief, that:
(1) such Form 10-Q for the quarter ended June 30, 2006, fully complies with the
requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934;
and
(2) the information contained in such Form 10-Q for the quarter ended
June 30, 2006, fairly presents, in all material respects, the financial
condition and results of operations of National Bankshares, Inc.
/s/ J. ROBERT BUCHANAN
------------------------
J. Robert Buchanan
Treasurer
(Principal Financial Officer)
34