**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 September 30,                        2007.                                                                                                                            |
| **o****Transition Report Pursuant To Section 13 OR                        15**(**d**                        )**Or The Securities Exchange Act Of                        1934**                       |

         

For the        transition period from ________ to ________.

 

Commission file number 0-15204

 

**NATIONAL BANKSHARES, INC.**

(Exact        name of Registrant as specified in its Charter)

 

| Virginia(State of incorporation) | 54-1375874(I.R.S. Employer Identification No.) |
|----------------------------------|------------------------------------------------|

 

101        Hubbard Street

P.O. Box        90002

Blacksburg, VA 24062-9002

(540)        951-6300

(Address        and telephone number of principal executive offices)

 

Indicate        by check mark whether the registrant (1) has filed all reports required to be filed by        section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months        (or for such shorter period that the registrant was required to file such reports), and (2)        has been subject to such filing requirements for the past 90        days.  Yes  x   No          o

 

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

 

| Large accelerated                        filer  o   | Accelerated filer  x   | Non-accelerated                        filer  o |
|-------------------------------------------------------------------------|--------------------------------------------|-----------------------------------------------------------|

 

Indicate by        check mark whether the registrant is a shell company (as defined in Rule 12b – 2 of        the Exchange Act).

| Yes o   | Nox |
|-------------------|-----|

         

Indicate        the number of shares outstanding of each of the issuer’s classes of common stock, as        of the latest practicable date.

 

| ClassCommon Stock, $1.25 Par Value | Outstanding at October 31, 20076,962,174 |
|------------------------------------|------------------------------------------|

 

(This        report contains 30 pages)

 

 

         

 

**NATIONAL BANKSHARES, INC. AND SUBSIDIARIES**

 

Form        10-Q

Index

 

 

| **Part I - Financial                        Information** |                                                                                                                                                                      | **Page** |
|-----------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                                                      |                                                                                                                                                                      |     |
| Item 1                                                    | Financial                        Statements                                                                                                                               | 3        |
|                                                      |                                                                                                                                                                      |     |
|                                                      | Consolidated Balance Sheets,                        September 30, 2007 (Unaudited) and December 31, 2006                                                                  | 3-4      |
|                                                      |                                                                                                                                                                      |     |
|                                                      | Consolidated Statements of Income                        for the Three Months Ended September 30, 2007 and 2006                        (Unaudited)                        | 5-6      |
|                                                      |                                                                                                                                                                      |     |
|                                                      | Consolidated Statements of Income                        for the Nine Months Ended September 30, 2007 and 2006                        (Unaudited)                         | 7-8      |
|                                                      |                                                                                                                                                                      |     |
|                                                      | Consolidated Statements of                        Changes in Stockholders’ Equity, Nine Months Ended September 30, 2007                        and 2006 (Unaudited) | 9        |
|                                                      |                                                                                                                                                                      |     |
|                                                      | Consolidated Statements of Cash                        Flows, Nine Months Ended September 30, 2007 and 2006                        (Unaudited)                            | 10-11    |
|                                                      |                                                                                                                                                                      |     |
|                                                      | Notes to Consolidated                        Financial Statements (Unaudited)                                                                                             | 12-16    |
|                                                      |                                                                                                                                                                      |     |
| Item 2                                                    | Management’s Discussion and                        Analysis of Financial Condition and Results of                        Operations                                 | 16-23    |
|                                                      |                                                                                                                                                                      |     |
| Item 3                                                    | Quantitative and Qualitative                        Disclosures About Market Risk                                                                                         | 24       |
|                                                      |                                                                                                                                                                      |     |
| Item 4                                                    | Controls and                        Procedures                                                                                                                            | 24       |
|                                                      |                                                                                                                                                                      |     |
| **Part II - Other                        Information**    |                                                                                                                                                                      |     |
|                                                      |                                                                                                                                                                      |     |
| Item 1                                                    | Legal                        Proceedings                                                                                                                                  | 25       |
|                                                      |                                                                                                                                                                      |     |
| Item 1A                                                   | Risk Factors                                                                                                                                                              | 25       |
|                                                      |                                                                                                                                                                      |     |
| Item 2                                                    | Unregistered Sales of                        Equity Securities and Use of Proceeds                                                                                        | 25       |
|                                                      |                                                                                                                                                                      |     |
| Item 3                                                    | Defaults Upon                        Senior Securities                                                                                                                    | 25       |
|                                                      |                                                                                                                                                                      |     |
| Item 4                                                    | Submission of Matters to a                        Vote of Security Holders                                                                                                | 25       |
|                                                      |                                                                                                                                                                      |     |
| Item 5                                                    | Other                        Information                                                                                                                                  | 25       |
|                                                      |                                                                                                                                                                      |     |
| Item 6                                                    | Exhibits                                                                                                                                                                  | 25       |
|                                                      |                                                                                                                                                                      |     |
| **Signatures**                                            |                                                                                                                                                                      | 26       |
|                                                      |                                                                                                                                                                      |     |
| **Index of                        Exhibits**              |                                                                                                                                                                      | 26-27    |

         

 

 

2

         

 

**Part I**

**Financial Information**

**Item        1. Financial Statements**

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Balance Sheets

 

 

|                                                                                                                                                                 |   | **(Unaudited)**   |        |   |   |             |   |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|-------------|--------|--------|------------------|--------|
|                                                                                                                                                                 |   | **September 30,** |        |   |   | **December 31,** |   |
| **($ In thousands, except share data)**                                                                                                                              |   | **2007**          |        |   |   | **2006**         |   |
| **Assets**                                                                                                                                                           |   |              |        |   |   |             |   |   |   |
| Cash and due from banks                                                                                                                                              |   | **$**             | **12,058**  |   |   |             | $      | 15,283 |   |
| Interest-bearing deposits                                                                                                                                            |   |              | **6,418**   |   |   |             |   | 19,617 |   |
| Securities available for sale, at fair value                                                                                                                         |   |              | **160,355** |   |   |             |   | 169,735 |   |
| Securities held to maturity (fair value approximates                        $119,894 at September 30, 2007 and $115,561 at December 31,                        2006) |   |              | **120,419** |   |   |             |   | 115,754 |   |
| Mortgage loans held for sale                                                                                                                                         |   |              | **378**     |   |   |             |   | 808 |   |
| Loans:                                                                                                                                                               |   |              |        |   |   |             |   |   |   |
| Real estate construction loans                                                                                                                                       |   |              | **42,826**  |   |   |             |   | 33,840 |   |
| Real estate mortgage loans                                                                                                                                           |   |              | **142,618** |   |   |             |   | 126,302 |   |
| Commercial and industrial loans                                                                                                                                      |   |              | **214,056** |   |   |             |   | 215,244 |   |
| Loans to individuals                                                                                                                                                 |   |              | **115,850** |   |   |             |   | 126,316 |   |
| Total loans                                                                                                                                                          |   |              | **515,350** |   |   |             |   | 501,702 |   |
| Less unearned income and deferred fees                                                                                                                               |   |              | **(1,104**  | **)**  |   |             |   | (1,059 | ) |
| Loans, net of unearned income and deferred fees                                                                                                                      |   |              | **514,246** |   |   |             |   | 500,643 |   |
| Less: allowance for loan losses                                                                                                                                      |   |              | **(5,043**  | **)**  |   |             |   | (5,157 | ) |
| Loans, net                                                                                                                                                           |   |              | **509,203** |   |   |             |   | 495,486 |   |
| Bank premises and equipment, net                                                                                                                                     |   |              | **12,206**  |   |   |             |   | 12,702 |   |
| Accrued interest receivable                                                                                                                                          |   |              | **6,125**   |   |   |             |   | 5,682 |   |
| Other real estate owned, net                                                                                                                                         |   |              | **192**     |   |   |             |   | 390 |   |
| Intangible assets and goodwill, net                                                                                                                                  |   |              | **15,123**  |   |   |             |   | 15,976 |   |
| Other assets                                                                                                                                                         |   |              | **17,438**  |   |   |             |   | 16,770 |   |
| **Total assets**                                                                                                                                                     |   | **$**             | **859,915** |   |   |             | $      | 868,203 |   |
|                                                                                                                                                                 |   |              |        |   |   |             |   |   |   |
| **Liabilities and Stockholders' Equity**                                                                                                                             |   |              |        |   |   |             |   |   |   |
| Noninterest-bearing demand deposits                                                                                                                                  |   | **$**             | **111,464** |   |   |             | $      | 101,167 |   |
| Interest-bearing demand deposits                                                                                                                                     |   |              | **211,276** |   |   |             |   | 233,023 |   |
| Savings deposits                                                                                                                                                     |   |              | **45,690**  |   |   |             |   | 47,988 |   |
| Time deposits                                                                                                                                                        |   |              | **381,561** |   |   |             |   | 382,514 |   |
| Total deposits                                                                                                                                                       |   |              | **749,991** |   |   |             |   | 764,692 |   |
| Other borrowed funds                                                                                                                                                 |   |              | **66**      |   |   |             |   | 73 |   |
| Accrued interest payable                                                                                                                                             |   |              | **807**     |   |   |             |   | 863 |   |
| Other liabilities                                                                                                                                                    |   |              | **6,282**   |   |   |             |   | 5,820 |   |
| **Total liabilities**                                                                                                                                                |   |              | **757,146** |   |   |             |   | 771,448 |   |
|                                                                                                                                                                 |   |              |        |   |   |             |   |   |   |
|                                                                                                                                                                 |   |              |        |   |   |             |   |   |   |
|                                                                                                                                                                 |   |              |        |   |   |             |   | *continued* |   |
|                                                                                                                                                                 |   |              |        |   |   |             |   |   |   |
|                                                                                                                                                                 |   |              |        |   |   |             |   |   |   |

 

 

3

         

 

 

| **Stockholders' Equity**                                                                                                   |   |   |        |   |   |   |   |    |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|--------|-------------|--------|--------|--------|--------|---------|--------|
| Preferred stock of no par value.                                                                                           |   |   |        |   |   |   |   |    |   |
| Authorized 5,000,000 shares; none issued and                        outstanding                                            |   |   | **---**     |   |   |   |   | ---     |   |
| Common stock of $1.25 par value.                                                                                           |   |   |        |   |   |   |   |    |   |
| Authorized 10,000,000 shares; issued and outstanding                        6,957,884 shares in 2007 and 6,980,234 in 2006 |   |   | **8,697**   |   |   |   |   | 8,725   |   |
| Retained earnings                                                                                                          |   |   | **97,440**  |   |   |   |   | 91,123  |   |
| Accumulated other comprehensive (loss), net                                                                                |   |   | **(3,368**  | **)**  |   |   |   | (3,093  | )      |
| **Total stockholders' equity**                                                                                             |   |   | **102,769** |   |   |   |   | 96,755  |   |
| **Total liabilities and stockholders' equity**                                                                             |   | **$**  | **859,915** |   |   |   | $      | 868,203 |   |

 

See        accompanying notes to the consolidated financial statements.

 

4

         

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Statements of Income

Three        Months Ended September 30, 2007 and 2006

(Unaudited)

 

 

|                                                                         |   | **September 30,** |       |   |   | **September 30,** |   |
|------------------------------------------------------------------------------|--------|-------------------|------------|--------|--------|-------------------|--------|
| **($ In thousands, except share and per share                        data)** |   | **2007**          |       |   |   | **2006**          |   |
| **Interest income**                                                          |   |              |       |   |   |              |   |   |   |
| Interest and fees on loans                                                   |   | **$**             | **9,367**  |   |   |              | $      | 8,863 |   |
| Interest on interest-bearing deposits                                        |   |              | **124**    |   |   |              |   | 110 |   |
| Interest on securities – taxable                                       |   |              | **1,882**  |   |   |              |   | 1,878 |   |
| Interest on securities – nontaxable                                    |   |              | **1,320**  |   |   |              |   | 1,191 |   |
| Total interest income                                                        |   |              | **12,693** |   |   |              |   | 12,042 |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
| **Interest expense**                                                         |   |              |       |   |   |              |   |   |   |
| Interest on time deposits $100,000 or more                                   |   |              | **1,665**  |   |   |              |   | 1,258 |   |
| Interest on other deposits                                                   |   |              | **3,775**  |   |   |              |   | 3,425 |   |
| Interest on borrowed funds                                                   |   |              | **2**      |   |   |              |   | 8 |   |
| Total interest expense                                                       |   |              | **5,442**  |   |   |              |   | 4,691 |   |
| Net interest income                                                          |   |              | **7,251**  |   |   |              |   | 7,351 |   |
| Provision for loan losses                                                    |   |              | **119**    |   |   |              |   | 16 |   |
| Net interest income after provision for loan                        losses   |   |              | **7,132**  |   |   |              |   | 7,335 |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
| **Noninterest income**                                                       |   |              |       |   |   |              |   |   |   |
| Service charges on deposit accounts                                          |   |              | **814**    |   |   |              |   | 862 |   |
| Other service charges and fees                                               |   |              | **85**     |   |   |              |   | 79 |   |
| Credit card fees                                                             |   |              | **710**    |   |   |              |   | 617 |   |
| Trust income                                                                 |   |              | **286**    |   |   |              |   | 314 |   |
| Other income                                                                 |   |              | **230**    |   |   |              |   | 313 |   |
| Realized securities gains, net                                               |   |              | **---**    |   |   |              |   | 47 |   |
| Total noninterest income                                                     |   |              | **2,125**  |   |   |              |   | 2,232 |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
| **Noninterest expense**                                                      |   |              |       |   |   |              |   |   |   |
| Salaries and employee benefits                                               |   |              | **2,621**  |   |   |              |   | 2,866 |   |
| Occupancy, furniture and fixtures                                            |   |              | **419**    |   |   |              |   | 474 |   |
| Data processing and ATM                                                      |   |              | **278**    |   |   |              |   | 294 |   |
| Credit card processing                                                       |   |              | **559**    |   |   |              |   | 479 |   |
| Intangibles amortization                                                     |   |              | **284**    |   |   |              |   | 284 |   |
| Net costs of other real estate owned                                         |   |              | **10**     |   |   |              |   | 2 |   |
| Other operating expenses                                                     |   |              | **929**    |   |   |              |   | 997 |   |
| Total noninterest expense                                                    |   |              | **5,100**  |   |   |              |   | 5,396 |   |
| Income before income tax expense                                             |   |              | **4,157**  |   |   |              |   | 4,171 |   |
| Income tax expense                                                           |   |              | **961**    |   |   |              |   | 970 |   |
| **Net income**                                                               |   | **$**             | **3,196**  |   |   |              | $      | 3,201 |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
|                                                                         |   |              |       |   |   |              |   | *continued* |   |
|                                                                         |   |              |       |   |   |              |   |   |   |

 

 

5

         

 

 

| Net income per share - basic      |   | **$**  | **0.46**      |   |   |   | $      | 0.46      |   |
|-----------------------------------|--------|--------|---------------|--------|--------|--------|--------|-----------|--------|
| **-**diluted                      |   | **$**  | **0.46**      |   |   |   | $      | 0.46      |   |
| Weighted average number of common |   |   |          |   |   |   |   |      |   |
| shares outstanding - basic        |   |   | **6,966,685** |   |   |   |   | 6,993,891 |   |
| - diluted                         |   |   | **6,978,676** |   |   |   |   | 7,014,961 |   |
| Dividends declared per share      |   | **$**  | **---**       |   |   |   | $      | ---       |   |

 

See        accompanying notes to consolidated financial statements.

 

6

         

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Statements of Income

Nine        Months Ended September 30, 2007 and 2006

(Unaudited)

 

 

|                                                                         |   | **September 30,** |       |   |   | **September 30,** |   |
|------------------------------------------------------------------------------|--------|-------------------|------------|--------|--------|-------------------|--------|
| **($ In thousands, except share and per share                        data)** |   | **2007**          |       |   |   | **2006**          |   |
| **Interest income**                                                          |   |              |       |   |   |              |   |   |   |
| Interest and fees on loans                                                   |   | **$**             | **27,745** |   |   |              | $      | 25,861 |   |
| Interest on interest-bearing deposits                                        |   |              | **508**    |   |   |              |   | 370 |   |
| Interest on securities – taxable                                       |   |              | **5,688**  |   |   |              |   | 5,574 |   |
| Interest on securities – nontaxable                                    |   |              | **3,977**  |   |   |              |   | 3,669 |   |
| Total interest income                                                        |   |              | **37,918** |   |   |              |   | 35,474 |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
| **Interest expense**                                                         |   |              |       |   |   |              |   |   |   |
| Interest on time deposits $100,000 or more                                   |   |              | **4,844**  |   |   |              |   | 3,449 |   |
| Interest on other deposits                                                   |   |              | **11,350** |   |   |              |   | 9,832 |   |
| Interest on borrowed funds                                                   |   |              | **34**     |   |   |              |   | 22 |   |
| Total interest expense                                                       |   |              | **16,228** |   |   |              |   | 13,303 |   |
| Net interest income                                                          |   |              | **21,690** |   |   |              |   | 22,171 |   |
| Provision for loan losses                                                    |   |              | **129**    |   |   |              |   | 40 |   |
| Net interest income after provision for loan                        losses   |   |              | **21,561** |   |   |              |   | 22,131 |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
| **Noninterest income**                                                       |   |              |       |   |   |              |   |   |   |
| Service charges on deposit accounts                                          |   |              | **2,467**  |   |   |              |   | 2,532 |   |
| Other service charges and fees                                               |   |              | **247**    |   |   |              |   | 292 |   |
| Credit card fees                                                             |   |              | **2,028**  |   |   |              |   | 1,777 |   |
| Trust income                                                                 |   |              | **1,019**  |   |   |              |   | 1,059 |   |
| Other income                                                                 |   |              | **751**    |   |   |              |   | 830 |   |
| Realized securities gains, net                                               |   |              | **51**     |   |   |              |   | 13 |   |
| Total noninterest income                                                     |   |              | **6,563**  |   |   |              |   | 6,503 |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
| **Noninterest expense**                                                      |   |              |       |   |   |              |   |   |   |
| Salaries and employee benefits                                               |   |              | **8,240**  |   |   |              |   | 8,706 |   |
| Occupancy, furniture and fixtures                                            |   |              | **1,316**  |   |   |              |   | 1,479 |   |
| Data processing and ATM                                                      |   |              | **858**    |   |   |              |   | 922 |   |
| Credit card processing                                                       |   |              | **1,585**  |   |   |              |   | 1,361 |   |
| Intangibles amortization                                                     |   |              | **853**    |   |   |              |   | 853 |   |
| Net costs of other real estate owned                                         |   |              | **71**     |   |   |              |   | 16 |   |
| Other operating expenses                                                     |   |              | **2,938**  |   |   |              |   | 2,959 |   |
| Total noninterest expense                                                    |   |              | **15,861** |   |   |              |   | 16,296 |   |
| Income before income tax expense                                             |   |              | **12,263** |   |   |              |   | 12,338 |   |
| Income tax expense                                                           |   |              | **2,811**  |   |   |              |   | 2,907 |   |
| **Net income**                                                               |   | **$**             | **9,452**  |   |   |              | $      | 9,431 |   |
|                                                                         |   |              |       |   |   |              |   |   |   |
|                                                                         |   |              |       |   |   |              |   | *continued* |  

                         

                          |

 

 

7

         

 

 

|                                                                           |   |   |          |   |   |   |   |      |   |
|--------------------------------------------------------------------------------|--------|--------|---------------|--------|--------|--------|--------|-----------|--------|
| Net income per share - basic                                              |   | **$**  | **1.36**      |   |   |   | $      | 1.35      |   |
| **-**diluted                                                                   |   | **$**  | **1.35**      |   |   |   | $      | 1.34      |   |
| Weighted average number of common                                              |   |   |          |   |   |   |   |      |   |
| shares outstanding     -                        basic |   |   | **6,975,344** |   |   |   |   | 7,006,767 |   |
| - diluted                                                                      |   |   | **6,991,712** |   |   |   |   | 7,031,118 |   |
| Dividends declared per share                                                   |   | **$**  | **0.37**      |   |   |   | $      | 0.36      |   |

 

 

See        accompanying notes to consolidated financial statements.

 

8

         

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Nine        Months Ended September 30, 2007 and 2006

(Unaudited)

 

 

| **($ In thousands, except per share data)**                                                       |   | **Common Stock** |      | **Retained Earnings** |   | **Accumulated Other Comprehensive Income                        (Loss)** |   | **Comprehensive Income** |       | **Total** |   |
|---------------------------------------------------------------------------------------------------|--------|------------------|-----------|-----------------------|--------|--------------------------------------------------------------------------|--------|--------------------------|------------|-----------|--------|
|                                                                                              |   |             |      |                  |   |                                                                     |   |                     |       |      |   |   |   |   |   |   |
| Balances at December 31, 2005                                                                     |   | $                | 8,775     |                  | $      | 84,610                                                                   |   | $                        | (1,446     | )         |   |   |   | $ | 91,939 |   |
| Net income                                                                                        |   |             | ---       |                  |   | 9,431                                                                    |   |                     | ---        |      | $      | 9,431 |   |   | 9,431 |   |
| Dividends ($0.36 per share)                                                                       |   |             |      |                  |   | (2,524                                                                   | )      |                     |       |      |   |   |   |   | (2,524 | ) |
| Exercise of stock options                                                                         |   |             | 13        |                  |   | 108                                                                      |   |                     | ---        |      |   | --- |   |   | 121 |   |
| Other comprehensive loss, net of tax:                                                             |   |             |      |                  |   |                                                                     |   |                     |       |      |   |   |   |   |   |   |
| Unrealized loss on securities available for sale, net of                        income tax $(104) |   |             | ---       |                  |   | ---                                                                      |   |                     | ---        |      |   | (194 | ) |   | --- |   |
| Reclass adjustment, net of tax $9                                                                 |   |             | ---       |                  |   | ---                                                                      |   |                     | ---        |      |   | 17 |   |   | --- |   |
| Other comprehensive loss, net of tax ($95)                                                        |   |             | ---       |                  |   | ---                                                                      |   |                     | (177       | )         |   | (177 | ) |   | (177 | ) |
| Comprehensive income                                                                              |   |             | ---       |                  |   | ---                                                                      |   |                     | ---        |      | $      | 9,254 |   |   | --- |   |
| Stock repurchase                                                                                  |   |             | (52       | )                     |   | (935                                                                     | )      |                     | ---        |      |   |   |   |   | (987 | ) |
| Balances at September 30, 2006                                                                    |   | $                | 8,736     |                  | $      | 90,690                                                                   |   | $                        | (1,623     | )         |   |   |   | $ | 97,803 |   |
|                                                                                              |   |             |      |                  |   |                                                                     |   |                     |       |      |   |   |   |   |   |   |
| Balances at December 31, 2006                                                                     |   | $                | 8,725     |                  | $      | 91,123                                                                   |   | $                        | (3,093     | )         |   |   |   | $ | 96,755 |   |
| Net income                                                                                        |   |             | ---       |                  |   | 9,452                                                                    |   |                     | ---        |      | $      | 9,452 |   |   | 9,452 |   |
| Dividends ($0.37 per share)                                                                       |   |             | ---       |                  |   | (2,584                                                                   | )      |                     | ---        |      |   | --- |   |   | (2,584 | ) |
| Exercise of stock options                                                                         |   |             | 13        |                  |   | 93                                                                       |   |                     | ---        |      |   | --- |   |   | 106 |   |
| Other comprehensive loss, net of tax:                                                             |   |             |      |                  |   |                                                                     |   |                     |       |      |   |   |   |   |   |   |
| Unrealized loss on securities available for sale, net of                        income tax $(130) |   |             | ---       |                  |   | ---                                                                      |   |                     | ---        |      |   | (242 | ) |   | --- |   |
| Reclass adjustment, net of income tax $(18)                                                       |   |             | ---       |                  |   | ---                                                                      |   |                     | ---        |      |   | (33 | ) |   | --- |   |
| Other comprehensive loss, net of tax ($148)                                                       |   |             | ---       |                  |   | ---                                                                      |   |                     | (275       | )         |   | (275 | ) |   | (275 | ) |
| Comprehensive income                                                                              |   |             | ---       |                  |   | ---                                                                      |   |                     | ---        |      | $      | 9,177 |   |   | --- |   |
| Stock repurchase                                                                                  |   |             | (41       | )                     |   | (644                                                                     | )      |                     | ---        |      |   |   |   |   | (685 | ) |
| **Balances at September 30, 2007**                                                                |   | **$**            | **8,697** |                  | **$**  | **97,440**                                                               |   | **$**                    | **(3,368** | **)**     |   |   |   | **$** | **102,769** |   |

 

 

See        accompanying notes to consolidated financial statements.

 

9

         

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Statements of Cash Flows

Nine        Months Ended September 30, 2007 and 2006

(Unaudited)

 

 

|                                                                                                                  |   | **September 30,** |        | **September 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|-------------------|-------------|-------------------|--------|
| **($In thousands)**                                                                                                   |   | **2007**          |        | **2006**          |   |
| **Cash flows from operating activities**                                                                              |   |              |        |              |   |   |   |
| Net income                                                                                                            |   | **$**             | **9,452**   |              | $      | 9,431 |   |
| Adjustments to reconcile net income to net cash provided by                        operating activities:              |   |              |        |              |   |   |   |
| Provision for loan losses                                                                                             |   |              | **129**     |              |   | 40 |   |
| Depreciation of bank premises and equipment                                                                           |   |              | **761**     |              |   | 752 |   |
| Amortization of intangibles                                                                                           |   |              | **853**     |              |   | 853 |   |
| Amortization of premiums and accretion of discount,                        net                                        |   |              | **177**     |              |   | 206 |   |
| Gains on disposal of fixed assets                                                                                     |   |              | **(6**      | **)**             |   | (4 | ) |
| (Gains) losses on sales and calls of securities available                        for sale, net                        |   |              | **(51**     | **)**             |   | 25 |   |
| Gains on call of securities held to maturity                                                                          |   |              | **---**     |              |   | (38 | ) |
| Losses and writedowns on other real estate owned                                                                      |   |              | **38**      |              |   | 10 |   |
| Net change in:                                                                                                        |   |              |        |              |   |   |   |
| Mortgage loans held for sale                                                                                          |   |              | **430**     |              |   | (223 | ) |
| Accrued interest receivable                                                                                           |   |              | **(443**    | **)**             |   | (372 | ) |
| Other assets                                                                                                          |   |              | **(520**    | **)**             |   | (309 | ) |
| Accrued interest payable                                                                                              |   |              | **(56**     | **)**             |   | 81 |   |
| Other liabilities                                                                                                     |   |              | **462**     |              |   | 691 |   |
| Net cash provided by operating activities                                                                             |   | **$**             | **11,226**  |              | $      | 11,143 |   |
|                                                                                                                  |   |              |        |              |   |   |   |
| **Cash flows from investing activities**                                                                              |   |              |        |              |   |   |   |
| Net change interest-bearing deposits                                                                                  |   | **$**             | **13,199**  |              | $      | (9,499 | ) |
| Proceeds from calls, principal payments, sales and                        maturities of securities available for sale |   |              | **15,233**  |              |   | 11,748 |   |
| Proceeds from calls, principal payments and maturities of                        securities held to maturity          |   |              | **3,508**   |              |   | 6,448 |   |
| Proceeds from sale of securities held to maturity                                                                     |   |              | **---**     |              |   | 823 |   |
| Purchases of securities available for sale                                                                            |   |              | **(6,336**  | **)**             |   | (11,225 | ) |
| Purchases of securities held to maturity                                                                              |   |              | **(8,239**  | **)**             |   | (2,458 | ) |
| Purchases of loan participations                                                                                      |   |              | **(3,500**  | **)**             |   | (2,232 | ) |
| Collections of loan participations                                                                                    |   |              | **4,720**   |              |   | 1,858 |   |
| Loan originations and principal collections, net                                                                      |   |              | **(15,368** | **)**             |   | (4,989 | ) |
| Proceeds from disposal of other real estate owned                                                                     |   |              | **386**     |              |   | --- |   |
| Recoveries on loans charged off                                                                                       |   |              | **76**      |              |   | 108 |   |
| Purchase of bank premises and equipment                                                                               |   |              | **(279**    | **)**             |   | (720 | ) |
| Proceeds from disposal of bank premises and                        equipment                                          |   |              | **20**      |              |   | 5 |   |
| Net cash provided by (used) in investing                        activities                                            |   | **$**             | **3,420**   |              | $      | (10,133 | ) |
|                                                                                                                  |   |              |        |              |   |   |   |
| **Cash flows from financing activities**                                                                              |   |              |        |              |   |   |   |
| Net change in other deposits                                                                                          |   | **$**             | **(13,748** | **)**             | $      | (25,319) |   |
| Net change in time deposits                                                                                           |   |              | **(953**    | **)**             |   | 22,463 |   |
| Net change in other borrowed funds                                                                                    |   |              | **(7**      | **)**             |   | (281 | ) |
| Stock options exercised                                                                                               |   |              | **106**     |              |   | 121 |   |
|                                                                                                                  |   |              |        |              |   |   |   |
|                                                                                                                  |   |              |        |              |   | *continued* |   |

 

 

10

         

 

 

|                                                                        |   |   |        |   |   |   |   |
|-----------------------------------------------------------------------------|--------|--------|-------------|--------|--------|--------|--------|
| Common stock repurchased                                                    |   |   | **(685**    | **)**  |   | (987   | )      |
| Cash dividends paid                                                         |   |   | **(2,584**  | **)**  |   | (2,524 | )      |
| Net cash provided (used) by financing activities                            |   | **$**  | **(17,871** | **)**  | $      | (6,527 | )      |
| Net change in cash and due from banks                                       |   |   | **(3,225**  | **)**  |   | (5,517 | )      |
| Cash and due from banks at beginning of period                              |   |   | **15,283**  |   |   | 20,115 |   |
| Cash and due from banks at end of period                                    |   | **$**  | **12,058**  |   | $      | 14,598 |   |
|                                                                        |   |   |        |   |   |   |   |
| **Supplemental disclosure of cash flow                        information** |   |   |        |   |   |   |   |
| Cash paid for interest                                                      |   | **$**  | **16,284**  |   | $      | 13,222 |   |
| Cash paid for income taxes                                                  |   | **$**  | **2,680**   |   | $      | 2,372  |   |
| Loans charged to the allowance for loan losses                              |   | **$**  | **319**     |   | $      | 345    |   |
| Loans transferred to other real estate owned                                |   | **$**  | **226**     |   | $      | 24     |   |
| Unrealized (losses) on securities available for                        sale |   | **$**  | **(423**    | **)**  | $      | (272   | )      |

 

 

See        accompanying notes to consolidated financial statements.

 

11

         

 

**National Bankshares, Inc. and        Subsidiaries**

**Notes        to Consolidated Financial Statements**

**September 30, 2007**

**(Unaudited)**

($ In        thousands, except share and per share data)

 

**Note        (1)**

 

The consolidated financial statements of National Bankshares, Inc.        (Bankshares) and its wholly-owned subsidiaries, The National Bank of Blacksburg (NBB) and        National Bankshares Financial Services, Inc. (NBFS), (the Company), conform to accounting        principles generally accepted in the United States of America and to general practices        within the banking industry. The accompanying interim period consolidated financial        statements are unaudited; however, in the opinion of management, all adjustments consisting        of normal recurring adjustments, which are necessary for a fair presentation of the        consolidated financial statements, have been included. The results of operations for the        nine months ended September 30, 2007 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        2006 Form 10-K. The Company posts all reports required to be filed under the Securities and        Exchange Act of 1934 on its web site at www.nationalbankshares.com.

 

**Note (2)        Stock-Based Compensation**

 

The Company adopted the National Bankshares, Inc. 1999 Stock Option Plan to        give key employees of Bankshares and its subsidiaries an opportunity to acquire shares of        National Bankshares, Inc. common stock. The purpose of the 1999 Stock Option Plan is to        promote the success of Bankshares and its subsidiaries by providing an incentive to key        employees that enhances the identification of their personal interest with the long term        financial success of the Company and with growth in stockholder value. Under the 1999 Stock        Option Plan, up to 500,000 shares of Bankshares common stock may be granted. The 1999 Stock        Option Plan is administered by the Stock Option Committee, which is the NBI Board of        Directors’ Compensation Committee, made up entirely of independent directors of        National Bankshares, Inc. The Stock Option Committee may determine whether options are        incentive stock options or nonqualified stock options and may determine the other terms of        grants, such as number of shares, term, a vesting schedule, and the exercise price. The        1999 Stock Option Plan limits the maximum term of any option granted to ten years, states        that options may be granted at not less than fair market value on the date of the grant and        contains certain other limitations on the exercisability of incentive stock options. The        options generally vest 25% after one year, 50% after two years, 75% after three years and        100% after four years. At the discretion of the Stock Option Committee options may be        awarded with the provision that they may be accelerated upon a change of control, merger,        consolidation, sale or dissolution of National Bankshares, Inc. At September 30, 2007,        there were 286,000 additional shares available for grant under the plan.

Compensation expense is calculated using the Black-Scholes model and is        amortized over the requisite service period using the straight-line method. Please refer to        the Company’s Form 10-K dated December 31, 2006 for assumptions used. There have been        no grants of stock options in 2007.

 

| **Options**                       |   | **Shares** |   |   | **Weighted-****Average****Exercise****Price** |   | **Weighted****Average****Remaining****Contractual****Term** |   |   | **Aggregate****Intrinsic****Value****($000)** |   |
|-----------------------------------|--------|------------|--------|--------|-----------------------------------------------|--------|-------------------------------------------------------------|--------|--------|-----------------------------------------------|--------|
| Outstanding at January 1, 2007    |   | 161,790    |   | $      | 20.46                                         |   |                                                        |   |   |                                          |   |
| Granted                           |   | ---        |   |   |                                          |   |                                                        |   |   |                                          |   |
| Exercised                         |   | (10,000    | )      | $      | 10.55                                         |   |                                                        |   |   |                                          |   |
| Forfeited or expired              |   | ---        |   |   |                                          |   |                                                        |   |   |                                          |   |
| Outstanding at September 30, 2007 |   | 151,790    |   | $      | 21.12                                         |   | 6.35                                                        |   | $      | ---                                           |   |
| Exercisable at September 30, 2007 |   | 151,790    |   | $      | 21.12                                         |   | 6.35                                                        |   | $      | ---                                           |   |

 

Because no        options were granted in 2007 and all options were fully vested at December 31, 2006, there        is no expense included in net income.

During the nine months ended September 30, 2007, there were no stock options        granted and 10,000 stock options were exercised with an intrinsic value of $88,500. For the        nine months ended September 30, 2006 there were no stock options granted and 10,710 options        were exercised with an intrinsic value of $129,000.

 

12

         

 

**Note        (3)**           **Allowance for Loan Losses, Nonperforming Assets and Impaired        Loans**

 

|                                                                                                                           |   | **For the periods ended** |       |
|--------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|------------|
|                                                                                                                           |   | **September 30,**         |       | December 31, |
| **($ In thousands, except % data)**                                                                                            |   | **2007**                  |       | **2006** |   | **2006** |   |
| Balance at beginning of period                                                                                                 |   | **$**                     | **5,157**  |   | $ | 5,449 |   | $ | 5,449 |   |
| Provision for loan losses                                                                                                      |   |                      | **129**    |   |   | 40 |   |   | 49 |   |
| Loans charged off                                                                                                              |   |                      | **(319**   | **)** |   | (345 | ) |   | (459 | ) |
| Recoveries                                                                                                                     |   |                      | **76**     |   |   | 108 |   |   | 118 |   |
| Balance at the end of period                                                                                                   |   | **$**                     | **5,043**  |   | $ | 5,252 |   | $ | 5,157 |   |
| Ratio of allowance for loan losses to the end of period                        loans, net of unearned income and deferred fees |   |                      | **0.98**   | **%** |   | **1.06** | **%** |   | 1.03 | % |
| Ratio of net charge-offs to average loans, net of unearned                        income and deferred fees1.                   |   |                      | **0.06**   | **%** |   | **0.06** | **%** |   | 0.07 | % |
| Ratio of allowance for loan losses to nonperforming                        loans2.                                             |   |                      | **417.47** | **%** |   | **1,313.00** | **%** |   | --- | % |

 

| 1. | Net charge-offs are on an annualized basis. |
|----|---------------------------------------------|

| 2. | The Company defines nonperforming loans as total nonaccrual                        and restructured loans. Loans 90 days past due and still accruing are                        excluded. |
|----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

         

         

|                                                                                                                                  |   | **September 30,** |      | **December 31,** |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|-----------|------------------|
| **($ In thousands, except % data)**                                                                                                   |   | **2007**          |      | **2006**         |   | **2006** |   |
| Nonperforming Assets:                                                                                                                 |   |              |      |             |   |   |   |   |   |   |
| Nonaccrual loans                                                                                                                      |   | **$**             | **1,208** |             | $ | 4 |   | $ | --- |   |
| Restructured loans                                                                                                                    |   |              | **---**   |             |   | --- |   |   | --- |   |
| Total nonperforming loans                                                                                                             |   |              | **1,208** |             |   | 4 |   |   | --- |   |
| Foreclosed property                                                                                                                   |   |              | **192**   |             |   | 390 |   |   | 390 |   |
| Total nonperforming assets                                                                                                            |   | **$**             | **1,400** |             | $ | 394 |   | $ | 390 |   |
| Ratio of nonperforming assets to loans, net of unearned                        income and deferred fees, plus other real estate owned |   |              | **0.27**  | **%**            |   | 0.08 | % |   | 0.08 | % |

 

 

|                                                                                                                                 |   | **September 30,** | **December 31,** |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------|------------------|
| **($ In thousands, except % data)**                                                                                                  |   | **2007**          |             | **2006** |   | **2006** |   |
| Loans past due 90 days or more and still accruing                                                                                    |   | **$**             | **288**          |   | $ | 495 |   | $ | 681 |   |
| Ratio of loans past due 90 days or more and still accruing                        to loans, net of unearned income and deferred fees |   |              | **0.06**         | **%** |   | 0.10 | % |   | 0.14 | % |
| Impaired loans                                                                                                                       |   |              |             |   |   |   |   |   |   |   |
| Total impaired loans                                                                                                                 |   | **$**             | **1,140**        |   | $ | --- |   | $ | --- |   |
| Impaired loans with a valuation allowance                                                                                            |   |              | **---**          |   |   | --- |   |   | --- |   |
| Valuation allowance                                                                                                                  |   |              | **---**          |   |   | --- |   |   | --- |   |
| Impaired loans, net of allowance                                                                                                     |   |              | **---**          |   |   | --- |   |   | --- |   |
| Impaired loans with no valuation allowance                                                                                           |   | **$**             | **1,140**        |   | $ | --- |   |   | --- |   |
| Average recorded investment in impaired loans                                                                                        |   | **$**             | **1,136**        |   | $ | 175 |   | $ | 140 |   |
| Income recognized on impaired loans                                                                                                  |   | **$**             | **---**          |   | $ | --- |   | $ | --- |   |
| Amount of income recognized on a cash basis                                                                                          |   | **$**             | **---**          |   | $ | --- |   | $ | --- |   |

 

Nonaccrual        loans exluded from impaired disclosure under SFAS114 at September 30, 2007 were $68. No        income was recognized on these loans at September 30, 2007.

 

13

         

 

**Note (4)        Securities**

 

The amortized costs, gross unrealized gains, gross unrealized losses and        fair values for securities available for the sale by major security type as of September        30, 2007 are as follows:

 

|                                      |   | **September 30, 2007**   |        |
|-------------------------------------------|--------|--------------------------|-------------|
| **($ In thousands)**                      |   | **Amortized**

**Costs** |        | **Gross**

**Unrealized**

**Gains** |   | **Gross**

**Unrealized**

**Losses** |   | **Fair**

**Values** |   |
| Available for sale:                       |   |                     |        |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury                             |   | **$**                    | **3,030**   |   | **$** | **---** |   | **$** | **66** |   | **$** | **2,964** |   |
| U.S. Government Agencies and Corporations |   |                     | **21,826**  |   |   | **11** |   |   | **93** |   |   | **21,744** |   |
| State and political subdivisions          |   |                     | **76,092**  |   |   | **571** |   |   | **724** |   |   | **75,939** |   |
| Mortgage-backed securities                |   |                     | **27,327**  |   |   | **8** |   |   | **340** |   |   | **26,995** |   |
| Corporate debt securities                 |   |                     | **30,469**  |   |   | **36** |   |   | **988** |   |   | **29,517** |   |
| Federal Reserve Bank stock-restricted     |   |                     | **92**      |   |   | **---** |   |   | **---** |   |   | **92** |   |
| Federal Home Loan Bank stock-restricted   |   |                     | **1,659**   |   |   | **---** |   |   | **---** |   |   | **1,659** |   |
| Other securities                          |   |                     | **1,312**   |   |   | **133** |   |   | **---** |   |   | **1,445** |   |
| Total securities available for sale       |   | **$**                    | **161,807** |   | **$** | **759** |   | **$** | **2,211** |   | **$** | **160,355** |   |

 

The amortized costs, gross unrealized gains, gross unrealized losses and        fair values for securities held to maturity by major security type as of September 30, 2007        are as follows:

 

 

|                                      |   | **September 30, 2007** |        |
|-------------------------------------------|--------|------------------------|-------------|
| **($ In thousands)**                      |   | **Amortized****Costs** |        | **Gross****Unrealized****Gains** |   | **Gross****Unrealized****Losses** |   | **Fair****Values** |   |
| Held to Maturity:                         |   |                   |        |   |   |   |   |   |   |   |   |   |   |
| U.S. Government Agencies and Corporations |   | **$**                  | **42,462**  |   | **$** | **26** |   | **$** | **324** |   | **$** | **42,164** |   |
| State and political subdivisions          |   |                   | **60,697**  |   |   | **566** |   |   | **433** |   |   | **60,830** |   |
| Mortgage-backed securities                |   |                   | **2,152**   |   |   | **7** |   |   | **32** |   |   | **2,127** |   |
| Corporate securities                      |   |                   | **15,108**  |   |   | **105** |   |   | **440** |   |   | **14,773** |   |
| Total securities held to maturity         |   | **$**                  | **120,419** |   | **$** | **704** |   | **$** | **1,229** |   | **$** | **119,894** |   |

 

 

Information        pertaining to securities with gross unrealized losses at September 30, 2007 and December        31, 2006, aggregated by investment category and length of time that individual securities        have been in a continuous loss position, follows:

 

|                                      |   | **September 30, 2007**  |   |
|-------------------------------------------|--------|-------------------------|--------|
|                                      |   | **Less Than 12 Months** |   | **12 Months or More** |   |
| **($ In thousands)**                      |   | **Fair****Value**       |   | **Unrealized****Loss** |   | **Fair****Value** |   | **Unrealized****Loss** |   |
| U.S. Government agencies and corporations |   | $                       | 7,820  |   | $ | 44 |   | $ | 37,068 |   | $ | 440 |   |
| State and political subdivisions          |   |                    | 26,412 |   |   | 503 |   |   | 33,245 |   |   | 653 |   |
| Mortgage-backed securities                |   |                    | 9,537  |   |   | 111 |   |   | 17,584 |   |   | 261 |   |
| Corporate debt securities                 |   |                    | 1,004  |   |   | 1 |   |   | 35,450 |   |   | 1,427 |   |
| Total temporarily impaired securities     |   | $                       | 44,773 |   | $ | 659 |   | $ | 123,347 |   | $ | 2,781 |   |

 

 

14

         

 

|                                      |   | **December 31, 2006**   |   |
|-------------------------------------------|--------|-------------------------|--------|
|                                      |   | **Less Than 12 Months** |   | **12 Months or More** |   |
| **($ In thousands)**                      |   | **Fair****Value**       |   | **Unrealized****Loss** |   | **Fair****Value** |   | **Unrealized****Loss** |   |
| U.S. Government agencies and corporations |   | $                       | 22,734 |   | $ | 83 |   | $ | 38,234 |   |   | 831 |   |
| State and political subdivisions          |   |                    | 14,449 |   |   | 91 |   |   | 30,503 |   |   | 587 |   |
| Mortgage-backed securities                |   |                    | 13,533 |   |   | 46 |   |   | 16,268 |   |   | 296 |   |
| Corporate debt securities                 |   |                    | ---    |   |   | --- |   |   | 35,462 |   |   | 1,495 |   |
| Total temporarily impaired securities     |   | $                       | 50,716 |   | $ | 220 |   | $ | 120,467 |   | $ | 3,209 |   |

 

The Company had 254 securities with a fair value of $168,120 which were        temporarily impaired at September 30, 2007. The total unrealized loss on these securities        was $3,440. Losses are attributed to interest rate movements. Credit quality of the        securities portfolio is continuously monitored by management. The Company has the ability        and intent to hold these securities until maturity or until the loss in value is recovered.        Therefore, the losses associated with these securities are considered temporary at        September 30, 2007. All securities shown are above investment grade.

 

**Note (5)        Recent Accounting Pronouncements**

 

In September 2006, the Financial Accounting Standards Board (FASB) issued        Statement of Financial Accounting Standards No. 157, “Fair Value Measurements”        (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value        in generally accepted accounting principles, and expands disclosures about fair value        measurements. SFAS 157 does not require any new fair value measurements but may change        current practice for some entities. This Statement is effective for financial statements        issued for fiscal years beginning after November 15, 2007 and interim periods within those        years. The Company does not expect the implementation of SFAS 157 to have a material impact        on its consolidated financial statements.

 

In February 2007, the FASB issued Statement of Financial Accounting        Standards No. 159, “The Fair Value Option for Financial Assets and Financial        Liabilities” (SFAS 159). This statement permits entities to choose to measure many        financial instruments and certain other items at fair value. The objective of this        Statement is to improve financial reporting by providing entities with the opportunity to        mitigate volatility in reported earnings caused by measuring related assets and liabilities        differently without having to apply complex hedge accounting provisions. The fair value        option established by this Statement permits all entities to choose to measure eligible        items at fair value at specified election dates. A business entity shall report unrealized        gains and losses on items for which the fair value option has been elected in earnings at        each subsequent reporting date. The fair value option may be applied instrument by        instrument and is irrevocable. SFAS 159 is effective as of the beginning of an        entity’s first fiscal year that begins after November 15, 2007. The Company is in the        process of evaluating the impact SFAS 159 may have on its consolidated financial        statements.

 

| **Note (6) Defined Benefit Plan** |
|-----------------------------------|

 

Components        of Net Periodic Benefit Cost

 

|                                         |   | **Pension Benefits**                |     |
|----------------------------------------------|--------|-------------------------------------|----------|
|                                         |   | **Nine Months Ended September 30,** |     |
| **($ in Thousands)**                         |   | **2007**                            |     | **2006** |   |
| Service cost                                 |   | **$**                               | **456**  |   | $ | 430 |   |
| Interest cost                                |   |                                | **525**  |   |   | 486 |   |
| Expected return on plan assets               |   |                                | **(477** | **)** |   | (395 | ) |
| Amortization of prior service cost           |   |                                | **6**    |   |   | (10 | ) |
| Amortization of net obligation at transition |   |                                | **(9**   | **)** |   | 166 |   |
| Recognized net actuarial loss                |   |                                | **135**  |   |   | 6 |   |
| Net periodic benefit cost                    |   | **$**                               | **636**  |   | $ | 683 |   |

 

 

15

         

 

Employer        Contributions

 

|   | Bankshares’ pension plan contribution for 2007 is                        $594. The contribution will be paid in quarterly installments. |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|

 

 

**National Bankshares, Inc. and Subsidiaries**

**(In        thousands, except per share data)**

 

**Item 2.**

**Management's Discussion and Analysis of Financial Condition        and**

**Results of Operations for the Nine Months Ended September 30,        2007**

 

The purpose of this discussion is to provide information about the financial        condition and results of operations of National Bankshares, Inc. and its wholly-owned        subsidiaries (the Company), which are not otherwise apparent from the consolidated        financial statements and other information included in this report. Refer to the financial        statements and other information included in this report as well as the 2006 Annual Report        on Form 10-K for an understanding of the following discussion and analysis.

This Quarterly Report on Form 10-Q contains forward-looking statements as        described in the Securities Exchange Act of 1934. The Company's actual results could differ        materially from those set forth in the forward-looking statements.

 

**Critical Accounting Policies**

**General**

 

The Company’s financial statements are prepared in accordance with        accounting principles generally accepted in the United States (GAAP). The financial        information contained within our statements is, to a significant extent, financial        information that is based on measures of the financial effects of transactions and events        that have already occurred. A variety of factors could affect the ultimate value that is        obtained when earning income, recognizing an expense, recovering an asset or relieving a        liability. We use historical loss factors as one element in determining the inherent loss        that may be present in our loan portfolio. Actual losses could differ significantly from        the historical factors that we use. In addition, GAAP itself may change from one previously        acceptable method to another method. Although the economics of our transactions would be        the same, the timing of events that would impact our transactions could change.

         

**Allowance for Loan Losses**

 

The allowance for loan losses is an estimate of the losses that may be        sustained in our loan portfolio. The allowance is based on two basic principles of        accounting: (i) SFAS 5,*Accounting for Contingencies,*which requires that losses be accrued when they are probable of occurring        and estimable and (ii) SFAS 114,*Accounting by Creditors for        Impairment of a Loan,*which requires that losses be accrued based        on the differences between the value of collateral, present value of future cash flows or        values that are observable in the secondary market and the loan balance.

Our allowance for loan losses has three basic components; the formula        allowance, the specific allowance and the unallocated allowance. Each of these components        is determined based upon estimates that can and do change when actual events occur. The        formula allowance uses a historical loss view and certain qualitative factors as an        indicator of future losses and, as a result, could differ from the loss incurred in the        future. However, since this history is updated with the most recent loss information, the        errors that might otherwise occur are mitigated. The specific allowance uses various        techniques to arrive at an estimate of loss. Expected cash flows and fair market value of        collateral are used to estimate these losses. The use of these values is inherently        subjective and our actual losses could be greater or less than the estimates. The        unallocated allowance captures losses that are attributable to various economic events,        industry or geographic sectors, whose impact on the portfolio have occurred but have yet to        be recognized in either the formula or specific allowance.

 

**Core        deposit intangibles**

 

Effective January 1, 2002, the Corporation adopted Financial Accounting        Standards Board Statement No. 142,*Goodwill and Other Intangible        Assets.*Accordingly, goodwill is no longer subject to        amortization over its estimated useful life, but is subject to at least an annual        assessment for impairment by applying a fair value based test. Additionally, Statement 142        requires that acquired intangible assets (such as core deposit intangibles) be separately        recognized if the benefit of the asset can be sold, transferred, licensed, rented, or        exchanged and amortized over its estimated useful life. Branch acquisition transactions        were outside the scope of

 

16

         

 

the        Statement and therefore any intangible asset arising from such transactions remained        subject to amortization over their estimated useful life.

In October 2002, the Financial Accounting Standards Board issued Statement        No. 147,*Acquisitions of Certain Financial        Institutions.*The Statement amends previous interpretive guidance        on the application of the purchase method of accounting to acquisitions of financial        institutions, and requires the application of Statement No. 141,*Business Combinations,*and Statement No. 142 to        branch acquisitions if such transactions meet the definition of a business combination. The        provisions of the Statement do not apply to transactions between two or more mutual        enterprises. In addition, the Statement amends Statement No. 144,*Accounting for the Impairment of Long-Lived Assets,*to include in its scope core deposit intangibles of financial institutions.        Accordingly, such intangibles are subject to a recoverability test based on undiscounted        cash flows, and to the impairment recognition and measurement provisions required for other        long-lived assets held and used. The Company has determined that the acquisitions that        generated the intangible assets on the consolidated balance sheets in the amount of $9,958        and $10,912 at December 31, 2003 and 2002, respectively, did not constitute the acquisition        of a business, and therefore will continue to be amortized.

 

**Overview**

         

National Bankshares, Inc. (NBI) is a financial holding company located in        Southwest Virginia. It conducts operations primarily through its full-service banking        affiliate, The National Bank of Blacksburg, which does business as National Bank. National        Bank has 26 locations in the region. It also has a nonbanking affiliate, National        Bankshares Financial Services, Inc., which offers investment and insurance products. Net        income derived from the nonbanking affiliate is not significant at this time or in the        foreseeable future. NBI is a community bank operation.

 

**Performance Summary**

 

The following table shows NBI’s key performance ratios for the period        ended September 30, 2007 and December 31, 2006. Per share data has been adjusted to reflect        the effects of a March 31, 2006 2-for-1 stock split.

 

|                                 |   | **September 30,****2007** |   | **December 31,****2006** |   |
|--------------------------------------|--------|---------------------------|--------|--------------------------|--------|
| Return on average assets             |   |                      | 1.46   | %                        |   | 1.50 | % |
| Return on average equity             |   |                      | 12.69  | %                        |   | 13.41 | % |
| Net interest margin (1)              |   |                      | 3.99   | %                        |   | 4.13 | % |
| Noninterest margin (2)               |   |                      | 1.45   | %                        |   | 1.54 | % |
| Basic net earnings per share         |   | $                         | 1.36   |                     | $      | 1.80 |   |
| Fully diluted net earnings per share |   | $                         | 1.35   |                     | $      | 1.80 |   |

 

|   | (1) | Net Interest Margin: Year-to-date tax-equivalent net                        interest income divided by year-to-date average earning assets using a tax                        rate of 35%. |
|--------|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | (2) | Noninterest Margin: Noninterest income (including securities                        gains and losses) less noninterest expense (excluding the provision for bad                        debts and income taxes) divided by average year-to-date assets. This is a                        non-GAAP financial measure of the level of noninterest income and                        expense. |
|--------|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The return on average assets for the first three quarters of 2007 was 1.46%,        down slightly from the 1.50% for the period ended December 31, 2006. The return on average        equity also experienced a decline.

 

**Growth**

 

|   | The following table shows NBI’s key growth                        indicators: |
|--------|-------------------------------------------------------------------------------------|

 

|         |   | **September 30, 2007** |    | **December 31, 2006** |   | **Percent Change** |   |
|--------------|--------|------------------------|---------|-----------------------|--------|--------------------|--------|
| Securities   |   | $                      | 280,774 |                  | $      | 285,489            |   |   | (1.65 | %) |
| Loans, net   |   |                   | 509,203 |                  |   | 495,486            |   |   | 2.77 | % |
| Deposits     |   |                   | 751,981 |                  |   | 764,692            |   |   | (1.66 | %) |
| Total assets |   |                   | 859,915 |                  |   | 868,203            |   |   | (0.95 | %) |

 

 

17

         

 

**Asset        Quality**

 

|   | Key asset quality indicators are shown below: |
|--------|-----------------------------------------------|

 

|                               |   | **September 30, 2007** |   | **December 31,2006** |   |
|------------------------------------|--------|------------------------|--------|----------------------|--------|
| Nonperforming loans                |   | $                      | 1,208  |                 | $      | --- |   |
| Loans past due over 90 days        |   |                   | 288    |                 |   | 681 |   |
| Other real estate owned            |   |                   | 192    |                 |   | 390 |   |
| Allowance for loan losses to loans |   |                   | 0.98   | %                    |   | 1.03 | % |
| Net charge-off ratio               |   |                   | 0.06   | %                    |   | 0.07 | % |

 

This data indicates that the level of nonperforming loans has increased,        while the level of loans past due 90 days or more has declined. The increase in        nonperforming loans is concentrated in one credit. There has been no specific allocation to        the allowance for loan losses for the single additional nonperforming loan, as management        believes that this credit is well collateralized. Measures of asset quality remain good        when viewed from a historical perspective and when compared with peers. Other real estate        owned continues to decline as properties foreclosed upon are sold.

 

**Net        Interest Income**

 

|   | Net interest income for the first nine months of 2007 was                        $21,690, a decrease of $481 or 2.17% over the same period in                        2006. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

There were regular and steady increases in interest rate levels until the        third quarter of 2006. Due to the liability-sensitive nature of the Company’s balance        sheet, funding costs rose at a faster rate than asset yields. This caused the interest rate        spread and the related net interest income to decrease. Recent reductions in the federal        funds rate by the Federal Reserve Bank should have a positive effect on the net interest        margin in the intermediate term.

Data in the table below, suggests that the net interest spread may have        stabilized in the first nine months of 2007. It is expected that a gradual improvement in        the net interest spread will occur, as interest rate levels have declined.

 

|                               | For the period ended   |
|------------------------------------|------------------------|
|                               | **September 30, 2007** |   | **June 30, 2007** |   | **March 31, 2007** |   | **December 31, 2006** |   |
| Loans                              | 7.36                   | % | 7.37 | % | 7.35 | % | 7.11 | % |
| Taxable securities                 | 4.94                   | % | 4.92 | % | 4.95 | % | 4.89 | % |
| Non-taxable securities             | 6.23                   | % | 6.32 | % | 6.36 | % | 6.25 | % |
| Interest-bearing deposits          | 5.40                   | % | 5.36 | % | 5.47 | % | 5.08 | % |
| Total interest-bearing assets      | 6.68                   | % | 6.69 | % | 6.68 | % | 6.51 | % |
|                               |                   |   |   |   |   |   |   |   |
| Interest-bearing demand deposits   | 1.96                   | % | 1.98 | % | 2.00 | % | 1.87 | % |
| Saving deposits                    | 0.45                   | % | 0.50 | % | 0.50 | % | 0.50 | % |
| Time deposits                      | 4.51                   | % | 4.48 | % | 4.47 | % | 3.94 | % |
| Other borrowings                   | 5.58                   | % | 5.56 | % | 5.56 | % | 6.19 | % |
| Total interest-bearing liabilities | 3.35                   | % | 3.32 | % | 3.33 | % | 2.94 | % |
|                               |                   |   |   |   |   |   |   |   |
| Interest rate spread               | 3.34                   | % | 3.37 | % | 3.35 | % | 3.57 | % |

 

From December 31, 2006 to September 30, 2007, the yield on loans has        increased by 25 basis points. During the same period, the yield on taxable securities has        gone up by 5 basis points, with nontaxable securities decreasing a nominal 2 basis points.        Among the asset categories interest-bearing deposits, which reprice daily, experienced the        highest level of increase.

The table above indicates that the Company’s interest rate spread has        remained relatively stable throughout 2007. The interest rate spread is compressed and is        at a lower level than management considers to be desirable for optimal        profitability.

In September of 2007, the Federal Reserve Bank lowered the targeted federal        funds rate by 50 basis points, and the prime rate for banks was in turn lowered by the same        amount. In general, a reduction in interest rates will, over time, positively impact the        Company’s interest rate spread. This is because its interest-bearing liabilities        re-price at a faster pace than its interest-earning assets. However, future changes in        interest rates are difficult to predict because of the number of economic variables in        play. It is unknown if the Federal Reserve Bank will cut interest rates further. Higher        inflation rates would likely result in future increases in the targeted federal funds        rate.

 

18

         

 

**Provision and Allowance for Loan Losses**

The provision for loan losses for the nine-month period ended September 30,        2007 was $129. The ratio of the allowance for loan losses to total loans at the end of the        first nine months of 2007 was 0.98%, which compares to 1.03% at December 31, 2006. The net        charge-off ratio was 0.06% at September 30, 2007 and .07% at December 31, 2006.

The Company regularly reviews asset quality and re-evaluates the allowance        for loan losses. During the third quarter of 2007, the Company made provisions of $119 to        the Allowance for Loan Losses. These aggregate additions, which were the first significant        additions in well over one year, were made based upon management’s opinion of current        asset quality and loan growth, evaluated in the context of historical loss experience and        current economic conditions. (See “Allowance for Loan Losses” under        “Critical Accounting Policies”.)

 

**Noninterest Income**

 

|                               |   | **September 30, 2007** |   | **September 30, 2006** |   | **Percent Change** |   |
|------------------------------------|--------|------------------------|--------|------------------------|--------|--------------------|--------|
| Service charges on deposits        |   | $                      | 2,467  |                   | $      | 2,532              |   |   | (2.57 | %) |
| Other service charges and fees     |   |                   | 247    |                   |   | 292                |   |   | (15.41 | %) |
| Credit card fees                   |   |                   | 2,028  |                   |   | 1,777              |   |   | 14.12 | % |
| Trust fees                         |   |                   | 1,019  |                   |   | 1,059              |   |   | (3.78 | %) |
| Other income                       |   |                   | 751    |                   |   | 830                |   |   | (9.52 | %) |
| Realized securities gains (losses) |   |                   | 51     |                   |   | 13                 |   |   | 292.31 | % |

 

Noninterest        income is made up of several categories. Following is a description of the catergories, as        well as the factors that influence each.

 

Service charges on deposit accounts consist of a variety of charges imposed        on demand deposits, interest-bearing deposits and savings deposit accounts. These include,        but are not limited to, the following:

|   | **•** | Demand deposit monthly activity fees |
|--------|------------|--------------------------------------|

|   | **•** | Service charges for checks for which there are                        non-sufficient funds or overdraft charges |
|--------|------------|-----------------------------------------------------------------------------------------------------------------|

|   | **•** | ATM transaction fees |
|--------|------------|----------------------|

|   | The principal factors affecting current or future levels of                        income from this category are: |
|--------|-------------------------------------------------------------------------------------------------------------------|

|   | **•** | Internally generated growth |
|--------|------------|-----------------------------|

|   | **•** | Acquisitions of other banks/branches or de novo                        branches |
|--------|------------|---------------------------------------------------------------------------------|

|   | **•** | Adjustments to service charge structures |
|--------|------------|------------------------------------------|

Service charges on deposits were $2,467 at September 30, 2007, a decrease of        $65 when compared to the same period in 2006.

 

|   | Other service charges and fees consist of several                        categories. The primary categories are listed below. |
|--------|-------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | Fees for the issuance of official checks |
|--------|------------|------------------------------------------|

|   | **•** | Safe deposit box rent |
|--------|------------|-----------------------|

|   | **•** | Income from the sale of customer checks |
|--------|------------|-----------------------------------------|

|   | **•** | Income from the sale of credit life and accident and health                        insurance |
|--------|------------|----------------------------------------------------------------------------------------------|

Levels of income derived from other service charges and fees vary. Fees for        the issuance of official checks and customer check sales tend to grow as the existing        franchise grows and as new offices are added. Fee schedules, while subject to change,        generally do not by themselves yield a significant increase in income when they change. The        most significant growth in safe deposit box rent also comes with an expansion of offices.        Safe deposit box fee schedules, which are already at competitive levels, are occasionally        adjusted. Income derived from the sale of credit life insurance and accident and health        insurance varies with loan volume.

Other service charges and fees at September 30, 2007 were $247, as compared        with $292 for the same period the prior year. As indicated above, this category, because of        its nature, varies from period to period. The total reported is a combination of declines        in several areas, including small declines in income from the sale of checks and letter of        credit fees. There was also a decrease in check cashing fees, which were        uncharacteristically high in the same period last year.

|   | Credit card fees consist of three types of                        revenues. |
|--------|-----------------------------------------------------------------------------|

|   | **•** | Credit card transaction fees |
|--------|------------|------------------------------|

|   | **•** | Debit card transaction fees |
|--------|------------|-----------------------------|

|   | **•** | Merchant fees |
|--------|------------|---------------|

 

19

         

 

In all three areas, growth is a critical factor for the level of income. For        debit and credit cards, the number of accounts, whether obtained from internal growth or by        acquisition, is the key factor. Merchant fees also depend on the number of merchants in the        Company’s program, as well as the type of business and the level of transaction        discounts associated with them.

Credit card fees increased by $251, or 14.12%, when September 30, 2007 and        September 30, 2006 are compared. The increase was attributable to organic growth, resulting        in increased volume.

         

Trust income is somewhat dependent upon market conditions and the number of        estate accounts being handled at any given time. Financial market conditions, which affect        the value of trust assets managed, can vary, leading to fluctuations in the related income.        Over the past few years and into 2007, the financial markets have experienced a degree of        volatility. Income from estates is also unpredictable. Trust income for the first nine        months of 2007 was $1,019, a decrease of $40 from the previous year.

         

Other income is used for types of income that cannot be classified with        other categories of noninterest income. The category includes such things as:

|   | **•** | Net gains on the sale of fixed assets |
|--------|------------|---------------------------------------|

|   | **•** | Rent on foreclosed property |
|--------|------------|-----------------------------|

|   | **•** | Income from cash value life insurance |
|--------|------------|---------------------------------------|

|   | **•** | Other infrequent or minor forms of income |
|--------|------------|-------------------------------------------|

|   | **•** | Revenue from investment and insurance sales |
|--------|------------|---------------------------------------------|

Other income was $751 for the first nine months of 2007, $79 less than for        the same period in the prior year. A decline of $78 in revenue derived from the sale of        investment products accounted for the decrease.

         

Realized net gains and (losses) on securities include equity adjustments in        certain investments in limited liability companies of which the Company is part owner, as        well as sales, maturities and calls of securities. Realized net gains and (losses) were $51        for the period ended September 30, 2007. The majority of this gain was attributable to        equity adjustments in investments in the following limited liability companies, Bankers        Insurance LLC, Bankers Investments Group LLC and Virginia Title Center LLC.

 

**Noninterest Expense**

 

|                                  |   | **September 30, 2007** |   | **September 30, 2006** |   | **Percent Change** |   |
|---------------------------------------|--------|------------------------|--------|------------------------|--------|--------------------|--------|
| Salaries and employee benefits        |   | $                      | 8,240  |                   | $      | 8,706              |   |   | (5.35 | %) |
| Occupancy and furniture and fixtures  |   |                   | 1,316  |                   |   | 1,479              |   |   | (11.02 | %) |
| Data processing and ATM               |   |                   | 858    |                   |   | 922                |   |   | (6.94 | %) |
| Credit card processing                |   |                   | 1,585  |                   |   | 1,361              |   |   | 16.46 | % |
| Intangibles and goodwill amortization |   |                   | 853    |                   |   | 853                |   |   | --- |   |
| Net costs of other real estate owned  |   |                   | 71     |                   |   | 16                 |   |   | 343.75 | % |
| Other operating expenses              |   |                   | 2,938  |                   |   | 2,959              |   |   | (0.71 | %) |

 

|   | Noninterest expense includes several categories. A brief                        description of the factors that affect each follows. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------|

         

In addition to employee salaries, the salaries and benefits expense category        includes the costs of employment taxes and employee fringe benefits. Certain of these        are:

|   | **•** | Health insurance |
|--------|------------|------------------|

|   | **•** | Employee life insurance |
|--------|------------|-------------------------|

|   | **•** | Dental insurance |
|--------|------------|------------------|

|   | **•** | Executive compensation plans (1) |
|--------|------------|----------------------------------|

|   | **•** | Qualified Pension plans (1) |
|--------|------------|-----------------------------|

|   | **•** | Supplemental retirement plan (salary continuation                        agreements) |
|--------|------------|--------------------------------------------------------------------------------------|

|   | **•** | Employer FICA |
|--------|------------|---------------|

|   | **•** | Unemployment taxes |
|--------|------------|--------------------|

|   | (1) | See the 2006 Form 10-K and the Proxy Statement for the 2007                        Annual Meeting of Stockholders for further information. |
|--------|-----|--------------------------------------------------------------------------------------------------------------------------------------------|

         

Salaries and employee benefits expense for the period ending September 30,        2007 was $8,240, a decline of $466 when compared to the same period in 2006. Expense        attributed to salaries and employee benefits declined for several reasons. First, the        consolidation of operations and support functions following the May 2006 merger of the        Company’s two bank subsidiaries has

 

20

         

 

resulted in        fewer employees through attrition and previously scheduled retirements. For example, at        December 31, 2005, the Company employed 263 full time equivalents. At December 31, 2006,        the number declined to 249, and it was 239 at September 30, 2007. Second, as compared with        the first nine months of 2006, the amount accrued through three quarters of 2007 for the        Company’s expense associated with employee health insurance plan premiums was down by        $466. Third, when the first nine months of 2007 and 2006 are compared, there was a decline        of $71 in the expense accrued for the employee stock ownership plan contribution. Higher        salary expense from normal merit raises partially offset the reductions described        above.

 

Occupancy expense for the first nine months of 2007 was $1,316, down $163        from the same period in 2006. This category contains several types of expenses, including        depreciation, maintenance, lease expense and taxes and insurance. The net decrease from        2006 was due in part to $35 in additional expense for signage in 2006. This additional        expense for signs in 2006 was related to the merger of the Company’s two banking        affiliates. When September 30, 2006 and September 30, 2007 are compared, depreciation for        furniture and fixtures decreased by $43. Utilities expense was down by $18. In the third        quarter, the Company received State-mandated refunds on its electric bills for earlier        overcharges. This accounted for most of the decline in utilities expense. Expense for taxes        and insurance were down by $31, as compared with the same period last year.

 

Data processing and ATM expense at September 30, 2007 decreased by $64 from        the same period in 2006. Declines in data processing supplies, maintenance and        communications line expense account for the decrease.

 

Because of increases in volume, credit card processing expenses grew by        $224, as compared with September 30, 2007. The increase in credit card expenses was more        than offset by the increase in credit card income. (See “Noninterest        Income.”)

 

Comparing the first nine months of 2007 with the same period in 2006, net        cost of other real estate owned increased by $55. Losses on the sale of OREO property were        $31, and $7 in write-downs were taken on properties in the first nine months of 2007. Other        foreclosure expense was $33.

 

Other operating expenses include all other types of expense not classified        elsewhere in the Company’s statement of income. Other operating expenses decreased by        a nominal $21, or 0.71%, when compared with the same period last year.

 

**Balance Sheet**

 

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

 

| **Assets**                          |   |   | **September 30, 2007** |   |   | **December 31, 2006** | **Percent Change** |   |
|-------------------------------------|--------|--------|------------------------|--------|--------|-----------------------|--------------------|--------|
| Interest-bearing deposits           |   | $      | 12,581                 |   | $      | 13,457                | (6.51              | %)     |
| Securities available for sale       |   |   | 164,424                |   |   | 164,421               | ---                | %      |
| Securities held to maturity         |   |   | 120,251                |   |   | 106,645               | 12.76              | %      |
| Mortgage loans held for sale        |   |   | 765                    |   |   | 543                   | 40.88              | %      |
| Real estate construction loans      |   |   | 40,449                 |   |   | 29,308                | 38.01              | %      |
| Real estate mortgage loans          |   |   | 132,869                |   |   | 121,912               | 8.99               | %      |
| Commercial and industrial loans     |   |   | 213,710                |   |   | 232,758               | (8.18              | %)     |
| Loans to individuals                |   |   | 120,893                |   |   | 110,967               | 8.95               | %      |
| Total Assets                        |   |   | 864,570                |   |   | 840,080               | 2.92               | %      |
|                                |   |   |                   |   |   |                  |               |   |
| Liabilities and stockholders equity |   |   |                   |   |   |                  |               |   |
| Noninterest-bearing demand deposits |   | $      | 107,818                |   | $      | 108,977               | (1.06              | %)     |
| Interest-bearing demand deposits    |   |   | 223,254                |   |   | 221,927               | 0.60               | %      |
| Savings deposits                    |   |   | 47,665                 |   |   | 51,745                | (7.88              | %)     |
| Time deposits                       |   |   | 378,448                |   |   | 358,422               | 5.59               | %      |
| Other borrowings                    |   |   | 814                    |   |   | 420                   | 93.81              | %      |
| Shareholders’ equity          |   |   | 99,588                 |   |   | 94,194                | 5.73               | %      |

 

 

21

         

 

**Securities**

 

Securities available for sale at September 30, 2007 were $160,355, a decline        of $9,380 from December 31, 2006. During the same period, securities held to maturity        increased by $4,665. The Company’s intent is to hold the securities to maturity. The        shift to the held to maturity portfolio is designed to mitigate the price volatility that        has affected the capital account. Fluctuations in the level of unrealized gains and losses        in the securities available for sale portfolio have been significant.

 

|                      |   |   | **At period ended**    |   |   | **At period ended**   |               |   |
|---------------------------|--------|--------|------------------------|--------|--------|-----------------------|--------------------|--------|
| **Loans**                 |   |   | **September 30, 2007** |   |   | **December 31, 2006** | **Percent Change** |   |
| Real estate construction  |   | $      | 42,826                 |   | $      | 33,840                | 26.55              | %      |
| Real estate mortgage      |   |   | 142,618                |   |   | 126,302               | 12.92              | %      |
| Commercial and industrial |   |   | 214,056                |   |   | 215,244               | (0.55              | %)     |
| Loans to individuals      |   |   | 115,850                |   |   | 126,316               | (8.29              | %)     |
| Total loans               |   | $      | 515,350                |   | $      | 501,702               | 2.72               | %      |
|                      |   |   |                   |   |   |                  |               |   |

 

The above table indicates that the highest level of growth has been in the        category of real estate construction loans. Most of the growth in construction loans has        been in commercial projects, not in the currently volatile housing sector.

Nearly all residential construction loans are sold on the secondary market        once construction is complete and the loans are converted to permanent mortgages. It is        policy to require a commitment for permanent mortgage financing from the secondary market        lender prior to approving a residential construction loan. This practice is particularly        helpful when the residential real estate market is unpredictable. Most commercial real        estate construction loans are converted to permanent financing and held by the Company.        Because this category of loans tends to be seasonal, volumes in the second and third        quarter are usually higher than in the first and last quarter of the year.

Loan to individuals have declined by 8.29%. Competitive factors, such as the        availability of low cost dealer auto loans and other products, such as home equity lines of        credit, have made the traditional installment loan less attractive to bank        customers.

 

|                             |   |   | **At period ended**    |   |   | **At period ended**   |               |   |
|----------------------------------|--------|--------|------------------------|--------|--------|-----------------------|--------------------|--------|
| **Deposits**                     |   |   | **September 30, 2007** |   |   | **December 31, 2006** | **Percent Change** |   |
| Noninterest-bearing deposits     |   | $      | 111,464                |   | $      | 101,167               | 10.18              | %      |
| Interest-bearing demand deposits |   |   | 211,276                |   |   | 233,023               | (9.33              | %)     |
| Saving deposits                  |   |   | 45,690                 |   |   | 47,988                | (4.79              | %)     |
| Time deposits                    |   |   | 381,561                |   |   | 382,514               | (0.25              | %)     |
| Total deposits                   |   | $      | 749,991                |   | $      | 764,692               | (1.92              | %)     |
|                             |   |   |                   |   |   |                  |               |   |

 

As seen above, total deposits have declined 1.66% from December 31, 2006 to        September 30, 2007. Demand deposits increased by 12.15%. Interest-bearing demand deposits        decreased by 9.33%.

 

**Liquidity and Capital Resources**

 

Net cash provided by operating activities was $11,226 for the period ended        September 30, 2007, which compares to $11,143 for the same period the previous        year.

Net cash provided investing activities was $3,420 for the period ended        September 30, 2007, compared to net cash of $10,133 used for the period ended September 30,        2006. Net cash used in financing activities was $17,871 for the period ending September 30,        2007.

Management is unaware of any commitment that would have a material and        adverse effect on liquidity at September 30, 2007.

Total shareholders’ equity grew by $6,014 from December 31, 2006 to        September 30, 2007. Earnings net of dividends and the changes in unrealized gains and        losses for securities available for sale accounted for the net increase. During the first        nine months of 2007, the Company repurchased 33,050 shares of its own stock for        approximately $685 at an average price of $21.08 per share (including broker commission).        The Tier I and Tier II risk-based capital ratios at September 30, 2007 were 14.98% and        15.82%, respectively. The Company’s leverage capital ratio was 10.74%

         

22

         

 

**Derivatives and Off Balance Sheet Items**

 

The Company is not a party to derivative financial instruments with        off-balance sheet risks, such as futures, forwards, and swaps. The Company has certain        written options related to the origination and sale of mortgage loans. The Company is a        party to financial instruments with off-balance sheet risks, such as commitments to extend        credit, standby letters of credit, and recourse obligations in the normal course of        business, to meet the financing needs of its customers. Management does not plan any future        involvement in high- risk derivative products.

The Company’s banking affiliate extends lines of credit to its        customers in the normal course of business. Amounts drawn upon these lines vary at any        given time depending on the business needs of the customers.

Standby letters of credit are also issued to the bank’s customers.        There are two types of standby letters of credit. The first is a guarantee of payment to        facilitate customer purchases. The second type is a performance letter of credit that        guarantees a payment if the customer fails to perform a specific obligation.

While it would be possible for customers to draw in full on approved lines        of credit and letters of credit, historically this has not occurred. In the event of a        sudden and substantial draw on these lines, the Company has its own lines of credit on        which it could draw funds. Sale of the loans would also be an option.

|   | The Company also sells mortgages on the secondary market for                        which there are recourse agreements should the borrower default. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | During the first nine months of 2007, there have been no                        significant or unusual changes in this area. |
|--------|------------------------------------------------------------------------------------------------------------------------------|

 

**Management’s Discussion and Analysis of Financial Condition        and**

**Results of Operations for the Three Months Ended September 30,        2007**

 

**Net        Interest Income**

 

Net interest income for the three months ended September 30, 2007 was        $7,251, a decrease of $100 from the corresponding period in 2006.

Overall the Company is experiencing a compression of the net interest        margin. The net interest margin appears, however, to have stabilized. The net interest        margin for the first three months of 2007 was 3.96%. For the second three months of 2007 it        was 4.03%. For the third quarter of 2007 the net interest margin was $3.98%. While future        improvements are anticipated, any improvement will be contingent upon interest rate levels        remaining stable.

 

**Noninterest Income**

 

|   | Noninterest income for the period ended September 30, 2007                        was $2,125, a decrease of $107 from 2006. |
|--------|-----------------------------------------------------------------------------------------------------------------------------|

Credit card processing income increased by $93 when the two periods are        compared. Income from credit card processing income is volume driven, as is credit card        processing expense, which increased by $80 in the third quarter.

As was previously discussed, a decrease in revenues from the sale of        investment products was the primary cause of the decline in other income.

Realized gains and losses result from calls of the Company’s        investment securities equity adjustments in limited liability company’s in which the        Company is invested. There were no calls or adjustments in the third quarter of 2007, so no        income or expense was generated in this category.

The decreases in Trust income and service charges on deposits are volume        driven. Because they are affected by volume, the level of income in these areas fluctuates        from time to time.

 

**Noninterest Expense**

 

Noninterest expense decreased by $296, or 5.49%, when the three months ended        September 30, 2007 and 2006 are compared.

Salaries and fringe benefit expense declined by $245 in the third quarter of        2007, as compared with the third quarter of 2006. The decrease is the result of a lower        number of employees, a drop in expense associated with employee health insurance plan        premiums and a reduction in expense related to the Company’s employee stock ownership        plan (ESOP). In the third quarter of 2006, the Company accrued $95 for the ESOP, as        compared with an accrual of ($13) in the third quarter this year. The net effect is a        reduction of $108 in ESOP expense when the two periods are compared.

Credit card processing expense was $80 higher in the third quarter of 2007        than in the same quarter last year. As noted above, the increase is the result of a higher        volume of transactions.

Occupancy and furniture and fixtures costs decreased by $55. The electric        bill refunds that were discussed above, together with general cost-control measures,        account for the decline.

Other expenses were $68 lower in the third quarter of 2007 than in 2006.        There was a net decrease of $55 in the accrual for charitable donations when the three        months ended September 30, 2007 is compared to the same period in 2006. General        cost-control measures contributed to expense reduction in this category as well.

 

23

         

 

| **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, 2006 in the        Company’s Form 10-K.

 

| **Item 4.** | **Controls and Procedures** |
|-------------|-----------------------------|

 

Under the supervision and with the participation of management, including        the Company’s principal executive officer and principal financial officer, the        Company has conducted an evaluation of the effectiveness of the design and operation of its        disclosure controls and procedures as of September 30, 2007. Based on that evaluation, the        Company’s principal executive officer and principal financial officer have concluded        that these controls and procedures are effective to give reasonable assurance in alerting        them in a timely fashion to material information relating to the Company that is required        to be included in the reports the Company files under the Act. There were no changes in the        Company’s internal controls over financial reporting during the period covered by        this report that have materially affected, or are reasonably likely to materially affect,        the Company’s internal control over financial reporting.

Disclosure controls and procedures are the Company’s controls and        procedures that are designed to ensure that information required to be disclosed by the        Company in the reports it files or submits under the Exchange Act is accumulated and        communicated to allow timely decisions regarding its required disclosure. The Company        believes that a controls system, no matter how well designed and operated, cannot provide        absolute assurance that all control issues have been detected.

 

 

24

         

 

**Part II**

**Other        Information**

 

| **Item 1.** | **Legal Proceedings** |
|-------------|-----------------------|

         

There were no material legal proceedings for the nine months ended September        30, 2007.

 

| **Item 1A.** | **Risk Factors** |
|--------------|------------------|

         

No material changes from risk factors as previously disclosed.

         

| **Item 2.** | **Unregistered Sales of Equity Securities and Use of                        Proceeds** |
|-------------|----------------------------------------------------------------------------------------|

         

The following table provides information about our purchases during the        third quarter of 2007 of equity securities that are registered by the Company pursuant to        Section 12 of the Exchange Act.

         

| **Fiscal Period** |   | **Total Number of****Shares Purchased** |   | **Average Price****Paid per****Share(1)** |   | **Total Number of Shares****Purchased as Part of****Publicly Announced****Plans or Programs(2)** |   | **Approximate Number of****Shares That May Yet Be****Purchased Under the****Plans or Programs(2)(3)** |   |
|-------------------|--------|-----------------------------------------|--------|-------------------------------------------|--------|--------------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------|--------|
| July              |   | 6,000                                   |   |                                      | 20.07  |                                                                                             | 6,000  |                                                                                                  | 89,000 |   |
| August            |   | 7,050                                   |   |                                      | 19.65  |                                                                                             | 7,050  |                                                                                                  | 81,950 |   |
| September         |   | 5,000                                   |   |                                      | 19.71  |                                                                                             | 5,000  |                                                                                                  | 76,950 |   |

         

 

|   | 1. | Average price per share includes commissions. |
|--------|----|-----------------------------------------------|

|   | 2. | On May 9, 2007 the Board approved the repurchase of up to                        100,000 shares of common stock in the period from June 1, 2007 through May                        31, 2008. |
|--------|----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

| **Item 3.** | **Defaults upon Senior Securities** |
|-------------|-------------------------------------|

 

|   | None for the nine months ended September 30,                        2007. |
|--------|---------------------------------------------------------------------------|

         

| **Item 4.** | **Submission of Matters to a Vote of Security                        Holders** |
|-------------|--------------------------------------------------------------------------------|

         

None

         

| **Item 5.** | **Other Information** |
|-------------|-----------------------|

 

None

 

| **Item 6.** | **Exhibits** |
|-------------|--------------|

 

|   | See Index of Exhibits. |  

                          |
|--------|------------------------|----------------------------------------|

 

 

 

 

 

 

 

25

         

 

**Signatures**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,        National Bankshares, Inc. has duly caused this report to be signed on its behalf by the        undersigned, thereunto duly authorized.

 

| DATE: November 9, 2007 | NATIONAL BANKSHARES, INC. |
|------------------------|---------------------------|

 

 

| /s/ JAMES G. RAKES                        |
|-------------------------------------------|
| James G. RakesChief Executive Officer     |
|                                      |
| /s/ J. ROBERT BUCHANAN                    |
| J. Robert BuchananChief Financial Officer |

 

 

 

| (1) | **Index of Exhibits** |
|-----|-----------------------|

         

|  

**Exhibit No.** |  

**Description**                                                                                                                                                                | **Page No. in**

**Sequential System**                                                                                                                                                   |
|-------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3(i)                    | Articles of Incorporation, as amended, of National                        Bankshares, Inc.                                                                                             | (incorporated herein by reference to Exhibit 3(a) of the                        Annual Report on

Form 10-K for fiscal year ended December 31,                        1993)              |
| 3(i)                    | Articles of Amendment to Articles of Incorporation of                        National Bankshares, Inc., dated April 8, 2003.                                                           | (incorporated herein by reference to exhibit 3(i) of the                        Annual Report on Form 10-K for the fiscal year ended December 31,                        2003)           |
| 3(i)                    | Amended and Restated Articles of Incorporation of National                        Bankshares, Inc.                                                                                     | (incorporated herein by reference to Exhibit 3.1 of Form 8-K                        filed on March 16, 2006)                                                                             |
| 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 10-K for fiscal year ended December 31,                        1993)              |
| 4(i)                    | Article Four of the Articles of Incorporation of National                        Bankshares, Inc. included in Exhibit No. 3(a)                                                         | (incorporated herein by reference to Exhibit 4(b) of the                        Annual Report on

Form 10-K for fiscal year ended December 31,                        1993)              |
| 10(ii)(B)               | Computer software license agreement dated June 18, 1990, by                        and between Information Technology, Inc. and The National Bank of                        Blacksburg | (incorporated herein by reference to Exhibit 10(e) of the                        Annual Report on

Form 10-K for fiscal year ended December 31,                        1992)             |
| *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) |

 

 

26

         

 

 

| *10(iii)(A) | Employment Agreement dated January 2002 between National                        Bankshares, Inc. and James G. Rakes                            | (incorporated herein by reference to Exhibit 10(iii)(A) of                        Form 10-Q for the period ended June 30, 2002)     |
|-------------|------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------|
| *10(iii)(A) | Employment Lease Agreement dated August 14, 2002, between                        National Bankshares, Inc. and The National Bank of Blacksburg | (incorporated herein by reference to Exhibit 10(iii)(A)of                        form 10-Q for the period ended September 30, 2002) |
| *10(iii)(A) | Change in Control Agreement dated January 5, 2003, between                        National Bankshares, Inc. and Marilyn B. Buhyoff             | (incorporated herein by reference to Exhibit 10 iii (A) of                        Form 10-K for the period ended December 31, 2002) |
| *10(iii)(A) | Change in Control Agreement dated January 8, 2003, between                        National Bankshares, Inc. and F. Brad Denardo                | (incorporated herein by reference to Exhibit 10 iii (A) of                        Form 10-K for the period ended December 31, 2002) |
| *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                        Form 8-K 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                        Form 8-K filed on February 8, 2006)               |
| *10(iii)(A) | Salary Continuation Agreement dated February 8, 2006,                        between Bank of Tazewell County and J. Robert Buchanan.           | (incorporated herein by reference to Exhibit 10(iii)(A) of                        Form 8-K filed on February 8, 2006)               |
| *10(iii)(A) | Salary Continuation Agreement dated February 8, 2006,                        between National Bankshares, Inc. and Marilyn B. Buhyoff.         | (incorporated herein by reference to Exhibit 10(iii)(A) of                        Form 8-K filed on February 8, 2006)               |
| 31(i)       | Section 302 Certification of Chief Executive                        Officer                                                                    | Page 28                                                                                                                             |
| 31(ii)      | Section 302 Certification of Chief Financial                        Officer                                                                    | Page 29                                                                                                                             |
| 32(i)       | 18 U.S.C. Section 1350 Certification of Chief Executive                        Officer                                                         | Page 30                                                                                                                             |
| 32(ii)      | 18 U.S.C. Section 1350 Certification of Chief Financial                        Officer                                                         | Page 30                                                                                                                             |

 

 

| * | Indicates a management contract or compensatory plan                        required to be filed herein. |
|---|----------------------------------------------------------------------------------------------------------|

 

27

         

 

Exhibit        No. 31(i)

 

CERTIFICATIONS UNDER SECTION 906 OF THE SARBANES OXLEY ACT OF        2002

 

|   | I, James G. Rakes, Chairman, President and Chief Executive                        Officer of National Bankshares, Inc., certify that: |
|--------|---------------------------------------------------------------------------------------------------------------------------------------|

 

|   | 1. | I have reviewed this quarterly report on Form 10-Q of                        National Bankshares, Inc.; |
|--------|----|---------------------------------------------------------------------------------------------------------|

 

2.      Based on my knowledge, this report        does not contain any untrue statement of a material fact or omit to state a material fact        necessary to make the statements made, in light of the circumstances under which such        statements were made, not misleading with respect to the period covered by this        report;

 

3.      Based on my knowledge, the financial        statements, and other financial information included in this report, fairly present in all        material respects the financial condition, results of operations and cash flows of the        registrant as of, and for, the periods presented in this report;

 

4.      The registrant’s other        certifying officer(s) and I are responsible for establishing and maintaining disclosure        controls and procedures (as defined in Exchange Act Rules 13a – 15 (e) and 15d        – 15 (e)) and internal control over financial reporting (as defined in Exchange Act        Rules 13a – 15(f) and 15d – 15(f)) for the registrant and have:

 

(a)          Designed such        disclosure controls and procedures, or caused such disclosure controls and procedures to be        designed under our supervision, to ensure that material information relating to the        registrant, including its consolidated subsidiaries, is made known to us by others within        those entities, particularly during the period in which this report is being        prepared;

         

(b)          Designed such        internal control over financial reporting, or caused such internal control over financial        reporting to be designed under our supervision, to provide reasonable assurance regarding        the reliability of financial reporting and the preparation of financial statements for        external purposes in accordance with generally accepted accounting principles;

         

(c)          Evaluated the        effectiveness of the registrant’s disclosure controls and procedures and presented in        this report our conclusions about the effectiveness of the disclosure controls and        procedures, as of the end of the period covered by this report based on such evaluations;        and

 

(d)          Disclosed in        this report any change in the registrant’s internal control over financial reporting        that occurred during the registrant’s most recent fiscal quarter (the        registrant’s fourth fiscal quarter in the case of an annual report) that has        materially affected, or is reasonably likely to materially affect, the registrant’s        internal control over financial reporting; and

 

5.      The registrant’s other        certifying officer(s) and I have disclosed, based on our most recent evaluation of internal        control over financial reporting, to the registrant’s auditors and the audit        committee of the registrant’s board of directors (or persons performing the        equivalent functions):

 

(a)          All        significant deficiencies and material weaknesses in the design or operation of internal        control over financial reporting which are reasonably likely to adversely affect the        registrant’s ability to record, process, summarize and report financial information;        and

         

(b)          Any fraud,        whether or not material, that involves management or other employees who have a significant        role in the registrant’s internal control over financial reporting.

 

Date:        November 9, 2007

 

| /s/ JAMES G. RAKES                                                                                                       |
|--------------------------------------------------------------------------------------------------------------------------|
| James G. RakesChairmanPresident and Chief Executive Officer(Principal Executive Officer)

                          |

 

 

28

         

 

Exhibit        31(ii)    

 

|   | I, J. Robert Buchanan, Treasurer (Chief Financial Officer)                        of National Bankshares, Inc., certify that: |
|--------|-------------------------------------------------------------------------------------------------------------------------------|

 

|   | 1. | I have reviewed this quarterly report on Form 10-Q of                        National Bankshares, Inc.; |
|--------|----|---------------------------------------------------------------------------------------------------------|

 

2. Based on my knowledge, this report does not contain any untrue statement        of a material fact or omit to state a material fact necessary to make the statements made,        in light of the circumstances under which such statements were made, not misleading with        respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial        information included in this report, fairly present in all material respects the financial        condition, results of operations and cash flows of the registrant as of, and for, the        periods presented in this report;

 

4.      The registrant’s other        certifying officer(s) and I are responsible for establishing and maintaining disclosure        controls and procedures (as defined in Exchange Act Rules 13a – 15 (e) and 15d        – 15 (e)) and internal control over financial reporting (as defined in Exchange Act        Rules 13a – 15(f) and 15d – 15(f)) for the registrant and have:

 

(a)        Designed such disclosure        controls and procedures, or caused such disclosure controls and procedures to be designed        under our supervision, to ensure that material information relating to the registrant,        including its consolidated subsidiaries, is made known to us by others within those        entities, particularly during the period in which this report is being prepared;        and

         

(b)        Designed such internal        control over financial reporting, or caused such internal control over financial reporting        to be designed under our supervision, to provide reasonable assurance regarding the        reliability of financial reporting and the preparation of financial statements for external        purpose in accordance with generally accepted accounting principles;

         

(c)        Evaluated the        effectiveness of the registrant’s disclosure controls and procedures and presented in        this report our conclusions about the effectiveness of the disclosure controls and        procedures, as of the end of the period covered by this report based on such evaluations;        and

 

(d)        Disclosed in this report        any change in the registrant’s internal control over financial reporting that        occurred during the registrant’s most recent fiscal quarter (the registrant’s        fourth fiscal quarter in the case of an annual report) that has materially affected, or is        reasonably likely to materially affect, the registrant’s internal control over        financial reporting; and

 

5.      The registrant’s other        certifying officer(s) and I have disclosed, based on our most recent evaluation of internal        control over financial reporting, to the registrant’s auditors and the audit        committee of the registrant’s board of directors (or persons performing the        equivalent functions):

 

(a)      All significant deficiencies and material        weaknesses in the design or operation of internal control over financial reporting which        are reasonably likely to adversely affect the registrant’s ability to record,        process, summarize and report financial information; and

 

(b) Any fraud, whether or not material, that involves management or other        employees who have a significant role in the registrant’s internal control over        financial reporting.

 

Date:        November 9, 2007

 

| /s/ J. ROBERT BUCHANAN                                   |
|----------------------------------------------------------|
| J. Robert BuchananTreasurer(Principal Financial Officer) |

 

 

29

         

 

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 September 30, 2007, I, James G. Rakes, President and Chief Executive Officer        of National Bankshares, Inc. (Principal Executive Officer), hereby certify pursuant to 18        U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,        to the best of my knowledge and belief, that:

 

(1)      such Form 10-Q for the quarter ended        September 30, 2007, 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        September 30, 2007, fairly presents, in all material respects, the financial condition and        results of operations of National Bankshares, Inc.

 

 

| /s/ JAMES G. RAKES                                                                                                       |
|--------------------------------------------------------------------------------------------------------------------------|
| James G. RakesChairmanPresident and Chief Executive Officer(Principal Executive Officer)

                          |

 

 

 

Exhibit 32        (ii)

 

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT        TO 18 U.S.C. SECTION 1350

 

In connection with the Form 10-Q of National Bankshares, Inc. for the        quarter ended September 30, 2007, I, J. Robert Buchanan, Treasurer (Principal Financial        Officer) of National Bankshares, Inc., hereby certify pursuant to 18 U.S.C. Section 1350,        as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, to the best of my        knowledge and belief, that:

 

(1)      such Form 10-Q for the quarter ended        September 30, 2007, 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        September 30, 2007, fairly presents, in all material respects, the financial condition and        results of operations of National Bankshares, Inc.

 

 

| /s/ J. ROBERT BUCHANAN                                   |
|----------------------------------------------------------|
| J. Robert BuchananTreasurer(Principal Financial Officer) |

 

 

30