10-Q 1 q093002.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 ------------------ or [ ] 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: 33-14252 FIRST NATIONAL BANKSHARES CORPORATION (Exact name of registrant as specified in its charter) West Virginia 62-1306172 ------------- ---------- (State or other jurisdiction (I.R.S. Employer of incorporation) Identification No.) One Cedar Street, Ronceverte, West Virginia 24970 --------------------------------------------- ----------- (Address of principal executive offices) (Zip Code) (304) 647-4500 (Registrant's telephone number, including area code) N/A (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----------- ---------- The number of shares outstanding of the issuer's classes of common stock as of November 1, 2002: Common Stock, $1 par value -- 981,780 shares THIS REPORT CONTAINS 24 PAGES FIRST NATIONAL BANKSHARES CORPORATION FORM 10-Q For the Quarter Ended September 30, 2002 INDEX Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Consolidated Balance Sheets - September 30, 2002 and December 31, 2001 3 Condensed Consolidated Statements of Income - Three Months Ended September 30, 2002 and 2001 and Nine Months Ended September 30, 2002 and 2001 4 Condensed Consolidated Statements of Shareholders' Equity - Three Months Ended September 30, 2002 and 2001 and Nine Months Ended September 30, 2002 and 2001 5 Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2002 and 2001 6 Notes to Condensed Consolidated Financial Statements 7-10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11-17 Item 3. Quantitative and Qualitative Disclosures About Market Risk 18 Item 4. Controls and Procedures 18 PART II. OTHER INFORMATION Item 1. Legal Proceedings 18 Item 2. Changes in Securities 18 Item 3. Defaults upon Senior Securities 18 Item 4. Submission of Matters to a Vote of Security Holders 18 Item 5. Other Information 18 Item 6. Exhibits and Reports on Form 8-K 18 SIGNATURES 19 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS FIRST NATIONAL BANKSHARES CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands of dollars, except per share data)

See Notes to Condensed Consolidated Financial Statements FIRST NATIONAL BANKSHARES CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (In thousands of dollars, except per share data)

See Notes to Condensed Consolidated Financial Statements FIRST NATIONAL BANKSHARES CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001 (In thousands of dollars, except per share data)

See Notes to Condensed Consolidated Financial Statements FIRST NATIONAL BANKSHARES CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, (In thousands of dollars)

See Notes to Condensed Consolidated Financial Statements FIRST NATIONAL BANKSHARES CORPORATION AND SUBSIDIARY NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 1. Basis of Presentation The accounting and reporting policies of First National Bankshares Corporation, (the "Company" or "First National"), and its wholly owned subsidiaries, First National Bank and FNB Insurance, LLC, conform to accounting principles generally accepted in the United States and to general policies within the financial services industry. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. The condensed consolidated statements include the accounts of the Company and its wholly owned subsidiaries, First National Bank and FNB Insurance, LLC. All significant intercompany balances and transactions have been eliminated. The information contained in the condensed consolidated financial statements is unaudited. In the opinion of management, all adjustments for a fair presentation of the results of the interim periods have been made. All such adjustments were of a normal, recurring nature. The results of operations for the nine months ended September 30, 2002 are not necessarily indicative of the results to be expected for the full year. The condensed consolidated financial statements and notes included herein should be read in conjunction with the Company's 2001 audited financial statements and Form 10-K. Certain amounts in the condensed consolidated financial statements for the prior year, as previously presented, have been reclassified to conform to current year classifications. Note 2. Securities The amortized cost, unrealized gains, unrealized losses and estimated fair values of securities at September 30, 2002 and December 31, 2001 are summarized as follows (in thousands):

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The maturities, amortized cost and estimated fair values of the Company's securities at September 30, 2002 are summarized as follows (in thousands):

The Company's Federal Reserve Bank stock and Federal Home Loan Bank stock are equity securities that are included in securities available for sale in the accompanying condensed consolidated financial statements. Such securities do not have a stated maturity date, and are carried at cost, since they may only be sold back to the respective issuer or another member at par value. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 3. Loans Total loans are summarized as follows (in thousands):

Note 4. Allowance for Credit Losses An analysis of the allowance for loan losses is presented below (in thousands) for the nine month periods ended September 30, 2002 and 2001 and for the year ended December 31, 2001:

The Company's total recorded investment in impaired loans at September 30, 2002 approximated $149,000, for which the related allowance for credit losses determined in accordance with accounting principles generally accepted in the United States approximated $0. All impaired loans at September 30, 2002 were collateral dependent, and accordingly, the fair value of the loan's collateral was used to measure the impairment of each loan. Note 5. Commitments and Contingencies In the ordinary course of business, the Company's subsidiary bank is party to financial instruments with off-balance sheet risk. These financial instruments include standby letters of credit and commitments to extend credit. The unused portions of existing lines of credit at September 30, 2001 and December 31, 2001, and the contractual amount of commitments to lend are as follows, in thousands of dollars: Sept. 30, Dec. 31, 2002 2001 ------------- ------------- Total loan commitments $ 15,726 $ 15,372 ============= ============= Management is not aware of any commitments or contingencies that may reasonably be expected to have a material impact on operating results, liquidity or capital resources. The Company continues to be involved in various legal actions and contractual matters arising in the normal course of business. Note 6. Earnings per share Diluted earnings per share amounts assume the conversion, exercise or issuance of all potential common stock instruments unless the effect is to reduce the loss or increase the income per common share from continuing operations. For purposes of computing basic earnings per share, weighted average shares outstanding were 981,780 and 975,354 for the quarters ended September 30, 2002 and 2001 and 981,780 and 973,868 for the nine months ended September 30, 2002 and 2001. The dilutive effect of stock options approximated 2,824 shares and 5,705 shares for the quarters ended September 30, 2002 and 2001 and 3,121 shares and 6,329 shares for the nine months ended September 30, 2002 and 2001. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS Note 7. Other Real Estate Owned During the third quarter, the Company completed the sale of commercial property it held as other real estate owned at June 30, 2002. A charge to earnings of $262,000 was recognized in the second quarter of 2002 in order to reduce the carrying value of the property to its net realizable value. Additional closing and selling expenses of $4,000 were recognized during the third quarter. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following is a discussion and analysis focused on significant changes in the financial condition and results of operations of First National Bankshares Corporation (the "Company" or "Bankshares"), and its wholly owned subsidiaries, First National Bank and FNB Insurance, LLC, for the periods indicated. This discussion and analysis should be read in conjunction with the Company's 2001 consolidated financial statements and notes included in its Annual Report to Shareholders and Form 10-K. The Private Securities Litigation Act of 1995 indicates that the disclosure of forward-looking information is desirable for investors and encourages such disclosure by providing a safe harbor for forward-looking statements by corporate management. This Quarterly Report on Form 10-Q contains forward-looking statements that involve risk and uncertainty. In order to comply with the terms of the safe harbor, the corporation notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in those forward-looking statements. EARNINGS SUMMARY Nine Months Ended September 30, 2002 vs. 2001 The Company reported consolidated net income of $728,000, or $0.74 per diluted share for the nine months ended September 30, 2002, compared to consolidated net income of $872,000, or $0.89 per diluted share, for the same period of 2001. The Company's annualized return on average assets (ROA) was 0.69% and 0.92% for the nine-month periods ended September 30, 2002 and 2001, respectively, while the annualized return on average shareholders' equity (ROE) was 8.1% and 10.3% for the nine months ended September 30, 2002 and 2001, respectively. Improvements in net interest income and non-interest income were mitigated by a greater provision for loan losses and higher non-interest expenses following the Company's opening of a de novo branch in Covington, Virginia in February 2002. In addition, a $266,000 pre-tax loss was recognized on the sale of other real estate owned. An analysis of the major components of the statement of income and expense on a basic earnings per share basis is presented below for the three-month and for the nine-month periods ended September 30, 2002 and 2001.

Three Months Ended September 30, 2002 vs. 2001 The Company reported consolidated net income of $359,000, or $0.36 per diluted share for the three months ended September 30, 2002, compared to consolidated net income of $309,000, or $0.31 per diluted share, for the same period of 2001. The Company's annualized return on average assets (ROA) was 0.98% and 0.96% for the three-month periods ended September 30, 2002 and 2001, respectively, while the annualized return on average shareholders' equity (ROE) was 11.8% and 10.9% for the same periods, respectively. On a quarter-to-quarter basis, the Company experienced a favorable variance in net interest income and non-interest income. As more fully discussed in the NET INTEREST INCOME section below, the growth in the Company's interest-bearing assets relative to its growth in interest-bearing liabilities equated to a positive impact on the Company's net interest income. Likewise, an increase in the volume of fee-related services has aided in enhancing non-interest income by 26.9%. Earnings also improved due to a decline in the loan loss provision. Slower loan demand coupled with a decline in the outstanding loans during the current quarter curbed the need for a comparative loan loss provision. As discussed above in the year to date summary, non-interest expense has increased dramatically due to the new branch in Covington. As expected, the expenses are currently exceeding the revenues generated by the office, however, each succeeding monthly result is steadily improving as the office tracks towards a breakeven asset base. NET INTEREST INCOME The most significant component of the Company's net earnings is net interest income, which represents the excess of interest income earned on earning assets over the interest expense paid for sources of funds. Net interest income is affected by changes in volume resulting from growth and alteration of the balance sheet's composition, as well as by fluctuations in market interest rates and maturities of sources and uses of funds. For purposes of this discussion, net interest income is presented on a fully tax-equivalent basis to enhance the comparability of the performance of tax-exempt to fully taxable earning assets. For the nine-month periods ended September 30, 2002 and 2001, the tax-equivalent adjustment was $61,000. Over the first nine months of 2002, the Company's net interest income has improved $548,000 or 14.4%. As shown in Table II, the majority of the improvement is volume related. Average interest-bearing assets were $134,000,000 in 2002 compared to $120,000,000 in 2001, an increase of 11.1%. The increased volume equated to an incremental increase in interest income of $830,000. Likewise, the growth in interest-bearing liabilities ($11,000,000) equated to an incremental increase in interest expense of $158,000. Overall, the net impact of the volume variance was an increase in net interest income of $672,000. Interest rates have steadily declined over the past several months with many indices and benchmarks at or near historical lows. As a result of variable interest rate provisions, maturities and prepayments, a significant portion of the Company's interest-earning assets have repriced at lower interest rates during 2002. As a result, the net yield on interest-earning assets has declined from 7.82% to 6.57%, or 125 basis points. Similarly, interest-bearing liabilities repriced during 2002, resulting in a 161 basis point decrease in the average interest rate paid on the liabilities. Overall, the net impact of change in interest rates resulted in a net decrease in net interest income of $124,000. An important component to any financial institution's financial success is its ability to effectively manage its net yield on interest-earning assets or "margin." Despite the falling rate environment, the Company was able to improve its margin by 13 basis points from the prior year (4.33% versus 4.20%). The improvement in the margin is a result of the loan growth over the past year (loans are the Company's highest yielding asset) and the incremental benefit derived from funding a portion of the growth in interest-earning assets with non-interest bearing deposits and internal capital (approximately $3,000,000). Going forward, the Company will continue to face a multitude of obstacles lowering its margin - fluctuations in interest rates, competition for loans, prepayments and others. Unfortunately, the current trend of slower loan demand will likely have a negative impact on the Company's margin in the fourth quarter. To combat the potential impact of the lower yield on its assets, the Company will be less aggressive with its funding prices, thereby better managing the asset growth of the Company. Further analysis of the Company's yields on interest-earning assets and interest-bearing liabilities and changes in net interest income as a result of changes in average volume and interest rates are presented in Tables I and II. NON-INTEREST INCOME Non-interest income includes revenues from all sources other than interest income and yield related loan fees from loans held in the Company's portfolio. On a quarter-to-quarter basis, non-interest income improved $46,000, or 26.9%, while for the nine month period ended September 30, 2002, it improved $184,000, or 39.4%. As a percentage of average assets, annualized non-interest income was 0.61% and 0.49% for the nine-month periods ended September 31, 2002 and 2001, respectively. The improvement in the quarter and year to date non-interest income totals is attributed to the Company's secondary market loan program. A favorable interest rate environment coupled with the allocation of additional resources to the program relative to the prior year, has led to a $39,000 and $147,000 improvement in the quarter and year-to-date totals, respectively. Management expects to further capitalize on its secondary market loan activity for the balance of the year. NON-INTEREST EXPENSE Non-interest expense includes overhead costs that are not related to interest expense or to losses from loans or securities. As of September 30, 2002, the Company's non-interest expense totaled $3,621,000, an increase of $848,000, or 30.5%, over total non-interest expense incurred for the nine months ended September 30, 2001. On a quarter-to-quarter basis, other non-interest expense increased to $162,000, or 17.1%, for the third quarter of 2002. Expressed as a percentage of average assets, annualized non-interest expense was 3.4% and 2.9% for the nine months ended September 30, 2002 and 2001, respectively.

The increase in both the quarter and year to date expenses from the prior year is due in part to the incremental operating expenses associated with the new Covington branch. Nearly all-major expense line items reported in the Consolidated Statements of Income in Item 1 are up from the prior year due to the de novo branch. Direct operating expenses attributed to the new location totaled $112,000 and $356,000, respectively for the quarter and nine months ended September 30, 2002. Salaries and employee benefits account for the majority of the incremental expenses, which are derived from the six full-time staff employed by the branch. A portion of the expenses incurred during the first nine months are nonrecurring and therefore are not indicative of the future ongoing expense of the branch. Subsequent to September 30, 2002, the Company hired a new executive, who will be largely responsible for spearheading the business development of the Covington branch. Therefore, non-interest expense is expected to increase in the fourth quarter. Included in non-interest expense is a $266,000 loss recorded on other real estate owned. INCOME TAXES The Company's provisions for state and federal income taxes during the third quarters of 2002 and 2001 were $191,000 and $147,000, respectively. For the year-to-date period, income tax expense was $345,000 in 2002 and $412,000 in 2001 representing effective tax rates of 32.2% and 32.1%, respectively. CHANGES IN FINANCIAL CONDITION The Company's total assets were $146,843,000 at September 30, 2002, compared to $131,319,000 at December 31, 2001, an increase of $15,524,000 or 11.8%. Average total assets were $141,336,000 during the nine month period ended September 30, 2002. Details concerning changes in the Company's major balance sheet items and changes in financial condition follow. Securities and Federal Funds Sold At September 30, 2002, the Company's securities position totaled $29,122,000, an increase of $10,795,000 or 58.9% from December 31, 2001. During the first nine months of 2002, the deposit growth has outpaced loan growth by nearly 5 to 1. As a result, additional funds were available for investing in the security portfolio. The ratio of securities designated as Available for Sale ("AFS") versus Held to Maturity ("HTM") continues to shift towards AFS. With this designation, the Company can more adequately meet its liquidity demands, should the need arise. Future designations of HTM will likely be limited to the purchase of small blocks of municipal securities. A more detailed discussion of the securities portfolio may be found in Note 2 of the condensed consolidated financial statements found in Item I. It is the Bank's philosophy to minimize its involvement in the overnight funds market, however due to liquidity reasons (i.e. fluctuations in loan and deposit balances), the bank may buy or sell funds on an overnight basis. On average, its position in the overnight market in 2002 has been $4,622,000 (this figure includes interest-bearing deposits with other banks) compared to $6,358,000 in the prior year. Loan Portfolio At September 30, 2002, gross loans totaled $107,084,000, an increase of 3.3% from December 31, 2001, while on average, gross loans totaled $106,360,000 during the first nine months of 2002. Loan demand has been markedly slower in 2002 in comparison to the prior year. A portion of the slow down is a result of the current economic conditions. Uncertainty has prompted many small businesses to delay expansion or in some cases, employ a retraction strategy. In addition, competition for high quality loans remains keen, particularly in the Company's primary market area (Greenbrier County, WV). The low interest rate environment has put tremendous pressure on the Company to remain competitive with its pricing and service. Prepayment risk in a falling rate environment continues to play a significant role in the volume of loans the Company must generate in order to maintain a flat growth trend. In the third quarter, total loan outstandings declined $928,000 due to these same competitive factors. In order to combat the current trend, the Company has and will continue to make interest rate concessions to loan customers so long as the decisions support the Company's long-term financial goals and are supported by the Company's asset/liability policies and interest rate risk guidelines. Additionally, the Company will focus efforts on its newest market - Covington, Virginia. Of the Company's $3,446,000 growth in loans during the first nine months of 2002, Covington contributed approximately $2,000,000 of the growth. As mentioned in the NON-INTEREST EXPENSE section, the Company has hired an additional executive who will be largely responsible for business development in the Covington market. As a result, management expects the majority of the future loan growth to come from the Covington location, while loan growth at will be moderate to flat in the other markets. See Note 3 of the condensed consolidated financial statements for further information on the loan portfolio. Allowance and Provision for Loan Losses The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably estimated. On a quarterly basis, management performs a comprehensive evaluation of the adequacy of the allowance that encompasses evaluating problem credits and their potential loss, if any. In addition, management considers historical loan loss experience, new loan volume, portfolio composition, levels of non-performing and past due loans and current and anticipated economic conditions in evaluating the adequacy of the allowance for loan losses. When determined necessary, a provision for loan losses is charged to earnings in order to maintain an adequate allowance for probable loan losses. During the third quarter of 2002, the Company made a $30,000 provision for loan losses compared to $81,000 during the third quarter of 2001. For the nine months ended September 30, 2002 and 2001, respectively, the provision for loan losses was $239,000 and $151,000. At September 30, 2002, the allowance for loan losses was $1,012,000 compared to $837,000 at December 31, 2001. Expressed as a percentage of loans, the allowance for loan losses was 0.95% and 0.81% at September 30, 2002 and December 31, 2001, respectively. In management's opinion, the allowance for loan losses is adequate to absorb the current estimated risk of loss in the existing portfolio. See Note 4 of the condensed consolidated financial statements for an analysis of the activity in the Company's allowance for loan losses for the nine-month periods ended September 30, 2002 and 2001, and for the year ended December 31, 2001. Asset quality trends represent an important factor in evaluating the adequacy of the allowance for loan losses. A summary of the Company's past due loans and non-performing assets is provided in the following table: SUMMARY OF PAST DUE LOANS AND NON-PERFORMING ASSETS (in thousands of dollars)

Total non-performing assets at September 30, 2002 decreased $760,000 from December 31, 2001. As more fully discussed in Note 7 of the Consolidated Financial Statements included in Item 1, the Company completed the sale of other real estate owned in the third quarter, which had a carrying amount of $796,000 at December 31, 2001. Deposits and Other Funding Sources Total deposits at September 30, 2002 increased $15,834,000 or 13.8% from December 31, 2001. On average, deposits totaled $124,293,000 during the nine months ended September 30, 2002, which is an 8.4% increase over the 2001 year-end deposit balance. The following table summarizes the quarter-end and average year to date deposit mix for September 30, 2002 as compared to December 31, 2001:

The opening of the Covington branch has had a significant impact on the Company's deposit growth. This location was responsible for $11,073,000 or nearly 70.0% of the total growth experienced in the first nine months of 2002. The deposit mix at the new location is similar to the consolidated mix shown in the above table. Deposit growth from the Company's other locations has slowed following a rapid increase over an 18-month period. Because of the slower loan demand, management has opted to be less aggressive with its deposit pricing. As a result, deposit growth has been flat in all markets with the exception of Covington. The Company will remain highly competitive in this market in order to build its book of business. Over the past year and coinciding with the fall in interest rates, there has been a distinct trend for depositor preference in short-term, liquid deposits, which yield a competitive return. This preference has led to significant growth in the Company's savings balance relative to other deposit products. As illustrated above, savings deposits have grown 22.5% since December 31, 2001. This trend is likely to continue should interest rates remain at their low levels and should equity markets continue to be highly volatile. The Company's use of short-term borrowings during the nine-months ended September 30, 2002 consisted entirely of repurchase agreements entered into with various customers and on average did not materially differ from the December 31, 2001 balance. LIQUIDITY Liquidity is a measure of the Company's ability to ensure the availability of adequate funds to meet loan commitments and deposit withdrawals, as well as to provide for other Company transactional requirements. Liquidity is provided primarily by funds invested in cash and due from banks, Federal funds sold and interest-bearing deposits with other banks, which totaled $7,525,000 at September 30, 2002 versus $5,722,000 at December 31, 2001. The Company's liquidity is further enhanced by the availability of $5,276,000 (amortized cost) in debt securities maturing within the succeeding one year. Also, the Company has classified additional debt securities with an estimated fair value at September 30, 2002 of $18,639,000 as available for sale in the event of unforeseen need for liquidity. Additionally, the Company has approximately $49,000,000 in available lines of credit with various correspondent banks should the need arise. Management's Asset/Liability Committee (ALCO) meets on a regular basis to review the Company's sources and uses of funds for the succeeding (30), (60) and (90) day time frames. In addition, projected balance sheets for the succeeding (12) month time frame are prepared and reviewed in order to ensure that liquidity is within policy guidelines, and if not, that appropriate strategies are formulated, implemented and measured for effectiveness in order to bring liquidity risk within policy guidelines. Management is not aware of any trends, commitments, events or uncertainties that have resulted in or are reasonably likely to result in a material change in the Company's liquidity. CAPITAL RESOURCES Maintenance of a strong capital position is a continuing goal of the Company. Through management of its capital resources, the Company seeks to provide an attractive financial return to its shareholders while retaining sufficient capital to support future growth. Total shareholders' equity at September 30, 2002 was $12,348,000 compared to $11,822,000 at December 31, 2001, an increase of $526,000. A reconciliation of the increase is reported in the Condensed Consolidated Statement of Shareholders' Equity included in Item I. Average total shareholders' equity expressed as a percentage of average total assets was approximately 8.5% at September 30, 2002 compared to December 31, 2001's level of 9.0%. Cash dividends totaling $314,000, or $0.32 per share were declared during the first nine months of 2002 compared to $379,000 or $0.39 per share declared in comparable period of 2001. These payout levels represented approximately 43.1% and 43.5% of the Company's year-to-date earnings for the nine-month periods ended September 30, 2002 and 2001, respectively. The Company has a dividend policy whereby the dividend payout level may not exceed 40% of the Company's annual net income. Accordingly, future declarations may be limited to the amounts that would be available under the policy directive. The Company has experienced rapid growth over the past two years, and accordingly, the Company's leverage ratio (equity to assets) has decreased. Although the Company continues to report capital ratios well above minimum guidelines as discussed in the following section, it has become prudent for the Company to manage the dividend growth rate in order to preserve capital for future internal asset growth and to build a capital position that will allow the Company to react in a timely manner to external growth opportunities should they present themselves. As a result, the board and management have opted to maintain a flat dividend rate with 2001's regular dividends as the "base year," provided year-to-date earnings support the divided policy mandate described above. REGULATORY RESTRICTIONS ON CAPITAL AND DIVIDENDS The primary source of funds for the dividends paid by First National Bankshares Corporation is dividends received from its subsidiary bank. Dividends paid by the subsidiary bank are subject to restrictions by banking regulations. The most restrictive provision requires approval by the regulatory agency if dividends declared in any year exceed the year's net income, as defined, plus the net retained profits of the two preceding years. Management does not anticipate any such restriction on its dividends in 2002. Quantitative measures established by regulation to ensure capital adequacy require the subsidiary bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier capital (as defined) to average assets (as defined). Management believes, as of September 30, 2002, that the subsidiary bank meets all capital adequacy requirements to which it is subject, as evidenced by the following table: RISK-BASED CAPITAL RATIOS September 30, 2002 Actual Minimum Requirement --------- ------------- Tier 1 risk-based capital ratio 11.16% 4.00% Total risk-based capital ratio 12.17% 8.00% Leverage ratio 7.67% 3.00% Improved operating results and a consistent dividend program, coupled with an effective management of credit and interest rate risk will be the key elements towards the Company continuing to maintain its present strong capital position in the future. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following table represents the results of the Company's interest sensitivity simulation analysis as of September 30, 2002 and December 31, 2001. Key assumptions in the preparation of the table include changes in market conditions including interest rates, loan volumes, and pricing; deposit sensitivity; customer preferences; and capital plans. To attempt to quantify the potential change in net interest income, given a change in interest rates, various interest rate scenarios are applied to projected balances, maturities and repricing opportunities. The resulting change in net interest income reflects the level of sensitivity that net interest income has in relation to changing interest. Annualized Hypothetical % Change in Net Interest Income Sept. 30, Dec. 31, Interest rate scenario 2002 2001 ------------------ ---------------- Up 100 basis points -2.3 -4.8 Down 100 basis points 1.8 4.8 As reported above, a sharp increase or decrease in interest rates would have a significant impact on the Company's earnings. Modest changes in the interest rate environment would not have as dramatic an impact. ITEM 4 CONTROLS AND PROCEDURES The Company's management, including the Chief Executive Officer and Chief Financial Officer, have conducted an evaluation of the effectiveness of disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in ensuring that all material information required to be filed in this quarterly report has been made known to them in a timely fashion. There have been no significant changes in internal controls, or in factors that could significantly affect internal controls, subsequent to the date the Chief Executive Officer and Chief Financial Officer completed their evaluation. PART II. OTHER INFORMATION Item 1. Legal Proceedings Various legal proceedings are presently pending in which the Bank is a named party. These proceedings involve routine litigation incidental to the Bank's business. In Management's opinion, based upon advice of counsel, the resolution of such proceedings will not have a material impact on the Bank's financial position. Item 2. Changes in Securities None Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K a) All exhibits included with this filing follow the signature page. 1. Exhibit 11, Computation of Per Share Earnings, is included on page 22. 2. Exhibit 99.1, Certification of Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002. 3. Exhibit 99.2, Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002. b). The Company did not file any Form 8-K, Current Reports during the quarter ended September 30, 2002. 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. FIRST NATIONAL BANKSHARES CORPORATION By /s/ L. Thomas Bulla L. Thomas Bulla President and Chief Executive Officer By /s/ Matthew L. Burns Matthew L. Burns, CPA Chief Financial Officer, First National Bank (Principal Financial and Accounting Officer) Date: November 14, 2002 CERTIFICATION I, L. Thomas Bulla, President and CEO, certify that: 1. I have reviewed this quarterly report on Form 10-Q of First National Bankshares Corporation; 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures 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 quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. By /s/ L. Thomas Bulla L. Thomas Bulla President and Chief Executive Officer Date: November 14, 2002 CERTIFICATION I, Matthew L. Burns, Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of First National Bankshares Corporation; 2. Based on my knowledge, this quarterly 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures 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 quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. By /s/ Matthew L. Burns Matthew L. Burns, CPA Chief Financial Officer, First National Bank (Principal Financial and Accounting Officer) Date: November 14, 2002 EXHIBIT 11 COMPUTATION OF PER SHARE EARNINGS Earnings Per Share Basic Earnings per Share is calculated based upon the Company's net income after income taxes, divided by the weighted average number of shares outstanding during the fiscal period. Diluted Earnings Per Share is calculated based upon the Company's net income after income taxes, divided by the weighted average number of shares outstanding during the period plus the conversion, exercise or issuance of all potential common stock instruments unless the effect is to increase the income per common share from continuing operations. EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of First National Bankshares Corporation ("First National") on Form 10-Q for the period ending September 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, L. Thomas Bulla, President and Chief Executive Officer of First National, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report 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 the Report fairly presents, in all material respects, the financial condition and results of operations of First National. By /s/ L. Thomas Bulla L. Thomas Bulla President and Chief Executive Officer Date: November 14, 2002 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of First National Bankshares Corporation ("First National") on Form 10-Q for the period ending September 30, 2002, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Matthew L. Burns, Chief Financial Officer of First National, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report 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 the Report fairly presents, in all material respects, the financial condition and results of operations of First National. By /s/ Matthew L. Burns Matthew L. Burns, CPA Chief Financial Officer, First National Bank Date: November 14, 2002

FIRST NATIONAL BANKSHARES CORP 10-Q