form10-q.htm
 
 

 

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 March 31, 2012
[  ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF 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
(State or other jurisdiction of incorporation or organization)
54-1375874
(I.R.S. Employer Identification No.)

101 Hubbard Street
P. O. Box 90002
Blacksburg, VA
 
 
24062-9002
(Address of principal executive offices)
(Zip Code)

(540) 951-6300
(Registrant’s telephone number, including area code)

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.  [x] Yes   [  ] No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). [x] Yes   [ ] No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b–2 of the Exchange Act.

Large accelerated filer  [  ]      Accelerated filer  [x]      Non-accelerated filer  [  ]       Smaller reporting company  [  ]
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b–2 of the Exchange Act).
[ ] 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
Common Stock, $1.25 Par Value
Outstanding at May 1, 2012
6,939,974

(This report contains 46 pages)


 
 

 

NATIONAL BANKSHARES, INC. AND SUBSIDIARIES

Form 10-Q
Index


 
Page
     
Item 1
3
     
 
3
     
 
4 - 5
     
 
6
     
 
7
 
 
 
 
8 - 9
 
 
 
 
10 – 31
     
Item 2
31 - 39
     
Item 3
39
     
Item 4
39 - 40
     
   
     
Item 1
40
     
Item 1A
40
     
Item 2
40
     
Item 3
40
 
 
 
Item 4
40
 
 
 
Item 5
40
     
Item 6
40
     
 
41
     
 
42 – 43
     
 
44 - 46


 
2

 

Part I
Item 1. Financial Statements                                                                  Financial Information
National Bankshares, Inc. and Subsidiaries
Consolidated Balance Sheets

 
(Unaudited)
       
 
March 31,
   
December 31,
 
$ in thousands, except per share data
2012
   
2011
 
Assets
             
Cash and due from banks
$
12,241
   
$
11,897
 
Interest-bearing deposits
 
101,301
     
98,355
 
Securities available for sale, at fair value
 
198,346
     
174,918
 
Securities held to maturity (fair value approximates $147,509 at March 31, 2012 and $151,429 at December 31, 2011)
 
139,367
     
143,995
 
Mortgage loans held for sale
 
1,371
     
2,623
 
Loans:
             
Loans, net of unearned income and deferred fees
 
584,564
     
588,470
 
Less allowance for loan losses
 
(8,063
)
   
(8,068
)
Loans, net
 
576,501
     
580,402
 
Premises and equipment, net
 
10,563
     
10,393
 
Accrued interest receivable
 
6,175
     
6,304
 
Other real estate owned, net
 
940
     
1,489
 
Intangible assets and goodwill
 
10,189
     
10,460
 
Bank-owned life insurance
 
19,991
     
19,812
 
Other assets
 
6,857
     
6,454
 
Total assets
$
1,083,842
   
$
1,067,102
 
               
Liabilities and Stockholders' Equity
             
Noninterest-bearing demand deposits
$
145,070
   
$
142,163
 
Interest-bearing demand deposits
 
415,352
     
404,801
 
Savings deposits
 
65,322
     
61,298
 
Time deposits
 
306,048
     
311,071
 
Total deposits
 
931,792
     
919,333
 
Accrued interest payable
 
191
     
206
 
Other liabilities
 
7,067
     
6,264
 
Total liabilities
 
939,050
     
925,803
 
Commitments and contingencies
 
---
     
---
 
Stockholders' Equity
             
Preferred stock, no par value, 5,000,000 sharesauthorized;
             
        none issued and outstanding
 
---
     
---
 
Common stock of $1.25 par value.
             
Authorized 10,000,000 shares; issued and outstanding 6,939,974 shares at March 31, 2012 and 6,939,974 shares at December 31, 2011
 
8,675
     
8,675
 
Retained earnings
 
138,374
     
133,945
 
Accumulated other comprehensive loss, net
 
(2,257
)
   
(1,321
)
Total stockholders' equity
 
144,792
     
141,299
 
Total liabilities and stockholders' equity
$
1,083,842
   
$
1,067,102
 

See accompanying notes to consolidated financial statements.

 
3

 

National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Income
Three Months Ended March 31, 2012 and 2011
(Unaudited)


   
March 31,
   
March 31,
 
$ in thousands, except per share data
 
2012
   
2011
 
Interest Income
               
Interest and fees on loans
 
$
8,878
   
$
9,095
 
Interest on interest-bearing deposits
   
71
     
32
 
Interest on securities – taxable
   
1,589
     
1,662
 
Interest on securities – nontaxable
   
1,576
     
1,676
 
Total interest income
   
12,114
     
12,465
 
                 
Interest Expense
               
Interest on time deposits of $100,000 or more
   
425
     
561
 
Interest on other deposits
   
1,692
     
1,818
 
Total interest expense
   
2,117
     
2,379
 
Net interest income
   
9,997
     
10,086
 
Provision for loan losses
   
672
     
800
 
Net interest income after provision for loan losses
   
9,325
     
9,286
 
                 
Noninterest Income
               
Service charges on deposit accounts
   
631
     
612
 
Other service charges and fees
   
49
     
58
 
Credit card fees
   
794
     
733
 
Trust income
   
326
     
246
 
BOLI income
   
200
     
184
 
Other income
   
99
     
91
 
Realized securities gains, net
   
53
     
10
 
Total noninterest income
   
2,152
     
1,934
 
                 
Noninterest Expense
               
Salaries and employee benefits
   
2,956
     
2,904
 
Occupancy and furniture and fixtures
   
397
     
423
 
Data processing and ATM
   
392
     
444
 
FDIC assessment
   
109
     
346
 
Credit card processing
   
572
     
586
 
Intangible assets amortization
   
271
     
271
 
Net costs of other real estate owned
   
48
     
134
 
Franchise taxes
   
162
     
242
 
Other operating expenses
   
804
     
734
 
Total noninterest expense
   
5,711
     
6,084
 
Income before income taxes
   
5,766
     
5,136
 
Income tax expense
   
1,337
     
1,112
 
Net Income
 
$
4,429
   
$
4,024
 
 
 
 
4

 
 
 
Basic net income per share
 
$
0.64
   
$
0.58
 
Fully diluted net income per share
 
$
0.64
   
$
0.58
 
Weighted average number of common
               
shares outstanding – basic
   
6,939,974
     
6,933,780
 
Weighted average number of common
               
shares outstanding – diluted
   
6,954,637
     
6,957,450
 
Dividends declared per share
 
$
---
   
$
---
 

See accompanying notes to consolidated financial statements.


 
5

 


National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
Three Months Ended March 31, 2012 and 2011
(Unaudited)

   
March 31,
   
March 31,
 
$ in thousands
 
2012
   
2011
 
Net Income
 
$
4,429
   
$
4,024
 
                 
Other Comprehensive Income, Net of Tax
               
Unrealized holding gains (losses) on available for sale securities net of taxes of ($489) and $228 for the periods ended March 31, 2012 and 2011, respectively
   
(907
)
   
423
 
Reclassification adjustment, net of taxes of ($15) and ($3) for the periods ended March 31, 2012 and 2011, respectively
   
(29
)
   
(5
)
Other comprehensive income (loss), net of taxes of ($504) and $225 for the periods ended March 31, 2012 and 2011, respectively
   
(936
)
   
418
 
Total Comprehensive Income
 
$
3,493
   
$
4,442
 
                 

See accompanying notes to consolidated financial statements.


 
6

 


National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity
Three Months Ended March 31, 2012 and 2011
(Unaudited)

$ in thousands
 
Common Stock
   
Retained Earnings
   
Accumulated Other Comprehensive Income (Loss)
   
Total
 
Balances at December 31, 2010
  $ 8,667     $ 123,161     $ (2,641 )   $ 129,187  
Net income
    ---       4,024       ---       4,024  
Stock options exercised
    3       33       ---       36  
Other comprehensive income, net of tax $225
    ---       ---       418       418  
Balances at March 31, 2011
  $ 8,670     $ 127,218     $ (2,223 )   $ 133,665  
                                 
Balances at December 31, 2011
  $ 8,675     $ 133,945     $ (1,321 )   $ 141,299  
Net income
    ---       4,429       ---       4,429  
Other comprehensive loss, net of tax ($504)
    ---       ---       (936 )     (936 )
Balances at March 31, 2012
  $ 8,675     $ 138,374     $ (2,257 )   $ 144,792  

See accompanying notes to consolidated financial statements.

 
7

 

National Bankshares, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2012 and 2011
(Unaudited)
 
   
March 31,
   
March 31,
 
$ in thousands
 
2012
   
2011
 
Cash Flows from Operating Activities
           
Net income
  $ 4,429     $ 4,024  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Provision for loan losses
    672       800  
Depreciation of bank premises and equipment
    192       209  
Amortization of intangibles
    271       271  
Amortization of premiums and accretion of discounts, net
    56       61  
Losses on sales and calls of securities available for sale, net
    (44 )     (8 )
Gains on calls of securities held to maturity, net
    (9 )     (2 )
Losses and write-downs on other real estate owned
    (24 )     100  
Net change in:
               
Mortgage loans held for sale
    1,252       2,460  
Accrued interest receivable
    129       (498 )
Other assets
    (55 )     228  
Accrued interest payable
    (15 )     3  
Other liabilities
    803       (1,368 )
Net cash provided by operating activities
    7,657       6,280  
                 
Cash Flows from Investing Activities
               
Net change interest-bearing deposits
    (2,946 )     13,726  
Proceeds from calls, principal payments, sales and maturities of securities available for sale
    41,168       10,659  
Proceeds from calls, principal payments and maturities of securities held to maturity
    13,846       5,449  
Purchases of securities available for sale
    (66,041 )     (16,000 )
Purchases of securities held to maturity
    (9,239 )     (7,138 )
Collections of loan participations
    90       25  
Loan originations and principal collections, net
    3,116       (12,622 )
Proceeds from disposal of other real estate owned
    573       295  
Recoveries on loans charged off
    23       25  
Additions to bank premises and equipment
    (362 )     (105 )
Net cash used in investing activities
    (19,772 )     (5,686 )
                 
Cash Flows from Financing Activities
               
Net change in time deposits
    (5,023 )     (13,820 )
Net change in other deposits
    17,482       15,132  
Stock options exercised
    ---       36  
Net cash provided by financing activities
    12,459       1,348  
Net change in cash and due from banks
    344       1,942  
Cash and due from banks at beginning of period
    11,897       9,858  
Cash and due from banks at end of period
  $ 12,241     $ 11,800  
                 

 
8

 


             
Supplemental Disclosures of Cash Flow Information
           
Interest paid on deposits and borrowed funds
  $ 2,132     $ 2,376  
Income taxes paid
    196       ---  
                 
Supplemental Disclosure of Noncash Activities
               
Loans charged against the allowance for loan losses
  $ 700     $ 243  
Loans transferred to other real estate owned
    ---       894  
Unrealized gains (losses) on securities available for sale
    (1,440 )     643  


See accompanying notes to consolidated financial statements.

 
9

 

National Bankshares, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
March 31, 2012
(Unaudited)

$ in thousands, except per share data

Note 1: General

The consolidated financial statements of National Bankshares, Inc. (“NBI”) and its wholly-owned subsidiaries, The National Bank of Blacksburg (“NBB”) and National Bankshares Financial Services, Inc. (“NBFS”) (collectively, the “Company”), conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The accompanying interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments consisting of normal recurring adjustments, which are necessary for a fair presentation of the consolidated financial statements, have been included.  The results of operations for the three months ended March 31, 2012 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 2011 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.
Subsequent events have been considered through the date when the Form 10-Q was issued.
 
Note 2: Stock-Based Compensation

The Company had a stock option plan, the 1999 Stock Option Plan, that was adopted in 1999 and that was terminated on March 9, 2009. Incentive stock options were granted annually to key employees of NBI and its subsidiaries from 1999 to 2005 and none have been granted since 2005.  All of the stock options are vested.

Options
 
Shares
   
Weighted
Average
Exercise
Price
   
Weighted
Average
Remaining
Contractual
Term
   
Aggregate
Intrinsic
Value
 
Outstanding at January 1, 2012
    77,000     $ 22.82              
Exercised
    ---       ---              
Forfeited or expired
    ---       ---              
Outstanding March 31, 2012
    77,000     $ 22.82       4.37     $ 560  
Exercisable at March 31, 2012
    77,000     $ 22.82       4.37     $ 560  

There were no stock options exercised during the three months ended March 31, 2012. There were 2,500 shares with an intrinsic value of $35 exercised during the first quarter of 2011.

Note 3:                      Loan Portfolio

The loan portfolio, excluding loans held for sale, was comprised of the following:

   
March 31,
2012
   
December 31,
2011
 
Real Estate Construction
  $ 48,266     $ 48,528  
Consumer Real Estate
    147,312       149,750  
Commercial Real Estate
    301,911       303,192  
Commercial Non Real Estate
    39,998       38,849  
Public Sector and IDA
    15,263       15,407  
Consumer Non Real Estate
    31,814       32,744  
Total
  $ 584,564     $ 588,470  
 
 
 
10

 

 
Note 4:                      Allowance for Loan Losses, Nonperforming Assets and Impaired Loans
 
The allowance for loan losses methodology incorporates individual evaluation of impaired loans and collective evaluation of groups of non-impaired loans. The Company performs ongoing analysis of the loan portfolio to determine credit quality and to identify impaired loans. Credit quality is rated based on the loan’s payment history, the borrower’s current financial situation and value of the underlying collateral.
Impaired loans are those loans that have been modified in a troubled debt restructure (“TDR” or “restructure”) and larger, non-homogeneous loans that are in nonaccrual or exhibit payment history or financial status that indicate the probability that collection will not occur according to the loan’s terms. Generally, impaired loans are risk rated “classified” or “other assets especially mentioned.” Impaired loans are measured at the lower of the invested amount or the fair market value. Impaired loans with an impairment loss are designated nonaccrual. Please refer to Note 1 of the Company’s 2011 Form 10-K, “Summary of Significant Accounting Policies” for additional information on evaluation of impaired loans and associated specific reserves, and policies regarding nonaccruals, past due status and charge-offs.
Troubled debt restructurings impact the estimation of the appropriate level of the allowance for loan losses. If the restructuring included forgiveness of a portion of principal or accrued interest, the charge-off is included in the historical charge-off rates applied to the collective evaluation methodology. Further, restructured loans are individually evaluated for impairment, with amounts below fair value accrued in the allowance for loan losses. TDRs that experience a payment default are examined to determine whether the default indicates collateral dependency or cash flows below those that were included in the fair value measurement. TDRs, as well as all impaired loans, that are determined to be collateral dependent or for which decreased cash flows indicate a decline in fair value are charged down to fair value.
The Company evaluated characteristics in the loan portfolio and determined major segments and smaller classes within each segment for application of the allowance for loan losses methodology. These characteristics include collateral type, repayment sources, and (if applicable) the borrower’s business model.

Change in Portfolio Segments and Classes
During the first quarter of 2012, the Company revised its basis for determining segments and classes for the allowance for loan losses. In previous periods, the loan portfolio was segmented primarily by repayment source, whereas beginning with the first quarter of 2012 disaggregation is based primarily upon collateral type for secured loans and borrower type or repayment terms for unsecured loans. This aligns the allowance categories with those used for financial statements and other notes, providing greater uniformity and comparability. Consistent with accounting guidance, prior periods have not been restated and are shown as originally published using the segments and classes in effect for the period. These changes had an insignificant effect on the calculation of the balance in the allowance for loan losses.
The segments and classes used in determining the allowance for loan losses, beginning with the first quarter of 2012 are as follows.

Real Estate Construction
Construction, residential
Construction, other
 
Consumer Real Estate
Equity lines
Residential closed-end first liens
Residential closed-end junior liens
 
Commercial Real Estate
Multifamily real estate
Commercial real estate, owner occupied
Commercial real estate, other
 
Commercial Non Real Estate
Commercial and Industrial
 
Public Sector and IDA
Public sector and IDA
 
Consumer Non Real Estate
Credit cards
Automobile
Other consumer loans



 
11

 


Prior to the first quarter of 2012, the Company’s segments and classes were as follows:

Consumer Real Estate
Equity lines
Closed-end consumer real estate
Consumer construction
 
Consumer, Non Real Estate
Credit cards
Consumer, general
Consumer overdraft
 
Commercial & Industrial
Commercial & industrial
 
Construction, Development and Land
Residential
Commercial
Commercial Real Estate
College housing
Office/Retail space
Nursing homes
Hotels
Municipalities
Medical professionals
Religious organizations
Convenience stores
Entertainment and sports
Nonprofits
Restaurants
General contractors
Other commercial real estate

Risk factors are analyzed for each class to estimate collective reserves. Factors include allocations for the historical charge-off percentage and changes in national and local economic and business conditions, in the nature and volume of the portfolio, in loan officers’ experience and in loan quality. Increased allocations for the risk factors applied to each class are made for special mention and classified loans. The Company allocates additional reserves for “high risk” loans, determined to be junior lien mortgages, high loan-to-value loans and interest-only loans.

A detailed analysis showing the allowance roll-forward by portfolio segment and related loan balance by segment follows:

 
Activity in the Allowance for Loan Losses for the three months ended March 31, 2012
 
Real Estate Construction
 
Consumer Real Estate
 
Commercial Real Estate
 
Commercial Non Real Estate
 
Public Sector and IDA
 
Consumer Non Real Estate
 
Unallocated
 
Total
 
Balance, December 31, 2011
$
1,079
 
$
1,245
 
$
3,515
 
 
$
 
1,473
 
$
232
 
$
403
 
$
121
 
$
8,068
 
Charge-offs
 
---
   
(95
)
 
(537
)
 
---
   
---
   
(68
)
 
---
   
(700
)
Recoveries
 
---
   
---
   
---
   
---
   
---
   
23
   
---
   
23
 
Provision for loan losses
 
(405
)
 
1,102
   
242
   
(347
)
 
(147
)
 
124
   
103
   
672
 
Balance, March 31, 2012
$
674
 
$
2,252
 
$
3,220
 
 
$
 
1,126
 
$
85
 
$
482
 
$
224
 
$
8,063
 


   
Activity in the Allowance for Loan Losses for the three months ended March 31, 2011
 
   
Consumer Real Estate
   
Consumer Non Real Estate
   
Commercial Real Estate
   
Commercial & Industrial
   
Construction, Development & Other Land
   
 
Unallocated
   
Total
 
Balance, December 31, 2010
  $ 1,059     $ 586     $ 4,033     $ 1,108     $ 749     $ 129     $ 7,664  
Charge-offs
    (36 )     (90 )     (118 )     ---       ---       ---       (244 )
Recoveries
    7       18       ---       ---       ---       ---       25  
Provision for loan losses
    72       (50 )     740       113       (59 )     (16 )     800  
Balance, March 31,  2011
  $ 1,102     $ 464     $ 4,655     $ 1,221     $ 690     $ 113     $ 8,245  


 
12

 


 
Allowance for Loan Losses as of March 31, 2012
 
 
Real Estate Construction
 
Consumer Real Estate
 
Commercial Real Estate
 
Commercial Non Real Estate
 
Public Sector and IDA
 
Consumer Non Real Estate
 
Unallocated
 
Total
 
Individually evaluated for impairment
$
13
 
$
169
 
$
42
 
 
$
 
361
 
$
---
 
$
8
 
$
---
 
$
593
 
Collectively evaluated for impairment
 
661
   
2,083
   
3,178
   
 
765
   
85
   
474
   
224
   
7,470
 
Total
$
674
 
$
2,252
 
$
3,220
 
$
1,126
 
$
85
 
$
482
 
$
224
 
$
8,063
 


 
Allowance for Loan Losses as of December 31, 2011
 
 
Consumer Real Estate
 
Consumer Non Real Estate
 
Commercial Real Estate
 
Commercial & Industrial
 
Construction, Development & Other Land
 
Unallocated
   
Total
 
Individually evaluated for impairment
  $ ---     $ ---     $ 1,014     $ 62     $ 47     $ ---     $ 1,123  
Collectively  evaluated for impairment
    1,052       401       3,497       973       901       121       6,945  
Total
  $ 1,052     $ 401     $ 4,511     $ 1,035     $ 948     $ 121     $ 8,068  


 
Loans as of March 31, 2012
 
 
Real Estate Construction
 
Consumer Real Estate
 
Commercial Real Estate
 
Commercial Non Real Estate
 
Public Sector and IDA
 
Consumer Non Real Estate
 
Unallocated
 
Total
 
Individually evaluated for impairment
  $ 6,367     $ 1,055     $ 4,849     $ 649     $ ---     $ 67     $ ---     $ 12,987  
Collectively evaluated for impairment
    41,899       146,257       297,062        39,349       15,263       31,747       ---       571,577  
Total
  $ 48,266     $ 147,312     $ 301,911     $ 39,998     $ 15,263     $ 31,814     $ ---     $ 584,564  
 
 

 
Loans as of December 31, 2011
 
 
Consumer Real Estate
 
Consumer Non Real Estate
 
Commercial Real Estate
 
Commercial & Industrial
 
Construction, Development & Other Land
 
Unallocated
   
Total
 
Individually evaluated for impairment
  $ 238     $ ---     $ 9,067     $ 139     $ 3,152     $ ---     $ 12,596  
Collectively  evaluated for impairment
    109,843       29,707       357,507       37,584       41,233       ---       575,874  
Total
  $ 110,081     $ 29,707     $ 366,574     $ 37,723     $ 44,385     $ ---     $ 588,470  



 
13

 


A summary of ratios for the allowance for loan losses follows:

   
Three Months ended
March 31,
    Year ended December 31,
 
   
2012
     
2011
   
2011
 
Ratio of allowance for loan losses to the end of period loans, net of unearned income and deferred fees
   
1.38
%
   
1.40
%
   
1.37
%
Ratio of net charge-offs to average loans, net of unearned income and deferred fees(1)
   
0.46
%
   
0.15
%
   
0.43
%

(1)  
Net charge-offs are on an annualized basis.

A summary of nonperforming assets follows:

   
March 31,
    December 31,
 
   
2012
   
2011
   
2011
 
Nonperforming assets:
                 
Nonaccrual loans
  $ 1,789     $ 2,339     $ 1,398  
Restructured loans in nonaccrual
    3,539       5,314       3,806  
Total nonperforming loans
    5,328       7,653       5,204  
Other real estate owned, net
    940       2,222       1,489  
Total nonperforming assets
  $ 6,268     $ 9,875     $ 6,693  
Ratio of nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned
    1.07 %     1.67
%
    1.13
%
Ratio of allowance for loan losses to nonperforming loans(1)
    151.33 %     107.74
%
    155.03
%

(1)           The Company defines nonperforming loans as total nonaccrual and restructured loans that are nonaccrual.  Loans 90 days past due and still accruing and accruing restructured loans are excluded.

A summary of loans past due 90 days or more and impaired loans follows:

   
March 31,
   
December 31,
 
   
2012
   
2011
   
2011
 
Loans past due 90 days or more and still accruing
  $ 210     $ 1,078     $ 481  
Ratio of loans past due 90 days or more and still accruing to loans, net of unearned income and deferred fees
    0.04 %     0.18 %     0.08 %
Accruing restructured loans
  $ 3,742     $ 884     $ 3,756  
Impaired loans:
                       
Impaired loans with no valuation allowance
  $ 9,933     $ ---     $ 5,505  
Impaired loans with a valuation allowance
    3,054       7,084       7,091  
Total impaired loans
  $ 12,987     $ 7,084     $ 12,596  
Valuation allowance
    (593 )     (1,256 )     (1,123 )
Impaired loans, net of allowance
  $ 12,394     $ 5,828     $ 11,473  
Average recorded investment in impaired loans(1)
  $ 14,555     $ 7,690     $ 8,734  
Interest income recognized on impaired loans, after designation as impaired
  $ 24     $ 20     $ 141  
Amount of income recognized on a cash basis
  $ ---     $ ---     $ ---  

(1)            Recorded investment includes principal, accrued interest and net deferred fees.

Nonaccrual loans that meet the Company’s balance thresholds are designated as impaired. No interest income was recognized on nonaccrual loans for the three months ended March 31, 2012 and March 31, 2011, respectively.
 
 
 
14

 

 
A detailed analysis of investment in impaired loans, associated reserves and interest income recognized, segregated by loan class follows:

   
Impaired Loans as of March 31, 2012
 
   
Principal Balance
   
(A)
Total Recorded Investment(1)
   
Recorded Investment(1) in (A) for Which There is No Related Allowance
   
Recorded Investment(1) in (A) for Which There is a Related Allowance
   
Related Allowance
 
Real Estate Construction
                             
Construction, residential
  $ 1,256     $ 1,251     $ 1,251     $ ---     $ ---  
Construction, other
    5,111       5,102       3,480       1,622       13  
Consumer Real Estate
                                       
Equity lines
    ---       ---       ---       ---       ---  
Residential closed-end first liens
    798       800       525       275       60  
Residential closed-end junior liens
    257       258       110       148       109  
Commercial Real Estate
                                       
Multifamily real estate
    529       529       529       ---       ---  
Commercial real estate, owner occupied
    4,320       4,334       3,909       425       42  
Commercial real estate, other
    ---       ---       ---       ---       ---  
Commercial Non Real Estate
                                       
Commercial and industrial
    649       649       121       528       361  
Public Sector and IDA
                                       
Public sector and IDA
    ---       ---       ---       ---       ---  
Consumer Non Real Estate
                                       
Credit cards
    ---       ---       ---       ---       ---  
Automobile
    ---       ---       ---       ---       ---  
Other consumer loans
    67       67       ---       67       8  
Total
  $ 12,987     $ 12,990     $ 9,925     $ 3,065     $ 593  

(1)           Recorded investment includes the unpaid principal balance and any accrued interest and net deferred fees.

 
15

 


   
Impaired Loans as of December 31, 2011
 
   
Unpaid Principal Balance
   
(A)
Total Recorded Investment(1)
   
Recorded Investment(1) in (A) for Which There is No Related Allowance
   
Recorded Investment(1) in (A) for Which There is a Related Allowance
   
Related Allowance
 
Consumer Real Estate(2)
                             
Closed-end Consumer Real Estate
  $ 237     $ 237     $ 237     $ ---     $ ---  
Commercial Real Estate(2)
                                       
College Housing
    366       366       366       ---       ---  
Office & Retail
    3,500       3,500       ---       3,500       57  
Hotel
    3,319       3,320       2,794       526       16  
Medical Professionals
    66       67       ---       67       66  
General Contractors
    703       703       176       527       402  
Other commercial real estate
    1,113       1,112       425       687       474  
Commercial & Industrial(2)
                                       
Commercial & Industrial
    139       139       ---       139       62  
Construction, Development and Land(2)
                                       
Residential
    2,901       2,912       1,256       1,656       46  
Commercial
    252       252       252       ---       ---  
Total
  $ 12,596     $ 12,608     $ 5,506     $ 7,102     $ 1,123  

(1)           Recorded investment includes the unpaid principal balance and any accrued interest and net deferred fees.
(2)  Only classes with impaired loans are shown.

 
16

 


The following tables show the average investment and interest income recognized for impaired loans.

   
For the Three Months Ended March 31, 2012
 
   
Average Recorded Investment(1)
   
Interest Income Recognized
 
Real Estate Construction
           
Construction, residential
  $ 1,514     $ ---  
Construction, other
    5,891       10  
Consumer Real Estate
               
Equity lines
    997       ---  
Residential closed-end first liens
    258       ---  
Residential closed-end junior liens
    ---       ---  
Commercial Real Estate
               
Multifamily real estate
    529       ---  
Commercial real estate, owner occupied
    4,627       14  
Commercial real estate, other
    ---       ---  
Commercial Non Real Estate
               
Commercial and industrial
    671       ---  
Public Sector and IDA
               
Public sector and IDA
    ---       ---  
Consumer Non Real Estate
               
Credit cards
    ---       ---  
Automobile
    ---       ---  
Other consumer
    68       ---  
Total
  $ 14,555     $ 24  

(1)           Recorded investment includes the unpaid principal balance and any accrued interest and net deferred fees.

   
Average Investment and Interest Income of Impaired Loans For the Year Ended
 
   
December 31, 2011
 
   
Average Recorded Investment(1)
   
Interest Income Recognized
 
Consumer Real Estate(2)
           
Closed-end Consumer Real Estate
  $ 450     $ 3  
Commercial Real Estate(2)
               
College Housing
    281       7  
Office & retail
    292       ---  
Hotel
    3,445       41  
Medical Professionals
    67       5  
General Contractors
    112       4  
Other commercial real estate
    1,139       24  
Commercial & Industrial(2)
               
Commercial & Industrial
    553       ---  
Construction, Development and Land(2)
               
Residential
    2,143       49  
Commercial
    252       8  
Total
  $ 8,734     $ 141  
 
 
(1)   Recorded investment includes the unpaid principal balance and any accrued interest and net deferred fees.
(2)  Only classes with impaired loans are shown.
 
 
 
17

 
 
An analysis of past due and nonaccrual loans as of March 31, 2012 follows:

   
30 – 89 Days Past Due
   
90 or More Days Past Due
   
90 Days Past Due and Still Accruing
   
Nonaccruals (Including Impaired Nonaccruals)
 
Real Estate Construction
                       
Construction, Residential
  $ ---     $ 1,256     $ ---     $ 1,256  
Construction, Other
    ---       ---       ---       ---  
Consumer Real Estate
                               
Equity Lines
    200       ---       ---       ---  
Residential closed-end first liens
    1,404       556       163       717  
Residential closed-end junior liens
    172       35       ---       182  
Commercial Real Estate
                               
Multifamily Real Estate
    1,334       250       ---       529  
Commercial Real Estate, Owner Occupied
    1,605       1,413       36       1,991  
Commercial Real Estate, Other
    ---       ---       ---       ---  
Commercial Non Real Estate
                               
Commercial and Industrial
    45       489       5       586  
Public Sector and IDA
                               
Public Sector and IDA
    ---       ---       ---       ---  
Consumer Non Real Estate
                               
Credit Cards
    3       1       1       ---  
Automobile
    186       5       5       ---  
Other Consumer Loans
    94       67       ---       67  
Total
  $ 5,043     $ 4,072     $ 210     $ 5,328  


 
18

 


December 31, 2011
                   
   
30 – 89 Days Past Due
   
90 or More Days Past Due
   
90 Days Past Due and Still Accruing
   
Nonaccruals (Including Impaired Nonaccruals)
 
Consumer Real Estate
                       
Equity Lines
  $ ---     $ ---     $ ---     $ ---  
Closed-ended Consumer Real Estate
    1,735       658       346       313  
Consumer Construction
    ---       ---       ---       ---  
Consumer Non-Real Estate
                               
Credit Cards
    26       8       8       ---  
Consumer General
    270       38       38       ---  
Consumer Overdraft
    ---       ---       ---       ---  
Commercial Real Estate
                               
College Housing
    452       250       ---       250  
Office/Retail
    ---       ---       ---       ---  
Nursing Homes
    ---       ---       ---       ---  
Hotels
    616       526       ---       1,397  
Municipalities
    ---       ---       ---       ---  
Medical Professionals
    ---       ---       ---       ---  
Religious Organizations
    ---       ---       ---       ---  
Convenience Stores
    ---       ---       ---       ---  
Entertainment and Sports
    ---       ---       ---       ---  
Nonprofits
    ---       ---       ---       ---  
Restaurants
    ---       ---       ---       ---  
General Contractors
    103       ---       ---       703  
Other Commercial Real Estate
    815       488       63       1,112  
Commercial and Industrial
                               
Commercial and Industrial
    31       26       26       139  
Construction, Development and Land
                               
Residential
    ---       1,290       ---       1,290  
Commercial
    252       ---       ---       ---  
Total
  $ 4,300     $ 3,284     $ 481     $ 5,204  

The estimate of credit risk for non-impaired loans is obtained by applying allocations for internal and external factors.  The allocations are increased for loans that exhibit greater credit quality risk.
Credit quality indicators, which the Company terms risk grades, are assigned through the Company’s credit review function for larger loans and selective review of loans that fall below credit review thresholds.  Loans that do not indicate heightened risk are graded as “pass.” Loans that appear to have elevated credit risk because of frequent or persistent past due status, which is less than 75 days, or that show weakness in the borrower’s financial condition are risk graded “special mention.”  Loans with frequent or persistent delinquency exceeding 75 days or that have a higher level of weakness in the borrower’s financial condition are graded “classified.” Classified loans have regulatory risk ratings of “substandard” and “doubtful.”   Allocations are increased by 50% and by 100% for loans with grades of “special mention” and “classified,” respectively.
Determination of risk grades was completed for the portfolio as of March 31, 2012 and 2011 and December 31. 2011.

 
19

 


The following displays non-impaired loans by credit quality indicator:

March 31, 2012
   
Pass
   
Special
Mention
   
Classified (Excluding Impaired)
 
Real Estate Construction
                 
Construction, 1-4 Family Residential
  $ 12,763     $ ---     $ ---  
Construction, Other
    26,175       2,961       ---  
Consumer Real Estate
                       
Equity Lines
    18,845       200       ---  
Closed-End First Liens
    117,866       566       1,682  
Closed-End, Junior Liens
    6,813       5       279  
Commercial Real Estate
                       
Multifamily Residential Real Estate
    29,839       1,232       164  
Commercial RE Owner-Occupied
    167,227       ---       1,510  
Commercial RE Non Owner-Occupied
    93,920       3,170       ---  
Commercial Non Real Estate
                       
C & I, Non Real Estate
    39,182       16       152  
Public Sector and IDA
                       
States & Political Subdivisions
    15,263       ---       ---  
Consumer Non Real Estate
                       
Credit Cards
    6,319       ---       ---  
Automobile
    12,548       95       73  
Other Consumer
    12,669       9       34  
Total
  $ 559,429     $ 8,254     $ 3,894  


 
20

 


December 31, 2011
   
Pass
   
Special
Mention
   
Classified
(Excluding Impaired)
 
Consumer Real Estate
                 
Equity Lines
  $ 17,971     $ ---     $ 14  
Closed-ended Consumer Real Estate
    87,882       595       1,332  
Consumer Construction
    2,050       ---       ---  
Consumer Non-Real Estate
                       
Credit Cards
    6,594       ---       1  
Consumer General
    22,679       42       105  
Consumer Overdraft
    285       ---       1  
Commercial Real Estate
                       
College Housing
    88,157       452       215  
Office/Retail
    73,106       420       267  
Nursing Homes
    16,173       ---       ---  
Hotel
    24,498       ---       616  
Municipalities
    19,230       ---       ---  
Medical Professionals
    18,577       ---       ---  
Religious Organizations
    15,852       ---       ---  
Convenience Stores
    10,519       ---       ---  
Entertainment and Sports
    7,346       ---       ---  
Nonprofit
    3,265       3,170       ---  
Restaurants
    6,138       ---       387  
General Contractors
    4,550       109       247  
Other Commercial Real Estate
    63,422       ---       790  
Commercial and Industrial
                       
Commercial and Industrial
    37,252       196       137  
Construction, Development and Land
                       
Residential
    15,732       ---       ---  
Commercial
    22,409       2,961       130  
Total
  $ 563,687     $ 7,945     $ 4,242  

Sales, Purchases and Reclassification of Loans
The Company finances mortgages under “best efforts” contracts with mortgage purchasers.  The mortgages are designated as held for sale upon initiation.  There have been no major reclassifications from portfolio loans to held for sale.  Occasionally, the Company purchases or sells participations in loans.  All participation loans purchased met the Company’s normal underwriting standards at the time the participation was entered.  Participation loans are included in the appropriate portfolio balances to which the allowance methodology is applied.

 
21

 


Troubled Debt Restructurings

The Company modified loans that were classified troubled debt restructurings during the three months ended March 31, 2012.  The following table present restructurings by class that occurred during the period.

Note: only classes with restructured loans are presented.

   
Restructurings that occurred during the three months ended
March 31, 2012
 
   
Number of Contracts
   
Pre-Modification Outstanding Principal Balance
   
Post-Modification Outstanding Principal Balance
   
Impairment Accrued
 
Consumer Real Estate
                       
Closed-end first liens
    3     $ 305     $ 324     $ 47  
Closed-end junior liens
    1       143       147       109  
Commercial Real Estate
                               
Commercial real estate, owner occupied
    1       17       22       ---  
Total
    5     $ 465     $ 493     $ 156  

The modifications provided payment relief primarily by extending maturity dates without reducing interest rates or amounts owed.  Restructured loans are designated impaired and measured for impairment. Of the consumer real estate loans summarized above, two were loans previously modified and reported as troubled debt restructurings in prior quarters.  The Company granted additional modifications in the first quarter of 2012, increasing the balance by $10 from December 31, 2011. The loans restructured in the current period are secured by real estate and the impairment measurement is based upon the fair value (reduced by selling costs) of the underlying collateral.  The impairment measurement resulted in $156 accrued to the allowance for loan losses.
The following table presents restructured loans that were modified between the dates of April 1, 2011 and March 31, 2012 and that experienced payment default during the three months ended March 31, 2012.  The company defines default as one or more payments that occur more than 30 days past the due date.

   
Number of Contracts
   
Principal Balance
   
Impairment Accrued
 
Consumer Real Estate
                 
Closed-end first liens
    1     $ 17     $ ---  
Commercial Real Estate
                       
Multifamily
    1       250       ---  
Commercial Non Real Estate
                       
Commercial and industrial
    1       58       ---  
Consumer Non Real Estate
                       
Other consumer
    1       67       8  
Total
    4     $ 392     $ 8  

Of the restructured loans that experienced a payment delay of 30 days or more during the period, $267 are secured by real estate.  The remaining restructured loans that experienced payment default during the period are secured by collateral other than real estate. The impairment measurement is based upon the fair value of the underlying collateral and as such, was not significantly affected by the payment default.  All of the above loans are in nonaccrual status.

 
22

 

Note 5: Securities

The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities available for sale by major security type as of March 31, 2012 are as follows:

   
March 31, 2012
 
   
Amortized
Costs
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Values
 
Available for sale:
                       
U.S. Treasury
  $ 2,009     $ 119     $ ---     $ 2,128  
U.S. Government agencies
    118,568       878       882       118,564  
Mortgage-backed securities
    6,054       528       ---       6,582  
States and political subdivisions
    46,891       1,940       12       48,819  
Corporate
    18,216       405       183       18,438  
Federal Home Loan Bank stock
    1,596       ---       ---       1,596  
Federal Reserve Bank stock
    92       ---       ---       92  
Other securities
    2,292       7       172       2,127  
Total
  $ 195,718     $ 3,877     $ 1,249     $ 198,346  

The amortized costs, gross unrealized gains, gross unrealized losses and fair values for securities held to maturity by major security type as of March 31, 2012 are as follows:

   
March 31, 2012
 
   
Amortized
Costs
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Values
 
Held to maturity:
                       
U.S. Government agencies
  $ 14,997     $ 488     $ 121     $ 15,364  
Mortgage-backed securities
    851       91       ---       942  
States and political subdivisions
    122,865       7,817       151       130,531  
Corporate
    654       18       ---       672  
Total
  $ 139,367     $ 8,414     $ 272     $ 147,509  

Information pertaining to securities with gross unrealized losses at March 31, 2012 and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

   
March 31, 2012
 
   
Less Than 12 Months
   
12 Months or More
 
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Temporarily impaired securities:
                       
U.S. Government agencies and corporations
  $ 72,910     $ 1,003     $ ---     $ ---  
States and political subdivisions
    9,777       162       256       1  
Corporate debt securities
    5,816       183       ---       ---  
Other
    ---       ---       133       172  
Total temporarily impaired securities
  $ 88,503     $ 1,348     $ 389     $ 173  


 
23

 


   
December 31, 2011
 
   
Less Than 12 Months
   
12 Months or More
 
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
Temporarily impaired securities:
                       
U.S. Government agencies and corporations
  $ 6,230     $ 20     $ ---     $ ---  
States and political subdivisions
    3,527       19       981       26  
Corporate debt securities
    4,916       97       ---       ---  
Other
    ---       ---       142       162  
Total temporarily impaired securities
  $ 14,673     $ 136     $ 1,123     $ 188  

The Company had 96 securities with a fair value of $88,892 which were temporarily impaired at March 31, 2012.  The total unrealized loss on these securities was $1,521. Of the temporarily impaired total, two securities with a fair value of $389 and an unrealized loss of $173 have been in a continuous loss position for twelve months or more. The Company has determined that these securities are temporarily impaired at March 31, 2012 for the reasons set out below.
U.S. Government agencies. The unrealized losses in this category of investments were caused by interest rate and market fluctuations. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the cost basis of each investment. Because the Company does not intend to sell any of the investments and it is not likely that the Company will be required to sell any of these investments before recovery of its amortized cost basis, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired.
States and political subdivisions. This category’s unrealized losses are primarily the result of interest rate and market fluctuations and also a certain few ratings downgrades brought about by the impact of the economic downturn on states and political subdivisions. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the cost basis of each investment. Because the Company does not intend to sell any of the investments and it is not likely that the Company will be required to sell any of the investments before recovery of its amortized cost basis, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired.
Corporate debt securities. The Company’s unrealized losses in corporate debt securities are related to interest rate and market fluctuations and to ratings downgrades for a limited number of securities. The contractual terms of the investments do not permit the issuer to settle the securities at a price less than the cost basis of each investment. Because the Company does not intend to sell any of the investments before recovery of its amortized cost basis, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired.
Other. The Company holds an investment in an LLC and a small amount of community bank stock. The value of these investments has been negatively affected by market conditions. Because the Company does not intend to sell these investments before recovery of amortized cost basis, the Company does not consider these investments to be other-than-temporarily impaired. 
As a member of the Federal Reserve and the Federal Home Loan Bank (“FHLB”) of Atlanta, NBB is required to maintain certain minimum investments in the common stock of those entities. Required levels of investment are based upon NBB’s capital and a percentage of qualifying assets. In addition, NBB is eligible to borrow from the FHLB with borrowings collateralized by qualifying assets, primarily residential mortgage loans and NBB’s capital stock investment in the FHLB. Redemption of FHLB stock is subject to certain limitations and conditions. At its discretion, the FHLB may declare dividends on the stock. Management reviews for impairment based upon the ultimate recoverability of the cost basis of the FHLB stock, and at March 31, 2012, management did not consider there to be any impairment.
Management regularly monitors the credit quality of the investment portfolio. Changes in ratings are noted and follow-up research on the issuer is undertaken when warranted. Management intends to carefully follow any changes in bond quality. Refer to “Securities” in this report for additional information.

Note 6: Recent Accounting Pronouncements

In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.”  The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion.  The amendments in this ASU were effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date.  The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements. 
 
 
 
24

 
 
 
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.”  This ASU is the result of joint efforts by the FASB and International Accounting Standards Board (IASB) to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements.  The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards (IFRS).  The amendments were effective for interim and annual periods beginning after December 15, 2011 with prospective application.  The Company has included the required disclosures in its consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.”  The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity.  The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income.  In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income.  The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share.  The amendments were effective for fiscal years and interim periods within those years beginning after December 15, 2011.  The amendments did not require transition disclosures.  The Company has included the required disclosures in its consolidated financial statements.
In September 2011, the FASB issued ASU 2011-08, “Intangible – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment.”  The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.  Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.  The amendments in this ASU were effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.”  This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company does not expect the adoption of ASU 2011-11 to have a material impact on its consolidated financial statements.
In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220) – Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.”  The amendments are being made to allow the Board time to redeliberate whether to present on the face of the financial statements the effects of reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income for all periods presented. While the Board is considering the operational concerns about the presentation requirements for reclassification adjustments and the needs of financial statement users for additional information about reclassification adjustments, entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before ASU 2011-05.  All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company has included the required disclosures in its consolidated financial statements.


 
25

 


Note 7: Defined Benefit Plan

Components of Net Periodic Benefit Cost:

   
Pension Benefits
 
   
Three Months ended March 31,
 
   
2012
   
2011
 
Service cost
  $ 117     $ 109  
Interest cost
    185       176  
Expected return on plan assets
    (269 )     (203 )
Amortization of prior service cost
    (25 )     (25 )
Recognized net actuarial loss
    127       73  
Net periodic benefit cost
  $ 135     $ 130  

2012 Plan Year Employer Contribution

Without considering the prefunding balance, NBI’s minimum required contribution to the National Bankshares, Inc. Retirement Income Plan (the “Plan”) is $733. Considering the prefunding balance, the 2012 minimum required contribution is $0. The Company elected to contribute $183 to the Plan in the quarter ended March 31, 2012.

Note 8: Fair Value Measurements

The Company records fair value adjustments to certain assets and liabilities and determines fair value disclosures utilizing a definition of fair value of assets and liabilities that states that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Additional considerations come into play in determining the fair value of financial assets in markets that are not active.
The Company uses a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy based on these two types of inputs are as follows:
 
Level 1 –
 
Valuation is based on quoted prices in active markets for identical assets and liabilities.
 
Level 2 –
 
Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
 
Level 3 –
 
Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market.
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:

Securities Available for Sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). The carrying value of restricted Federal Reserve Bank and Federal Home Loan Bank stock approximates fair value based upon the redemption provisions of each entity and is therefore excluded from the following table.


 
26

 


The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis:

         
Fair Value Measurements at March 31, 2012 Using
 
Description
 
Balance as of
March 31, 2012
   
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable Inputs
(Level 3)
 
U.S. Treasury
  $ 2,128     $ ---     $ 2,128     $ ---  
U.S. Government agencies and corporations
    118,564       ---       118,564       ---  
States and political subdivisions
    48,819       ---       48,819       ---  
Mortgage-backed securities
    6,582       ---       6,582       ---  
Corporate debt securities
    18,438       ---       18,438       ---  
Other securities
    2,127       ---       2,127       ---  
Total securities available for sale
  $ 196,658     $ ---     $ 196,658     $ ---  

         
Fair Value Measurements at December 31, 2011 Using
 
Description
 
Balance as of
 December 31,
2011
   
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   
Significant
Other
Observable
Inputs
(Level 2)
   
Significant
Unobservable Inputs
(Level 3)
 
U.S. Treasury
  $ 2,150     $ ---     $ 2,150     $ ---  
U.S. Government agencies and corporations
    96,003       ---       96,003       ---  
States and political subdivisions
    49,122       ---       49,122       ---  
Mortgage-backed securities
    7,725       ---       7,725       ---  
Corporate debt securities
    16,077       ---       16,077       ---  
Other securities
    2,175       ---       2,175       ---  
Total securities available for sale
  $ 173,252     $ ---     $ 173,252     $ ---  

Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:

Loans Held for Sale

Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale at March 31, 2012 or December 31, 2011. Gains and losses on the sale of loans are recorded within income from mortgage banking on the Consolidated Statements of Income.

Impaired Loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that the Company will be unable to collect all the contractual interest and principal payments as scheduled in the loan agreement. Troubled debt restructurings are impaired loans. The measurement of loss associated with impaired loans may be based on either the observable market price of the loan, the present value of the expected cash flows or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction, if an appraisal of the real estate property is over 12 months old or if the real estate market is considered by management to be experiencing volatility, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal using observable market data, if the collateral is
 
 
 
27

 
 
 
deemed significant. If the collateral is not deemed significant, the value of business equipment is based on the net book value on the borrower’s financial statements. Likewise, values for inventory and accounts receivables collateral are based on the borrower’s financial statement balances or aging reports (Level 3). Estimated losses on impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
The following table summarizes the Company’s impaired loans that were measured at fair value on a nonrecurring basis at March 31, 2012 and at December 31, 2011.

           
Carrying Value
 
Date
 
Description
 
Balance
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
   
Assets:
                         
March 31, 2012
 
Impaired loans net of valuation allowance
    $ 2,461     $ ---     $ ---     $ 2,461  
December 31, 2011
 
Impaired loans net of valuation allowance
      5,968       ---       ---       5,968  

The following table summarizes the activity in Company’s impaired loans that were valued using Level 3 inputs for the three months ended March 31, 2012.

   
Carrying Value,
December 31, 2011
   
Additions
   
Deletions due to Foreclosure
   
Change in Balance (1)
   
Impaired Loans Removed from Level 3 (2)
   
Carrying Value,
March 31, 2012
 
Impaired loans
                                               
Principal balance
 
$
7,091
   
$
726
   
$
(423
)
 
$
(34
)
 
$
(4,306
)
 
$
3,054
 
Impairment allocation
   
1,123
     
120
     
(322
)
   
(87
)
   
(241
)
   
593
 
Net impaired loans
 
$
5,968
   
$
606
   
$
(101
)
 
$
53
   
$
(4,065
)
 
$
2,461
 

(1) The reported amounts represent changes in the balance due to principal payments by borrowers and reductions in impairment measurements as a result of current valuation procedures.
(2) The reported amount represents loans that were valued using Level 3 inputs as of December 31, 2011 that no longer have impairment allocations under Level 3 valuation.

Impaired loans are measured quarterly for impairment.  The Company employs the most applicable valuation method for each loan based on current information at the time of valuation.  The valuation procedures for the first quarter of 2012 resulted in changes to valuation method from collateral-based to the present value of cash flows for certain loans, and  resulted in reduced allocations for certain loans.  The impaired loans removed from Level 3 as well as the change in balance for impairment allocation summarized above reflect the change in valuation method and allocation for these loans.
Certain loans were removed from impaired Level 3 due to foreclosure. None of the foreclosures resulted in increases to the Company’s other real estate owned, as the loans were either unsecured or secured by properties that were purchased by third parties at auction.

The following table presents information about Level 3 Fair Value Measurements for March 31, 2012:
 
 
   
Valuation Technique
 
Unobservable Input
 
Range
(Weighted Average)
 
Impaired loans
 
Discounted appraised value
 
Selling cost
 
5% - 25% (14%)
 
Impaired loans
 
Discounted appraised value
 
Discount for lack of marketability and age of appraisal
 
0% - 50% (9%)
 
Impaired loans
 
Present value of cash flows
 
Discount rate
 
6.0% - 7.5% (6.2%)
 
 
 
 
28

 
 
 
Other Real Estate Owned

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell.

The following table summarizes the Company’s other real estate owned that was measured at fair value on a nonrecurring basis at March 31, 2012 and at December 31, 2011.

           
Carrying Value
 
Date
 
Description
 
Balance
 
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
   
Assets:
                         
March 31, 2012
 
Other real estate owned net of valuation allowance
    $ 940     $ ---     $ ---     $ 940  
December 31, 2011
 
Other real estate owned net of valuation allowance
      1,489       ---       ---       1,489  

The following table summarizes the activity in the Company’s other real estate owned that were valued using Level 3 inputs for the three months ended March 31, 2012

   
Carrying Value,
December 31, 2011
   
Additions
   
Sale of Property
   
Increase to Valuation Allowance
   
Carrying Value,
March 31, 2012
 
Other real estate owned
  $ 1,489     $ ---     $ (543 )   $ (6 )   $ 940  

The following table presents information about Level 3 Fair Value Measurements for March 31, 2012:

   
Valuation Technique
 
Unobservable Input
 
Range
(Weighted Average)
 
Other Real Estate Owned
 
Discounted appraised value
 
Selling cost
 
5% - 10% (6%)
 
Other Real Estate Owned
 
Discounted appraised value
 
Discount for lack of marketability and age of appraisal
 
0% - 22.57% (8.87%)
 

The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:

Cash and Due from Banks, Interest-Bearing Deposits, and Federal Funds Sold

The carrying amounts approximate fair value.

Securities

The fair value of securities, excluding restricted stock, is determined by quoted market prices or dealer quotes. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments adjusted for differences between the quoted instruments and the instruments being valued. The carrying value of restricted securities approximates fair value based upon the redemption provisions of the applicable entities.


 
29

 


Loans Held for Sale

The fair value of loans held for sale is based on commitments on hand from investors or prevailing market prices.

Loans

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, real estate – commercial, real estate – construction, real estate – mortgage, credit card and other consumer loans. Each loan category is further segmented into fixed and adjustable rate interest terms and by performing and nonperforming categories.
The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan, as well as estimates for prepayments. The estimate of maturity is based on the Company’s historical experience with repayments for loan classification, modified, as required, by an estimate of the effect of economic conditions on lending.
Fair value for significant nonperforming loans is based on estimated cash flows which are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are determined within management’s judgment, using available market information and specific borrower information.

Deposits

The fair value of demand and savings deposits is the amount payable on demand. The fair value of fixed maturity term deposits and certificates of deposit is estimated using the rates currently offered for deposits with similar remaining maturities.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Commitments to Extend Credit and Standby Letters of Credit

The only amounts recorded for commitments to extend credit, standby letters of credit and financial guarantees written are the deferred fees arising from these unrecognized financial instruments. These deferred fees are not deemed significant at March 31, 2012 and December 31, 2011, and, as such, the related fair values have not been estimated.

The estimated fair values, and related carrying amounts, of the Company’s financial instruments are as follows:

   
March 31, 2012
 
   
Carrying
Amount
   
Quoted Prices in Active Markets for Identical Assets
Level 1
   
Significant Other Observable Inputs
Level 2
   
Significant Unobservable Inputs
Level 3
   
Total Estimated
Fair Value
 
Financial assets:
                             
Cash and due from banks
  $ 12,241     $ 12,241                 $ 12,241  
Interest-bearing deposits
    101,301       101,301                   101,301  
Securities
    337,713               345,855             345,855  
Mortgage loans held for sale
    1,371               1,371             1,371  
Loans, net
    576,501               570,495       2,461       572,956  
Accrued interest receivable
    6,175               6,175               6,175  
BOLI
    19,991               19,991               19,991  
Financial liabilities:
                                       
Deposits
  $ 931,792             $ 926,706             $ 926,706  
Accrued interest payable
    191               191               191  


 
30

 


   
December 31, 2011
 
   
Carrying
Amount
   
Estimated Fair
 Value
 
Financial assets:
           
Cash and due from banks
  $ 11,897     $ 11,897  
Interest-bearing deposits
    98,355       98,355  
Securities
    318,913       326,347  
Mortgage loans held for sale
    2,623       2,623  
Loans, net
    580,402       572,357  
Accrued interest receivable
    6,304       6,304  
BOLI
    19,812       19,812  
Financial liabilities:
               
Deposits
  $ 919,333       913,882  
Accrued interest payable
    206       206  


Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
$ in thousands, except per share data

The purpose of this discussion and analysis 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.  Please refer to the financial statements and other information included in this report as well as the 2011 Annual Report on Form 10-K for an understanding of the following discussion and analysis.

Cautionary Statement Regarding Forward-Looking Statements

We make forward-looking statements in this Form 10-Q that are subject to significant risks and uncertainties.  These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals, and are based upon our management’s views and assumptions as of the date of this report.  The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,”  “forecasts,” “intends,” or other similar words or terms are intended to identify forward-looking statements.
These forward-looking statements are based upon or are affected by factors that could cause our actual results to differ materially from historical results or from any results expressed or implied by such forward-looking statements. These factors include, but are not limited to, changes in:
· interest rates,
· general economic conditions,
· the legislative/regulatory climate,
·  
monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury, the Office of the Comptroller of the Currency, the Federal Reserve Board and the Federal Deposit Insurance Corporation, and the impact of any policies or programs implemented pursuant to the Emergency Economic Stabilization Act of 2008 (“EESA”) the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) and other financial reform legislation,
· unanticipated increases in the level of unemployment in the Company’s trade area,
· the quality or composition of the loan and/or investment portfolios,
· demand for loan products,
· deposit flows,
· competition,
· demand for financial services in the Company’s trade area,
· the real estate market in the Company’s trade area,
· the Company’s technology initiatives,
· loss or retirement of key executives,
· adverse changes in the securities market, and
· applicable accounting principles, policies and guidelines.
These risks and uncertainties should be considered in evaluating the forward-looking statements contained in this report. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report. This discussion and analysis should be read in conjunction with the description of our “Risk Factors” in Item 1A. of our 2011 Annual Report on Form 10-K.
 
 
 
31

 
 
 
The recession continues to impact the national economy as well as the Company’s market. Signs of economic recovery are mixed with continued high unemployment and diminished real estate values.  The Company’s trade area contains a diverse economy that includes large public colleges and universities, which somewhat insulated the Company’s market from the dramatic declines in real estate values seen in some other areas of the country.  Real estate values in the Company’s market area saw moderate declines in 2009 and 2010 that appeared to stabilize in 2011.  Nonperforming assets increased during 2009 and 2010 but decreased in 2011.  If the economic recovery wavers or reverses, it is likely that unemployment will continue at higher-than-normal levels or rise in the Company’s trade area. Because of the importance to the Company’s markets of state-funded universities, cutbacks in the funding provided by the State as a result of the recession could also negatively impact employment. This could lead to an even higher rate of delinquent loans and a greater number of real estate foreclosures. Higher unemployment and the fear of layoffs causes reduced consumer demand for goods and services, which negatively impacts the Company’s business and professional customers. In conclusion, a slow economic recovery could have an adverse effect on all financial institutions, including the Company.

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. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in the loan portfolio. Actual losses could differ significantly from one previously acceptable method to another method. Although the economics of the Company’s transactions would be the same, the timing of events that would impact the transactions could change.

Allowance for Loan Losses

The allowance for loan losses is an accrual of estimated losses that have been sustained in our loan portfolio. The allowance is reduced by charge-offs of loans and increased by the provision for loan losses and recoveries of previously charged-off loans.  The determination of the allowance is based on two accounting principles, FASB Topic 450-20 (Contingencies) which requires that losses be accrued when occurrence is probable and the amount of the loss is reasonably estimable, and FASB Topic 310-10 (Receivables) which requires accrual of losses on impaired loans if the recorded investment exceeds fair value.
Probable losses are accrued through two calculations, individual evaluation of impaired loans and collective evaluation of the remainder of the portfolio. Impaired loans are larger non-homogeneous loans for which there is a probability that collection will not occur according to the loan terms, as well as loans whose terms have been modified in a troubled debt restructuring. Impaired loans with an estimated impairment loss are placed on nonaccrual status.
Estimated loss for an impaired loan is the amount of recorded investment that exceeds the loan’s fair value. Fair value of an impaired loan is measured by one of three methods, the fair value (less cost to sell) of collateral, the present value of future cash flows, or observable market price. For loans that are not collateral dependent, the potential loss is accrued in the allowance. For collateral-dependent loans, the potential loss is charged-off against the allowance, instead of being accrued. Impaired loans with partial charge-offs are maintained as impaired until it becomes evident that the borrower can repay the remaining balance of the loan according to the terms.
Non-impaired loans are grouped by portfolio segment and loan class. Loans within a segment or class have similar risk characteristics. Each segment and class is evaluated for probable loss by applying quantitative and qualitative factors, including net charge-off trends, delinquency rates, concentration trends and economic trends. The Company accrues additional estimated loss for criticized loans within each class and for loans designated high risk. High risk loans are defined as junior lien mortgages, loans with high loan-to-value ratios and loans with payments of interest-only required. Both criticized loans and high risk loans are included in the base risk analysis for each class and are allocated additional reserves.
The estimation of the accrual involves analysis of internal and external variables, methodologies, assumptions and our judgment and experience. Key judgments used in determining the allowance for loan losses include internal risk rating determinations, market and collateral values, discount rates, loss rates, and our view of current economic conditions. These judgments are inherently subjective and our actual losses could be greater or less than the estimate. Future estimates of the allowance could increase or decrease based on changes in the financial condition of individual borrowers, concentrations of various types of loans, economic conditions or the markets in which collateral may be sold. The estimate of the allowance accrual determines the amount of provision expense and directly affects our financial results.
The estimate of the allowance for March 31, 2012 considered market and portfolio conditions during the first quarter of 2012 as well as the elevated levels of delinquencies and net charge-offs in 2010 and 2011. Given the continued economic difficulties, the ultimate amount of loss could vary from that estimate. For additional discussion of the allowance, see Note 3 to the financial statements and “Asset Quality,” and “Provision and Allowance for Loan Losses.”
 
 
 
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Goodwill and Core Deposit Intangibles

Goodwill is subject to at least an annual assessment for impairment by applying a fair value based test. The Company performs impairment testing in the fourth quarter of each year. The Company’s goodwill impairment analysis considers three valuation techniques appropriate to the measurement. The first technique uses the Company’s market capitalization as an estimate of fair value; the second technique estimates fair value using current market pricing multiples for companies comparable to NBI; while the third technique uses current market pricing multiples for change-of-control transactions involving companies comparable to NBI. Each measure indicated that the Company’s fair value exceeded its book value, validating that goodwill is not impaired.
Certain key judgments were used in the valuation measurement. Goodwill is held by the Company’s bank subsidiary. The bank subsidiary is 100% owned by the Company, and no market capitalization is available.  Because most of the Company’s assets are comprised of the subsidiary bank’s equity, the Company’s market capitalization was used to estimate NBB’s capitalization. Other judgments include the assumption that the companies and transactions used as comparables for the second and third technique were appropriate to the estimate of the Company’s fair value, and that the comparable multiples are appropriate indicators of fair value, and compliant with accounting guidance.
Acquired intangible assets (such as core deposit intangibles) are recognized separately from goodwill if the benefit of the asset can be sold, transferred, licensed, rented, or exchanged, and amortized over its useful life. The Company amortizes intangible assets arising from branch transactions over their useful life. Core deposit 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 impairment testing showed that the expected cash flows of the intangible assets exceeded the carrying value.

Overview

National Bankshares, Inc. (“NBI”) is a financial holding company incorporated under the laws of Virginia. Located in southwest Virginia, NBI has two wholly-owned subsidiaries, the National Bank of Blacksburg (“NBB”) and National Bankshares Financial Services, Inc. (“NBFS”). NBB, which does business as National Bank from twenty-five office locations, is a community bank. NBB is the source of nearly all of the Company’s revenue. NBFS does business as National Bankshares Investment Services and National Bankshares Insurance Services. Income from NBFS is not significant at this time, nor is it expected to be so in the near future.
NBI common stock is listed on the NASDAQ Capital Market and is traded under the symbol “NKSH.” National Bankshares, Inc. has been included in the Russell Investments Russell 3000 and Russell 2000 Indexes since June 29, 2009.

Performance Summary

The following table presents NBI’s key performance ratios for the three months ended March 31, 2012 and the year ended December 31, 2011. The measures for March 31, 2012 are annualized, except for basic net earnings per share and fully diluted net earnings per share.

   
March 31,
2012
   
December 31,
2011
 
Return on average assets
    1.67 %     1.71 %
Return on average equity
    12.40 %     12.89 %
Basic net earnings per share
  $ 0.64     $ 2.54  
Fully diluted net earnings per share
  $ 0.64     $ 2.54  
Net interest margin (1)
    4.36 %     4.59 %
Noninterest margin (2)
    1.36 %     1.45 %

(1)  
Net interest margin: Year-to-date tax-equivalent net interest income divided by year-to-date average earning assets.
(2)  
Noninterest margin: Noninterest expense (excluding the provision for bad debts and income taxes) less noninterest income (excluding securities gains and losses) divided by average year-to-date assets.

The annualized return on average assets declined slightly for the three months ended March 31, 2012 as compared to the year ended December 31, 2011, due primarily to growth in average assets.  The annualized return on average equity declined 49 basis points for the same period, due to growth in average equity.  Average equity tends to build in the months preceding the payment of dividends which have historically been paid semi-annually.
 
 
 
33

 
 
 
The annualized net interest margin was a healthy 4.36% at the end of the first quarter of 2012, though down 23 basis points from the 4.59% reported for the year ended December 31, 2011. The primary factor driving the decrease in the net interest margin was the declining yield on earning assets offset by a smaller decline in the cost to fund earning assets.
The annualized noninterest margin decreased 9 basis points from 2011 primarily because of a decrease in noninterest expense. Please refer to the discussion under noninterest expense for further information.

Growth

NBI’s key growth indicators are shown in the following table:

   
March 31, 2012
   
December 31, 2011
   
Percent Change
   
Interest bearing deposits
  $ 101,301     $ 98,355       3.00   %
Securities
    337,713       318,913       5.90   %
Loans, net
    576,501       580,402       (0.67 ) %
Deposits
    931,792       919,333       1.36   %
Total assets
    1,083,842       1,067,102       1.57   %

Net loans contracted slightly from December 31, 2011 to March 31, 2012, due to competitive, economic and market forces.  The increase in deposits generated the increases in securities and interest-bearing deposit assets.

Asset Quality

Key indicators of NBI’s asset quality are presented in the following table:

   
March 31, 2012
   
March 31, 2011
   
December 31, 2011
   
Nonperforming loans
  $ 5,328     $ 7,653     $ 5,204    
Accruing restructured loans
    3,742       ---       3,756    
Loans past due 90 days or more, and still accruing
    210       1,078       481    
Other real estate owned
    940       2,222       1,489    
Allowance for loan losses to loans
    1.38 %     1.40 %     1.37   %
Net charge-off ratio
    0.46 %     0.15 %     0.43   %
Ratio of nonperforming assets to loans, net of unearned income and deferred fees, plus other real estate owned
    1.07 %     1.67 %     1.13   %
Ratio of allowance for loan losses to nonperforming loans
    151.33 %     107.74 %     155.03   %

The Company monitors asset quality indicators in managing credit risk and in determining the allowance and provision for loan losses.  The recent economic recession and slow recovery have contributed to levels of some asset quality measures that are higher than normal for the Company.  Overall, the indicators remained at similar levels to those at December 31, 2011, except other real estate owned which declined substantially.  When compared to March 31, 2011, the annualized net charge-off rate increased while most other asset quality indicators improved substantially.
The Company’s risk analysis determined an allowance for loan losses of $8,063 at March 31, 2012, remaining at a similar level to the $8,068 at December 31, 2011.  The provision for the three months ended March 31, 2012 was $672, a decrease of $128 or 16% from the $800 from the same period in 2011.  The ratio of the allowance for loan losses to loans increased slightly from December 31, 2011, but was two basis points below the level at March 31, 2011. The stability in most asset quality indicators consistent with year-end 2011 levels contributed to a comparable degree of allowance for loan losses.  The Company continues to monitor risk levels within the loan portfolio.
Other real estate owned declined $549 from December 31, 2011 and $1,282 from March 31, 2011, primarily due to the disposal of such real estate.  As of March 31, 2012, total properties approximating $627 are in various stages of foreclosure and may impact other real estate owned in future quarters.  It is not possible to accurately predict the future total of other real estate owned because property sold at foreclosure may be acquired by third parties and NBB’s other real estate owned properties are regularly marketed and sold.

 
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Net Interest Income

The net interest income analysis for the three months ended March 31, 2012 and 2011 follows:

   
March 31, 2012
   
March 31, 2011
 
   
Average
Balance
   
 
Interest
   
Average
Yield/
Rate
   
Average
Balance
   
 
Interest
   
Average
Yield/
Rate
 
Interest-earning assets:
                                   
Loans, net (1)(2)(3)
  $ 585,348     $ 8,957       6.15 %   $ 585,162     $ 9,159       6.35 %
Taxable securities
    152,563       1,589       4.19 %     153,501       1,662       4.39 %
Nontaxable securities (1)(4)
    159,494       2,440       6.15 %     166,799       2,592       6.30 %
Interest-bearing deposits
    110,901       71       0.26 %     54,089       32       0.24 %
Total interest-earning assets
  $ 1,008,306     $ 13,057       5.21 %   $ 959,551     $ 13,445       5.68 %
Interest-bearing liabilities:
                                               
Interest-bearing demand deposits
  $ 408,262     $ 1,057       1.04 %   $ 368,191     $ 979       1.08 %
Savings deposits
    62,602       9       0.06 %     56,184       11       0.08 %
Time deposits
    309,940       1,051       1.36 %     323,237       1,389       1.74 %
Total interest-bearing liabilities
  $ 780,804     $ 2,117       1.09 %   $ 747,612     $ 2,379       1.29 %
Net interest income and interest rate spread
          $ 10,940       4.12 %           $ 11,066       4.39 %
Net yield on average interest-earning assets
                    4.36 %                     4.68 %

(1)  
Interest on nontaxable loans and securities is computed on a fully taxable equivalent basis using a Federal income tax rate of 35% in the two three-month periods presented.
(2)  
Included in interest income are loan fees of $198 and $205 for the three months ended March 31, 2012 and 2011, respectively.
(3)  
Nonaccrual loans are included in average balances for yield computations.
(4)  
Daily averages are shown at amortized cost.

The net interest margin for the three months ended March 31, 2012 decreased 32 basis points from the three months ended March 31, 2011. The decrease in net interest margin was driven by a decline in the yield on earning assets of 47 basis points offset by a decline in the cost of interest bearing liabilities of 20 basis points. Both loans and securities experienced a decline in yield.  The 20 basis point decline in the yield on loans stemmed from contractual repricing terms and the renegotiation of loan interest rates in response to competition.  The yield on taxable securities was 20 basis points lower for the three months ended March 31, 2012, when compared with the same period in 2011, while the yield on nontaxable securities declined 15 basis points over the same period.  The market yield for securities of a comparable term has declined over the past year, causing matured and called bonds to be replaced with lower yielding investments.  The decline in the cost of interest-bearing liabilities came primarily from a 38 basis point reduction in the cost of time deposits when the three-month periods ended March 31, 2012 and March 31, 2011 are compared.
The Company’s yield on earning assets and cost of funds are largely dependent on the interest rate environment.  In the recent past, historically low interest rates caused funding costs to decline at a faster pace than the yield on earning assets. The decline in deposit pricing has begun to slow while competitive and market forces continue to pressure the yield on earning assets.  The Company’s cost of funding is more sensitive to interest rate changes than is the yield on earning assets.

Provision and Allowance for Loan Losses

The provision for loan losses for the three month period ended March 31, 2012 was $672, compared with $800 for the first three months of 2011. The ratio of the allowance for loan losses to total loans at the end of the first quarter of 2012 was 1.38%, which compares to 1.37% at December 31, 2011. The net charge-off ratio was 0.46% at March 31, 2012 and 0.43% at December 31, 2011. See “Asset Quality” for additional information.

 
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Noninterest Income

   
Three Months ended
         
   
March 31, 2012
   
March 31, 2011
   
Percent Change
   
Service charges on deposits
  $ 631     $ 612       3.10   %
Other service charges and fees
    49       58       (15.52 ) %
Credit card fees
    794       733       8.32   %
Trust fees
    326       246       32.52   %
BOLI income
    200       184       8.70   %
Other income
    99       91       8.79   %
Realized securities gains
    53       10       430.00   %

Service charges on deposit accounts increased $19 when the three months ended March 31, 2012 are compared with the same period in 2011. Contributing to the increase was an increase of $32 in fees from checking account overdrafts and checks returned for insufficient funds, offset by smaller decreases in ATM fees and account service fees.
Other service charges and fees includes charges for official checks, income from the sale of checks to customers, safe deposit box rent, fees for letters of credit and the income earned from commissions on the sale of credit life, accident and health insurance. Income for the three months ended March 31, 2012 decreased $9 from the same period in 2011, due to minor and typical fluctuations.
Credit card fees for the first three months of 2012 increased $61, or 8.32%, when compared with the same period last year. The increase was due to a higher volume of merchant transaction fees and credit card fees. Management anticipates that this category of noninterest income may be negatively affected by provisions included in the Dodd-Frank Wall Street Reform and Consumer Protection Act. This recent legislation, which became effective on October 1, 2011 but which exempts financial institutions with less than $10 billion in assets, directs the Federal Reserve Bank to control the level of debit card interchange fees. It is not yet known the extent to which the legislation may impact the level of credit card fees or when that impact will occur.
Income from Trust fees increased 32.52% or $80 from the $246 earned in the same period of 2011. Trust income varies depending on the total assets held in Trust accounts, the type of accounts under management and financial market conditions. Estate fees contributed to the increase in the first quarter.
BOLI income increased $16 from March 31, 2011 to March 31, 2012.  The increase in income stems from a purchase of $1,900 in BOLI assets in the fourth quarter of 2011.
Other income includes net gains from the sales of fixed assets, revenue from investment and insurance sales and other smaller miscellaneous components. Other income for the three months ended March 31, 2012 increased 8.79%, when compared with the three months ended March 31, 2011. These areas fluctuate with market conditions and because of competitive factors.
Realized securities gains for the three months ended March 31, 2012 were $53, as compared with $10 for the same period in 2011. Net realized securities gains and losses are market driven and have resulted from calls of securities.

Noninterest Expense

   
Three Months ended
         
   
March 31, 2012
   
March 31, 2011
   
Percent Change
   
Salaries and employee benefits
  $ 2,956     $ 2,904       1.79   %
Occupancy, furniture and fixtures
    397       423       (6.15 ) %
Data processing and ATM
    392       444       (11.71 ) %
FDIC assessment
    109       346       (68.50 ) %
Credit card processing
    572       586       (2.39 ) %
Intangibles amortization
    271       271       ---    
Net costs of other real estate owned
    48       134       (64.18 ) %
Franchise taxes
    162       242       (33.06 ) %
Other operating expenses
    804       734       9.54   %


 
36

 

Total noninterest expense declined $373 or 6.13% when the first quarter of 2012 is compared to the same period of 2011.  The most significant contributing factor was the decrease in FDIC assessment expense, which fell $237 from the first quarter of 2011.  Prior to the third quarter of 2011, the FDIC assessment was based on the level of deposits. The FDIC implemented a new formula in the fourth quarter of 2011 that uses assets as the assessment base.  The new formula resulted in decreased expense for the Company.
Salary and benefits expense was $2,956 for the three months ended March 31, 2012, an increase of 1.79% from $2,904 for the three months ended March 31, 2011. No material items effected the increase.
Occupancy, furniture and fixtures expense declined 6.15%, from $423 for the three months ended March 31, 2011 to $397 as of March 31, 2012. The decline is a result of general cost control measures with no significant decreases in any one factor.
Data processing and ATM expense for the three months ended March 31, 2012 decreased $52 from the three months ended March 31, 2011. The first three months of 2011 contained higher data processing expense associated with increased costs for communications because of infrastructure upgrades.
Credit card processing expense declined by 2.39% from the total for the three months ended March 31, 2011. This expense is driven by volume and other factors such as merchant discount rates and is subject to a degree of variability.
The expense for intangibles amortization is related to acquisitions. There were no acquisitions in the past year, with no change in expense between the three month periods ended March 31, 2012 and March 31, 2011.
Net costs of other real estate owned decreased $86 or 64.18% from the three months ended March 31, 2011 to $48 for the three months ended March 31, 2012. This expense category includes maintenance costs as well as valuation write-downs and gains and losses on the sale of properties. The expense varies with the number of properties, the maintenance required and changes in the real estate market.
Bank franchise taxes have declined 33.06%, from $242 at March 31, 2011 to $162 for the three months ended 2012.  Bank franchise taxes are calculated based on equity.  The expense for 2012 was reduced by additional deductions.
The category of other operating expenses includes noninterest expense items such as professional services, stationery and supplies, telephone costs, postage and charitable donations. Other operating expenses for the three months ended March 31, 2012 increased $70 or 9.54% when compared with the same period in 2011.  The increase is due to normal fluctuations.

Balance Sheet

Year-to-date daily averages for the major balance sheet categories are as follows:

Assets
 
March 31, 2012
   
December 31, 2011
   
Percent Change
   
Interest-bearing deposits
  $ 110,901     $ 64,977       70.68   %
Securities available for sale
    175,232       186,296       (5.94 ) %
Securities held to maturity
    140,743       134,612       4.55   %
Loans, net
    575,583       580,037       (0.77 ) %
Total assets
    1,068,848       1,031,899       3.58   %
                           
Liabilities and stockholders’ equity
                         
Noninterest-bearing demand deposits
  $ 137,583     $ 135,880       1.25   %
Interest-bearing demand deposits
    408,262       378,971       7.73   %
Savings deposits
    62,602       58,273       7.43   %
Time deposits
    309,940       314,920       (1.58 ) %
Stockholders’ equity
    143,603       136,794       4.98   %

Securities

Management regularly monitors the quality of the securities portfolio, and management closely follows the uncertainty in the economy and the volatility of financial markets.  The value of individual securities will be written down if the decline in fair value is considered to be other than temporary based upon the totality of circumstances. See Note 4 Securities for additional information.

 
37

 


Loans

   
March 31, 2012
   
December 31, 2011
     
Percent Change
 
Real estate construction loans
  $ 48,266     $ 48,528       (0.54 ) %
Consumer real estate loans
    147,312       149,750       (1.63 ) %
Commercial real estate loans
    301,911       303,192       (0.42 ) %
Commercial non real estate loans
    39,998       38,849       2.96   %
Public sector and IDA
    15,263       15,407       (0.93 ) %
Consumer non real estate
    31,814       32,744       (2.84 ) %
Loans  net of unearned income
  $ 584,564     $ 588,470       (0.66 ) %

The Company’s loans net of unearned income decreased by $3,906 or 0.66%, from $588,470 at December 31, 2011 to $584,564 at March 31, 2012. Growth in commercial non real estate loans was offset by small declines in all other categories.  Commercial non real estate loans increased 2.96% or $1,149 from December 31, 2011 to March 31, 2012.
The 2.84% decline in consumer non real estate loans continues a trend that has been evident over the past several years. The availability of low cost dealer auto loans and other products, such as home equity lines of credit, make traditional consumer installment loans less attractive to customers.
Real estate construction loans and commercial real estate loans at March 31, 2012 remained at similar levels as those at December 31, 2011 while consumer real estate loans declined $2,438 or 1.63% and public sector and IDA loans declined 0.93%. The declines are due to market, economic and competitive forces and are not the result of changes in lending policies.
The Company does not now, nor has it ever, offered certain types of higher-risk loans such as subprime loans, option ARM products or loans with initial teaser rates.

Deposits

   
March 31, 2012
   
December 31, 2011
     
Percent Change
 
Noninterest-bearing demand deposits
  $ 145,070     $ 142,163       2.04   %
Interest-bearing demand deposits
    415,352       404,801       2.61   %
Saving deposits
    65,322       61,298       6.56   %
Time deposits
    306,048       311,071       (1.61 ) %
Total deposits
  $ 931,792     $ 919,333       1.36   %

Total deposits increased $12,459, or 1.36% from $919,333 at December 31, 2011 to $931,792 at March 31, 2012. Increases in all deposit categories other than time deposits totaled $17,482, or 2.87%. These increases were offset by a decline in time deposits of $5,023, or 1.61%, when March 31, 2012 is compared with December 31, 2011. Historically low rates have caused a migration from time deposits to other types of deposits. As longer-term certificates of deposit mature, customers are unwilling to commit their funds for extended periods at low interest rates. Time deposits do not include any brokered deposits.

Liquidity

Liquidity measures the Company’s ability to meet its financial commitments at a reasonable cost. Demands on the Company’s liquidity include funding additional loan demand and accepting withdrawals of existing deposits. The Company has diverse sources of liquidity, including customer and purchased deposits, customer repayments of loan principal and interest, sales, calls and maturities of securities, Federal Reserve discount window borrowing, short-term borrowing, and Federal Home Loan Bank (“FHLB”) advances. At March 31, 2012, the bank did not have purchased deposits, discount window borrowings, short-term borrowings, or FHLB advances.  To assure that short-term borrowing is readily available, the Company tests accessibility annually.
Liquidity from securities is restricted by accounting and business considerations. The securities portfolio is segregated into available-for-sale and held-to-maturity. The Company considers only securities designated available-for-sale for typical liquidity needs.  Further, portions of the securities portfolio are pledged to meet state requirements for public funds deposits. Discount window borrowings also require pledged securities. Increased or decreased liquidity from public funds deposits or discount window borrowings results in increased or decreased liquidity from pledging requirements. The Company monitors public funds pledging requirements and the amount of unpledged available-for-sale securities that are accessible for liquidity needs.
Regulatory capital levels determine the Company’s ability to utilize purchased deposits and the Federal Reserve discount window for liquidity needs. At March 31, 2012, the Company is considered well capitalized and does not have any restrictions on purchased deposits or the Federal Reserve discount window.
 
 
 
38

 
 
 
The Company monitors factors that may increase its liquidity needs. Some of these factors include deposit trends, large depositor activity, maturing deposit promotions, interest rate sensitivity, maturity and repricing timing gaps between assets and liabilities, the level of unfunded loan commitments and loan growth. At March 31, 2012, the Company’s liquidity is sufficient to meet projected trends in these areas.
To monitor and estimate liquidity levels, the Company performs stress testing under varying assumptions on credit sensitive liabilities. It also tests the sources and amounts of balance sheet and external liquidity available to replace outflows. The Company’s Contingency Funding Plan sets forth avenues for rectifying liquidity shortfalls. At March 31, 2012, the analysis indicated adequate liquidity under the tested scenarios.
The Company utilizes several other strategies to maintain sufficient liquidity. Loan and deposit growth are managed to keep the loan to deposit ratio within the Company’s own policy range of 65% to 75%. At March 31, 2012, the loan to deposit ratio was 62.74%, slightly below the Company’s internal target. The investment strategy takes into consideration the term of the investment, and securities in the available for sale portfolio are laddered to account for projected funding needs.

Capital Resources

Total stockholders’ equity at March 31, 2012 was $144,792, an increase of $3,493, or 2.47%, from the $141,299 at December 31, 2011. The Tier I and Tier II risk-based capital ratios at March 31, 2012 were 20.50% and 21.71%, respectively. Capital levels remain significantly above the regulatory minimum capital requirements of 4.0% for Tier I and 8.0% for Tier II capital.

Off-Balance Sheet Arrangements

In the normal course of business, NBB extends lines of credit and letters of credit to its customers.  Depending on their needs, customers may draw upon lines of credit at any time, in any amount up to a pre-approved limit.  Standby letters of credit are issued for two purposes.  Financial letters of credit guarantee payments to facilitate customer purchases.  Performance letters of credit guarantee payment if the customer fails to complete a specific obligation.
Historically, the full approved amount of letters and lines of credit has not been drawn at any one time. The Company has developed plans to meet a sudden and substantial funding demand. These plans include accessing a line of credit with a correspondent bank, borrowing from the FHLB, selling available for sale investments or loans and raising additional deposits.
The Company sells mortgages on the secondary market for which there are recourse agreements should the borrower default.   Mortgages must meet strict underwriting and documentation requirements for the sale to be completed.  The Company has determined that its risk in this area is not significant because of a low volume of secondary market mortgage loans and high underwriting standards. The Company estimates a potential loss reserve for recourse provisions that is not material as of March 31, 2012.  To date, no recourse provisions have been invoked. If funds were needed, the Company would access the same sources as noted above for funding lines and letters of credit.
There were no material changes in off-balance sheet arrangements during the three months ended March 31, 2012, except for normal seasonal fluctuations in the total of mortgage loan commitments.

Contractual Obligations

The Company had no capital lease or purchase obligations and no long-term debt at March 31, 2012. Operating lease obligations, which are for buildings used in the Company’s day-to-day operations, were not material at the end of the three months of 2012 and have not changed materially from those which were disclosed in the Company’s 2011 Form 10-K.

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 provide management with an indication of potential economic loss due to future rate changes. There have not been any changes which would significantly alter the results disclosed as of December 31, 2011 in the Company’s 2011 Form 10-K.

Item 4.   Controls and Procedures

The Company’s management evaluated, with the participation of the Company’s principal executive officer and principal financial officer, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective as of March 31, 2012 to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
 
 
39

 
 
 
There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) during the three months ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.
Because of the inherent limitations in all control systems, the Company believes that no system of controls, no matter how well designed and operated, can provide absolute assurance that all control issues have been detected.

Part II
Other Information

Item 1.                      Legal Proceedings

There are no pending or threatened legal proceedings to which the Company or any of its subsidiaries is a party or to which the property of the Company or any of its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company.

Item 1A.
Risk Factors

Please refer to the “Risk Factors” previously disclosed in Item 1A of our 2011 Annual Report on Form 10-K and the factors discussed under “Cautionary Statement Regarding Forward-Looking Statements” in Part I. Item 2 of this Form 10-Q.

Item 2.                      Unregistered Sales of Equity Securities and Use of Proceeds

The Company did not repurchase stock during the first three months of 2012.

Item 3.                      Defaults Upon Senior Securities

There were no defaults upon senior secuirites for the three months ended March 31, 2012.

Item 4.
 
Mine Safety Disclosures

 
Not applicable.

Item 5.                      Other Information

Subsequent Events
From March 31, 2012, the balance sheet date of this Form 10-Q, through the date of filing the Form 10-Q with the Securities and Exchange Commission, there have been no material subsequent events that 1) provide additional evidence about conditions that existed on the date of the balance sheet, or 2) provide evidence about conditions that did not exist at the date of the balance sheet, but arose after the balance sheet date.

Item 6.                      Exhibits

See Index of Exhibits.



 
40

 


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.



Date: May 9, 2012
/s/ James G. Rakes      
 
James G. Rakes
Chairman, President and
Chief Executive Officer
(Principal Executive Officer)
   
Date: May 9, 2012
/s/ David K. Skeens      
 
David K. Skeens
Treasurer and
Chief Financial Officer
(Principal Financial Officer)
(Principal Accounting Officer)
 

 
 
41

 

Index of Exhibits

Exhibit No.
 
 
Description
 
Page No. in
Sequential System
3(i)
 
Amended and Restated Articles of Incorporation of National Bankshares, Inc.
 
(incorporated herein by reference to Exhibit 3.1 of the Form 8K for filed on March 16, 2006)
3(ii)
 
Amended By-laws of National Bankshares, Inc.
 
(incorporated herein by reference to Exhibit 3(ii) of the Annual Report on Form 10K for fiscal year ended December 31, 2007)
4(i)
 
Specimen copy of certificate for National Bankshares, Inc. common stock
 
(incorporated herein by reference to Exhibit 4(a) of the Annual Report on Form 10K for fiscal year ended December 31, 1993)
*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)
 
Executive Employment Agreement dated December 17, 2008, between National Bankshares, Inc. and James G. Rakes
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Annual Report on Form 10K for the fiscal year ended December 31, 2008)
*10(iii)(A)
 
Employee Lease Agreement dated August 14, 2002, between National Bankshares, Inc. and The National Bank of Blacksburg
 
(incorporated herein by reference to Exhibit 10 (iii) (A) of Form 10Q for the period ended September 30, 2002)
*10(iii)(A)
 
Executive Employment Agreement dated December 17, 2008, between National Bankshares, Inc. and F. Brad Denardo
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Annual Report on Form 10K for the fiscal year ended December 31, 2008)
*10(iii)(A)
 
Salary Continuation Agreement dated February 8, 2006, between The National Bank of Blacksburg and James G. Rakes
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on February 8, 2006)
*10(iii)(A)
 
Salary Continuation Agreement dated February 8, 2006, between The National Bank of Blacksburg and F. Brad Denardo
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on February 8, 2006)
*10(iii)(A)
 
Salary Continuation Agreement dated February 8, 2006, between
The National Bank of Blacksburg  and David K. Skeens
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on January 25, 2012)
*10(iii)(A)
 
First Amendment, dated December 19, 2007, to The National Bank of Blacksburg Salary Continuation Agreement for James G. Rakes
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on December 19, 2007)
*10(iii)(A)
 
First Amendment, dated December 19, 2007, to The National Bank of Blacksburg Salary Continuation Agreement for F. Brad Denardo
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on December 19, 2007)
*10(iii)(A)
 
First Amendment, dated December 19, 2007, to The National Bank of Blacksburg  Salary Continuation Agreement for David K. Skeens
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on January 25, 2012)
*10(viii)(A)
 
Second Amendment, dated June 12, 2008, to The National Bank of Blacksburg Salary Continuation Agreement for F. Brad Denardo
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on June 12, 2008)

 
42

 


*10(viii)(A)
 
Second Amendment, dated December 17, 2008, to The National Bank of Blacksburg Salary Continuation Agreement for James G. Rakes
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Annual Report on Form 10K for the fiscal year ended December 31, 2008)
*10(iii)(A)
 
Second Amendment, dated June 12, 2008, to The National Bank of Blacksburg  Salary Continuation Agreement for David K. Skeens
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on January 25, 2012)
*10(viii)(A)
 
Third Amendment, dated December 17, 2008, to The National Bank of Blacksburg Salary Continuation Agreement for F. Brad Denardo
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Annual Report on Form 10K for the fiscal year ended December 31, 2008)
*10(iii)(A)
 
Third Amendment, dated  January 20 2012, to The National Bank of Blacksburg  Salary Continuation Agreement for David K. Skeens
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on January 25, 2012)
*10(iii)(A)
 
Salary Continuation Agreement dated January 20, 2012 between
The National Bank of Blacksburg  and Bryson J. Hunter
 
(incorporated herein by reference to Exhibit 10(iii)(A) of the Form 8K filed on January 25, 2012)
31(i)
 
Section 906 Certification of Chief Executive Officer
 
(included herewith)
31(ii)
 
Section 906 Certification of Chief Financial Officer
 
(included herewith)
32(i)
 
18 U.S.C. Section 1350 Certification of Chief Executive Officer
 
(included herewith)
32(ii)
 
18 U.S.C. Section 1350 Certification of Chief Financial Officer
 
(included herewith)
101
 
Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company's Quarterly Report on Form 10-Q for the period ended March 31, 2012 is formatted in XBRL interactive data files: (i) Consolidated Statements of Income for the three months ended March 31, 2012, and 2011; (ii) Consolidated Balance Sheets at March 31, 2012 and December 31, 2011; (iii) Consolidated Statements of Changes in Stockholders’ Equity for the three months ended March 31, 2012 and 2011; (iv) Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011; and (v) Notes to Financial Statements
 
   


*       Indicates a management contract or compensatory plan.

 
43

 

Exhibit 31(i)

CERTIFICATIONS

I, James G. Rakes, 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 evaluation; 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: May 9, 2012

/s/ James G. Rakes      
James G. Rakes
Chairman, President and Chief Executive Officer
(Principal Executive Officer)
 


 
44

 

Exhibit 31(ii)

CERTIFICATIONS
 
 
I, David K. Skeens, 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 evaluation; 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: May 9, 2012

/s/David K. Skeens      
David K. Skeens
Treasurer and
Chief Financial Officer
(Principal Financial Officer)


 
45

 

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 March 31, 2012, I, James G. Rakes, Chairman, President and Chief Executive Officer (Principal Executive 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 March 31, 2012, 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 March 31, 2012, 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)
May 9, 2012





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 March 31, 2012, I, David K. Skeens, Treasurer and Chief Financial Officer (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 March 31, 2012, 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 March 31, 2012, fairly presents, in all material respects, the financial condition and results of operations of National Bankshares, Inc.


/s/David K. Skeens      
David K. Skeens
Treasurer and
Chief Financial Officer
(Principal Financial Officer)
May 9, 2012


 
46