**UNITED        STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D. C. 20549**

 

**FORM        10-Q**

 

| **x****Quarterly Report                        Pursuant to Section 13 or                        15**(**d**)**Of the Securities Exchange Act of                        1934** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| For the Quarterly Period Ended March 31, 2008.                                                                                                                               |
| **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, a        non-accelerated filer or a smaller reporting company. See definitions of “large        accelerated filer”, “accelerated filer” and “smaller reporting        company” in Rule 12b – 2 of the Exchange Act.

 

| Large accelerated                        filer  o   | Accelerated filer  x   | Non-accelerated                        filer  o | Smaller reporting company                        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 April 30, 20086,922,974 |
|------------------------------------|----------------------------------------|

 

(This        report contains 27 pages)

 

 

         

 

**NATIONAL BANKSHARES, INC. AND SUBSIDIARIES**

 

Form        10-Q

Index

 

 

| **Part I - Financial                        Information** |                                                                                                                                                                   | **Page** |
|-----------------------------------------------------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                                                      |                                                                                                                                                                   |     |
| Item 1                                                    | Financial                        Statements                                                                                                                            | 3        |
|                                                      |                                                                                                                                                                   |     |
|                                                      | Consolidated Balance Sheets,                        March 31, 2008 (Unaudited) and December 31, 2007                                                                   | 3-4      |
|                                                      |                                                                                                                                                                   |     |
|                                                      | Consolidated Statements of Income                        for the Three Months Ended March 31, 2008 and 2007                        (Unaudited)                         | 5-6      |
|                                                      |                                                                                                                                                                   |     |
|                                                      | Consolidated Statements of                        Changes in Stockholders’ Equity, Three Months Ended March 31, 2008                        and 2007 (Unaudited) | 7        |
|                                                      |                                                                                                                                                                   |     |
|                                                      | Consolidated Statements of Cash                        Flows, Three Months Ended March 31, 2008 and 2007                        (Unaudited)                            | 8-9      |
|                                                      |                                                                                                                                                                   |     |
|                                                      | Notes to Consolidated                        Financial Statements (Unaudited)                                                                                          | 10-14    |
|                                                      |                                                                                                                                                                   |     |
| Item 2                                                    | Management’s Discussion and                        Analysis of Financial Condition and Results of                        Operations                              | 15-21    |
|                                                      |                                                                                                                                                                   |     |
| Item 3                                                    | Quantitative and Qualitative                        Disclosures About Market Risk                                                                                      | 21       |
|                                                      |                                                                                                                                                                   |     |
| Item 4                                                    | Controls and                        Procedures                                                                                                                         | 21       |
|                                                      |                                                                                                                                                                   |     |
| **Part II - Other                        Information**    |                                                                                                                                                                   |     |
|                                                      |                                                                                                                                                                   |     |
| Item 1                                                    | Legal                        Proceedings                                                                                                                               | 21       |
|                                                      |                                                                                                                                                                   |     |
| Item 1A                                                   | Risk Factors                                                                                                                                                           | 21       |
|                                                      |                                                                                                                                                                   |     |
| Item 2                                                    | Unregistered Sales of                        Equity Securities and Use of Proceeds                                                                                     | 22       |
|                                                      |                                                                                                                                                                   |     |
| Item 3                                                    | Defaults Upon                        Senior Securities                                                                                                                 | 22       |
|                                                      |                                                                                                                                                                   |     |
| Item 4                                                    | Submission of Matters to a                        Vote of Security Holders                                                                                             | 22       |
|                                                      |                                                                                                                                                                   |     |
| Item 5                                                    | Other                        Information                                                                                                                               | 22       |
|                                                      |                                                                                                                                                                   |     |
| Item 6                                                    | Exhibits                                                                                                                                                               | 22       |
|                                                      |                                                                                                                                                                   |     |
| **Signatures**                                            |                                                                                                                                                                   | 22       |
|                                                      |                                                                                                                                                                   |     |
| **Index of                        Exhibits**              |                                                                                                                                                                   | 23-24    |

         

 

 

2

         

 

**Part I**

**Financial Information**

**Item        1. Financial Statements**

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Balance Sheets

 

 

|                                                                                                                                      |   | **(Unaudited)** |        |   |   |             |   |
|-------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|-------------|--------|--------|------------------|--------|
|                                                                                                                                      |   | **March 31,**   |        |   |   | **December 31,** |   |
| **($ in thousands, except share data)**                                                                                                   |   | **2008**        |        |   |   | **2007**         |   |
| **Assets**                                                                                                                                |   |            |        |   |   |             |   |   |   |
| Cash and due from banks                                                                                                                   |   | **$**           | **18,742**  |   |   |             | $      | 16,324 |   |
| Interest-bearing deposits                                                                                                                 |   |            | **43,876**  |   |   |             |   | 29,687 |   |
| Securities available for sale, at fair value                                                                                              |   |            | **161,302** |   |   |             |   | 158,594 |   |
| Securities held to maturity (fair value approximates                        $118,287 at March 31, 2008 and $115,463 at December 31, 2007) |   |            | **116,190** |   |   |             |   | 114,749 |   |
| Mortgage loans held for sale                                                                                                              |   |            | **469**     |   |   |             |   | 220 |   |
| Loans:                                                                                                                                    |   |            |        |   |   |             |   |   |   |
| Real estate construction loans                                                                                                            |   |            | **52,287**  |   |   |             |   | 46,697 |   |
| Real estate mortgage loans                                                                                                                |   |            | **148,656** |   |   |             |   | 145,542 |   |
| Commercial and industrial loans                                                                                                           |   |            | **219,346** |   |   |             |   | 216,830 |   |
| Loans to individuals                                                                                                                      |   |            | **108,395** |   |   |             |   | 115,704 |   |
| Total loans                                                                                                                               |   |            | **528,684** |   |   |             |   | 524,773 |   |
| Less unearned income and deferred fees                                                                                                    |   |            | **(1,113**  | **)**  |   |             |   | (1,119 | ) |
| Loans, net of unearned income and deferred fees                                                                                           |   |            | **527,571** |   |   |             |   | 523,654 |   |
| Less: allowance for loan losses                                                                                                           |   |            | **(5,228**  | **)**  |   |             |   | (5,219 | ) |
| Loans, net                                                                                                                                |   |            | **522,343** |   |   |             |   | 518,435 |   |
| Bank premises and equipment, net                                                                                                          |   |            | **11,841**  |   |   |             |   | 12,016 |   |
| Accrued interest receivable                                                                                                               |   |            | **5,703**   |   |   |             |   | 5,711 |   |
| Other real estate owned, net                                                                                                              |   |            | **270**     |   |   |             |   | 263 |   |
| Intangible assets and goodwill, net                                                                                                       |   |            | **14,554**  |   |   |             |   | 14,838 |   |
| Other assets                                                                                                                              |   |            | **16,431**  |   |   |             |   | 16,810 |   |
| **Total assets**                                                                                                                          |   | **$**           | **911,721** |   |   |             | $      | 887,647 |   |
|                                                                                                                                      |   |            |        |   |   |             |   |   |   |
| **Liabilities and Stockholders' Equity**                                                                                                  |   |            |        |   |   |             |   |   |   |
| Noninterest-bearing demand deposits                                                                                                       |   | **$**           | **118,554** |   |   |             | $      | 113,361 |   |
| Interest-bearing demand deposits                                                                                                          |   |            | **247,411** |   |   |             |   | 237,772 |   |
| Savings deposits                                                                                                                          |   |            | **45,010**  |   |   |             |   | 44,349 |   |
| Time deposits                                                                                                                             |   |            | **384,110** |   |   |             |   | 380,857 |   |
| Total deposits                                                                                                                            |   |            | **795,085** |   |   |             |   | 776,339 |   |
| Other borrowed funds                                                                                                                      |   |            | **61**      |   |   |             |   | 64 |   |
| Accrued interest payable                                                                                                                  |   |            | **800**     |   |   |             |   | 792 |   |
| Other liabilities                                                                                                                         |   |            | **6,818**   |   |   |             |   | 5,652 |   |
| **Total liabilities**                                                                                                                     |   |            | **802,764** |   |   |             |   | 782,847 |   |
|                                                                                                                                      |   |            |        |   |   |             |   |   |   |
|                                                                                                                                      |   |            |        |   |   |             |   |   |   |
|                                                                                                                                      |   |            |        |   |   |             |   | *continued* |   |
|                                                                                                                                      |   |            |        |   |   |             |   |   |   |
|                                                                                                                                      |   |            |        |   |   |             |   |   |   |

 

 

3

         

 

 

| **Stockholders' Equity**                                                                                                   |   |   |        |   |   |   |   |    |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|--------|-------------|--------|--------|--------|--------|---------|--------|
| Preferred stock of no par value.                                                                                           |   |   |        |   |   |   |   |    |   |
| Authorized 5,000,000 shares; none issued and                        outstanding                                            |   |   | **---**     |   |   |   |   | ---     |   |
| Common stock of $1.25 par value.                                                                                           |   |   |        |   |   |   |   |    |   |
| Authorized 10,000,000 shares; issued and outstanding                        6,928,574 shares in 2008 and 6,952,274 in 2007 |   |   | **8,661**   |   |   |   |   | 8,690   |   |
| Retained earnings                                                                                                          |   |   | **100,518** |   |   |   |   | 97,810  |   |
| Accumulated other comprehensive (loss), net                                                                                |   |   | **(222**    | **)**  |   |   |   | (1,700  | )      |
| **Total stockholders' equity**                                                                                             |   |   | **108,957** |   |   |   |   | 104,800 |   |
| **Total liabilities and stockholders' equity**                                                                             |   | **$**  | **911,721** |   |   |   | $      | 887,647 |   |

 

See        accompanying notes to the consolidated financial statements.

 

4

         

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Statements of Income

Three        Months Ended March 31, 2008 and 2007

(Unaudited)

 

 

|                                                                         |   | **March 31,** |       |   |   | **March 31,** |   |
|------------------------------------------------------------------------------|--------|---------------|------------|--------|--------|---------------|--------|
| **($ in thousands, except share and per share                        data)** |   | **2008**      |       |   |   | **2007**      |   |
| **Interest income**                                                          |   |          |       |   |   |          |   |   |   |
| Interest and fees on loans                                                   |   | **$**         | **9,353**  |   |   |          | $      | 9,037 |   |
| Interest on interest-bearing deposits                                        |   |          | **261**    |   |   |          |   | 274 |   |
| Interest on securities – taxable                                       |   |          | **1,710**  |   |   |          |   | 1,896 |   |
| Interest on securities – nontaxable                                    |   |          | **1,387**  |   |   |          |   | 1,323 |   |
| Total interest income                                                        |   |          | **12,711** |   |   |          |   | 12,530 |   |
|                                                                         |   |          |       |   |   |          |   |   |   |
| **Interest expense**                                                         |   |          |       |   |   |          |   |   |   |
| Interest on time deposits $100,000 or more                                   |   |          | **1,664**  |   |   |          |   | 1,583 |   |
| Interest on other deposits                                                   |   |          | **3,742**  |   |   |          |   | 3,832 |   |
| Interest on borrowed funds                                                   |   |          | **1**      |   |   |          |   | 1 |   |
| Total interest expense                                                       |   |          | **5,407**  |   |   |          |   | 5,416 |   |
| Net interest income                                                          |   |          | **7,304**  |   |   |          |   | 7,114 |   |
| Provision for loan losses                                                    |   |          | **100**    |   |   |          |   | (3 | ) |
| Net interest income after provision for loan                        losses   |   |          | **7,204**  |   |   |          |   | 7,117 |   |
|                                                                         |   |          |       |   |   |          |   |   |   |
| **Noninterest income**                                                       |   |          |       |   |   |          |   |   |   |
| Service charges on deposit accounts                                          |   |          | **768**    |   |   |          |   | 810 |   |
| Other service charges and fees                                               |   |          | **84**     |   |   |          |   | 83 |   |
| Credit card fees                                                             |   |          | **637**    |   |   |          |   | 598 |   |
| Trust income                                                                 |   |          | **303**    |   |   |          |   | 373 |   |
| Other income                                                                 |   |          | **221**    |   |   |          |   | 264 |   |
| Realized securities gains, net                                               |   |          | **283**    |   |   |          |   | 51 |   |
| Total noninterest income                                                     |   |          | **2,296**  |   |   |          |   | 2,179 |   |
|                                                                         |   |          |       |   |   |          |   |   |   |
| **Noninterest expense**                                                      |   |          |       |   |   |          |   |   |   |
| Salaries and employee benefits                                               |   |          | **2,857**  |   |   |          |   | 2,841 |   |
| Occupancy, furniture and fixtures                                            |   |          | **456**    |   |   |          |   | 485 |   |
| Data processing and ATM                                                      |   |          | **349**    |   |   |          |   | 258 |   |
| Credit card processing                                                       |   |          | **460**    |   |   |          |   | 447 |   |
| Intangibles amortization                                                     |   |          | **284**    |   |   |          |   | 284 |   |
| Net costs of other real estate owned                                         |   |          | **14**     |   |   |          |   | 58 |   |
| Other operating expenses                                                     |   |          | **1,037**  |   |   |          |   | 884 |   |
| Total noninterest expense                                                    |   |          | **5,457**  |   |   |          |   | 5,257 |   |
| Income before income tax expense                                             |   |          | **4,043**  |   |   |          |   | 4,039 |   |
| Income tax expense                                                           |   |          | **862**    |   |   |          |   | 923 |   |
| **Net income**                                                               |   | **$**         | **3,181**  |   |   |          | $      | 3,116 |   |
|                                                                         |   |          |       |   |   |          |   |   |   |
|                                                                         |   |          |       |   |   |          |   |   |   |
|                                                                         |   |          |       |   |   |          |   | *continued* |   |
|                                                                         |   |          |       |   |   |          |   |   |   |

 

 

5

         

 

 

| Net income per share - basic      |   | **$**  | **0.46**      |   |   |   | $      | 0.45      |   |
|-----------------------------------|--------|--------|---------------|--------|--------|--------|--------|-----------|--------|
| **-**diluted                      |   | **$**  | **0.46**      |   |   |   | $      | 0.45      |   |
| Weighted average number of common |   |   |          |   |   |   |   |      |   |
| shares outstanding - basic        |   |   | **6,937,933** |   |   |   |   | 6,979,094 |   |
| - diluted                         |   |   | **6,947,278** |   |   |   |   | 7,000,683 |   |
| Dividends declared per share      |   | **$**  | **---**       |   |   |   | $      | ---       |   |

 

See        accompanying notes to consolidated financial statements.

 

6

         

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three        Months Ended March 31, 2008 and 2007

(Unaudited)

 

 

| **($ in thousands, except per share data)**                                                      |   | **Common Stock** |      | **Retained Earnings** |   | **Accumulated Other Comprehensive (Loss)** |   | **Comprehensive Income** |     | **Total** |   |
|--------------------------------------------------------------------------------------------------|--------|------------------|-----------|-----------------------|--------|--------------------------------------------|--------|--------------------------|----------|-----------|--------|
|                                                                                             |   |             |      |                  |   |                                       |   |                     |     |      |   |   |   |   |   |   |
| Balances at December 31, 2006                                                                    |   | $                | 8,725     |                  | $      | 91,123                                     |   | $                        | (3,093   | )         |   |   |   | $ | 96,755 |   |
| Net income                                                                                       |   |             | ---       |                  |   | 3,116                                      |   |                     | ---      |      | $      | 3,116 |   |   | 3,116 |   |
| Exercise of stock options                                                                        |   |             | 8         |                  |   | 52                                         |   |                     | ---      |      |   | --- |   |   | 60 |   |
| Other comprehensive income, net of tax:                                                          |   |             |      |                  |   |                                       |   |                     |     |      |   |   |   |   |   |   |
| Unrealized gain on securities available for sale, net of                        income tax $22   |   |             | ---       |                  |   | ---                                        |   |                     | ---      |      |   | 40 |   |   | --- |   |
| Reclass adjustment, net of tax $(18)                                                             |   |             | ---       |                  |   | ---                                        |   |                     | ---      |      |   | (33 | ) |   | --- |   |
| Other comprehensive income, net of tax $4                                                        |   |             | ---       |                  |   | ---                                        |   |                     | 7        |      |   | 7 |   |   | 7 |   |
| Comprehensive income                                                                             |   |             | ---       |                  |   | ---                                        |   |                     | ---      |      | $      | 3,123 |   |   | --- |   |
| Stock repurchase                                                                                 |   |             | (6        | )                     |   | (109                                       | )      |                     | ---      |      |   |   |   |   | (115 | ) |
| Balances at March 31, 2007                                                                       |   | $                | 8,727     |                  | $      | 94,182                                     |   | $                        | (3,086   | )         |   |   |   | $ | 99,823 |   |
|                                                                                             |   |             |      |                  |   |                                       |   |                     |     |      |   |   |   |   |   |   |
| Balances at December 31, 2007                                                                    |   | $                | 8,690     |                  | $      | 97,810                                     |   | $                        | (1,700   | )         |   |   |   | $ | 104,800 |   |
| Net income                                                                                       |   |             | ---       |                  |   | 3,181                                      |   |                     | ---      |      | $      | 3,181 |   |   | 3,181 |   |
| Exercise of stock options                                                                        |   |             | ---       |                  |   | ---                                        |   |                     | ---      |      |   | --- |   |   | --- |   |
| Other comprehensive income, net of tax:                                                          |   |             |      |                  |   |                                       |   |                     |     |      |   |   |   |   |   |   |
| Unrealized gain on securities available for sale, net of                        income tax $886  |   |             | ---       |                  |   | ---                                        |   |                     | ---      |      |   | 1,645 |   |   | --- |   |
| Reclass adjustment, net of income tax $(92)                                                      |   |             | ---       |                  |   | ---                                        |   |                     | ---      |      |   | (170 | ) |   | --- |   |
| Other comprehensive income, net of tax $794                                                      |   |             | ---       |                  |   | ---                                        |   |                     | 1,475    |      |   | 1,475 |   |   | 1,475 |   |
| Comprehensive income                                                                             |   |             | ---       |                  |   | ---                                        |   |                     | ---      |      | $      | 4,656 |   |   | --- |   |
| Effect of changing pension plan measurement date pursuant to                        SFAS No. 158 |   |             |      |                  |   | (45                                        | )      |                     | 3        |      |   |   |   |   | (42 | ) |
| Stock repurchase                                                                                 |   |             | (29       | )                     |   | (428                                       | )      |                     | ---      |      |   |   |   |   | (457 | ) |
| **Balances at March 31, 2008**                                                                   |   | **$**            | **8,661** |                  | **$**  | **100,518**                                |   | **$**                    | **(222** | **)**     |   |   |   | **$** | **108,957** |   |

 

 

See        accompanying notes to consolidated financial statements.

 

7

         

 

National Bankshares, Inc. and        Subsidiaries

Consolidated Statements of Cash Flows

Three        Months Ended March 31, 2008 and 2007

(Unaudited)

 

 

|                                                                                                                  |   | **March 31,** |        | **March 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------|--------|---------------|-------------|---------------|--------|
| **($ in thousands)**                                                                                                  |   | **2008**      |        | **2007**      |   |
| **Cash flows from operating activities**                                                                              |   |          |        |          |   |   |   |
| Net income                                                                                                            |   | **$**         | **3,181**   |          | $      | 3,116 |   |
| Adjustments to reconcile net income to net cash provided by                        operating activities:              |   |          |        |          |   |   |   |
| Provision for loan losses                                                                                             |   |          | **100**     |          |   | (3 | ) |
| Depreciation of bank premises and equipment                                                                           |   |          | **249**     |          |   | 247 |   |
| Amortization of intangibles                                                                                           |   |          | **284**     |          |   | 284 |   |
| Amortization of premiums and accretion of discount,                        net                                        |   |          | **63**      |          |   | 55 |   |
| Gains on sales and calls of securities available for sale,                        net                                 |   |          | **(262**    | **)**         |   | (51 | ) |
| Gains on calls of securities held to maturity                                                                         |   |          | **(21**     | **)**         |   | --- |   |
| Losses and writedowns on other real estate owned                                                                      |   |          | **---**     |          |   | 37 |   |
| Net change in:                                                                                                        |   |          |        |          |   |   |   |
| Mortgage loans held for sale                                                                                          |   |          | **(249**    | **)**         |   | (495 | ) |
| Accrued interest receivable                                                                                           |   |          | **8**       |          |   | (224 | ) |
| Other assets                                                                                                          |   |          | **(394**    | **)**         |   | (191 | ) |
| Accrued interest payable                                                                                              |   |          | **8**       |          |   | (21 | ) |
| Other liabilities                                                                                                     |   |          | **1,103**   |          |   | 1,095 |   |
| Net cash provided by operating activities                                                                             |   | **$**         | **4,070**   |          | $      | 3,849 |   |
|                                                                                                                  |   |          |        |          |   |   |   |
| **Cash flows from investing activities**                                                                              |   |          |        |          |   |   |   |
| Net change interest-bearing deposits                                                                                  |   | **$**         | **(14,189** | **)**         | $      | (9,884 | ) |
| Proceeds from calls, principal payments, sales and                        maturities of securities available for sale |   |          | **10,150**  |          |   | 7,799 |   |
| Proceeds from calls, principal payments and maturities of                        securities held to maturity          |   |          | **17,031**  |          |   | 130 |   |
| Purchases of securities available for sale                                                                            |   |          | **(10,370** | **)**         |   | (4,198 | ) |
| Purchases of securities held to maturity                                                                              |   |          | **(18,471** | **)**         |   | (6,240 | ) |
| Purchases of loan participations                                                                                      |   |          | **(117**    | **)**         |   | --- |   |
| Collections of loan participations                                                                                    |   |          | **61**      |          |   | 281 |   |
| Loan originations and principal collections, net                                                                      |   |          | **(4,028**  | **)**         |   | (3,076 | ) |
| Proceeds from disposal of other real estate owned                                                                     |   |          | **8**       |          |   | 230 |   |
| Recoveries on loans charged off                                                                                       |   |          | **61**      |          |   | 27 |   |
| Purchase of bank premises and equipment                                                                               |   |          | **(74**     | **)**         |   | (90 | ) |
| Net cash used in investing activities                                                                                 |   | **$**         | **(19,938** | **)**         | $      | (15,021 | ) |
|                                                                                                                  |   |          |        |          |   |   |   |
| **Cash flows from financing activities**                                                                              |   |          |        |          |   |   |   |
| Net change in other deposits                                                                                          |   | **$**         | **15,493**  |          | $      | 13,147 |   |
| Net change in time deposits                                                                                           |   |          | **3,253**   |          |   | (3,575 | ) |
| Net change in other borrowed funds                                                                                    |   |          | **(3**      | **)**         |   | (2 | ) |
| Stock options exercised                                                                                               |   |          | **---**     |          |   | 60 |   |
|                                                                                                                  |   |          |        |          |   |   |   |
|                                                                                                                  |   |          |        |          |   |   |   |
|                                                                                                                  |   |          |        |          |   |   |   |
|                                                                                                                  |   |          |        |          |   | *continued* |   |
|                                                                                                                  |   |          |        |          |   |   |   |

 

 

8

         

 

 

| Common stock repurchased                                                    |   |   | **(457**   | **)**  |   | (115   | )      |
|-----------------------------------------------------------------------------|--------|--------|------------|--------|--------|--------|--------|
| Net cash provided by financing activities                                   |   | **$**  | **18,286** |   | $      | 9,515  |   |
| Net change in cash and due from banks                                       |   | **$**  | **2,418**  |   | $      | (1,657 | )      |
| Cash and due from banks at beginning of period                              |   |   | **16,324** |   |   | 15,283 |   |
| Cash and due from banks at end of period                                    |   | **$**  | **18,742** |   | $      | 13,626 |   |
|                                                                        |   |   |       |   |   |   |   |
| **Supplemental disclosure of cash flow                        information** |   |   |       |   |   |   |   |
| Cash paid for interest                                                      |   | **$**  | **5,399**  |   | $      | 5,437  |   |
| Cash paid for income taxes                                                  |   | **$**  | **105**    |   | $      | 44     |   |
| Loans charged to the allowance for loan losses                              |   | **$**  | **152**    |   | $      | 136    |   |
| Loans transferred to other real estate owned                                |   | **$**  | **15**     |   | $      | 128    |   |
| Unrealized gains on securities available for sale                           |   | **$**  | **2,269**  |   | $      | 11     |   |
| Effect of changing pension plan measurement data                            |   | **$**  | **63**     |   |   | ---    |   |

 

 

See        accompanying notes to consolidated financial statements.

 

9

         

 

**National Bankshares, Inc. and        Subsidiaries**

**Notes        to Consolidated Financial Statements**

**March        31, 2008**

**(Unaudited)**

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

 

**Note        (1)**

 

The consolidated financial statements of National Bankshares, Inc. (NBI) and        its wholly-owned subsidiaries, The National Bank of Blacksburg (NBB) and National        Bankshares Financial Services, Inc. (NBFS), (the Company), conform to accounting principles        generally accepted in the United States of America and to general practices within the        banking industry. The accompanying interim period consolidated financial statements are        unaudited; however, in the opinion of management, all adjustments consisting of normal        recurring adjustments, which are necessary for a fair presentation of the consolidated        financial statements, have been included. The results of operations for the three months        ended March 31, 2008 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 2007 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 NBI 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 NBI 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 NBI 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 March 31, 2008, there were 286,000        additional shares available for grant under the plan. There were no nonvested shares        outstanding at March 31, 2008.

Compensation expense is calculated using the Black-Scholes model and is        amortized over the requisite service period using the straight-line method. There have been        no grants of stock options in 2008.

 

| **Options**                    |   | **Shares** |   |   | **Weighted-****Average****Exercise****Price** |   | **Weighted****Average****Remaining****Contractual****Term** |   |   | **Aggregate****Intrinsic****Value****($000)** |   |
|--------------------------------|--------|------------|--------|--------|-----------------------------------------------|--------|-------------------------------------------------------------|--------|--------|-----------------------------------------------|--------|
| Outstanding at January 1, 2008 |   | 145,000    |   | $      | 21.46                                         |   |                                                        |   |   |                                          |   |
| Granted                        |   | ---        |   |   |                                          |   |                                                        |   |   |                                          |   |
| Exercised                      |   | ---        |   |   |                                          |   |                                                        |   |   |                                          |   |
| Forfeited or expired           |   | ---        |   |   |                                          |   |                                                        |   |   |                                          |   |
| Outstanding at March 31, 2008  |   | 145,000    |   | $      | 21.46                                         |   | 5.85                                                        |   | $      | ---                                           |   |
| Exercisable at March 31, 2008  |   | 145,000    |   | $      | 21.46                                         |   | 5.85                                                        |   | $      | ---                                           |   |

 

Because no        options have been granted in 2008 and all options were fully vested at December 31, 2007,        there is no expense included in net income.

During the three months ended March 31, 2008, there were no stock options        granted or exercised. For the three months ended March 31, 2007 there were no stock options        granted and 6,000 options were exercised with an intrinsic value of $83,000.

 

10

         

 

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

 

|                                                                                                                           |   | **For the periods ended** |       |
|--------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------|------------|
|                                                                                                                           |   | **March 31,**             |       | December 31, |
| **($ in thousands, except % data)**                                                                                            |   | **2008**                  |       | **2007** |   | **2007** |   |
| Balance at beginning of period                                                                                                 |   | **$**                     | **5,219**  |   | $ | 5,157 |   | $ | 5,157 |   |
| Provision for loan losses                                                                                                      |   |                      | **100**    |   |   | (3 | ) |   | 423 |   |
| Loans charged off                                                                                                              |   |                      | **(152**   | **)** |   | (136 | ) |   | (471 | ) |
| Recoveries                                                                                                                     |   |                      | **61**     |   |   | 27 |   |   | 110 |   |
| Balance at the end of period                                                                                                   |   | **$**                     | **5,228**  |   | $ | 5,045 |   | $ | 5,219 |   |
| Ratio of allowance for loan losses to the end of period                        loans, net of unearned income and deferred fees |   |                      | **0.99**   | **%** |   | **1.00** | **%** |   | 1.00 | % |
| Ratio of net charge-offs to average loans, net of unearned                        income and deferred fees1.                   |   |                      | **0.07**   | **%** |   | **0.09** | **%** |   | 0.07 | % |
| Ratio of allowance for loan losses to nonperforming                        loans2.                                             |   |                      | **396.36** | **%** |   | **445.76** | **%** |   | 453.83 | % |

 

| 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. |
|----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

         

         

|                                                                                                                                  |   | **March 31,** |      | **December 31,** |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|-----------|------------------|
| **($ in thousands, except % data)**                                                                                                   |   | **2008**      |      | **2007**         |   | **2007** |   |
| Nonperforming Assets:                                                                                                                 |   |          |      |             |   |   |   |   |   |   |
| Nonaccrual loans                                                                                                                      |   | **$**         | **1,319** |             | $ | 1,132 |   | $ | 1,150 |   |
| Restructured loans                                                                                                                    |   |          | **---**   |             |   | --- |   |   | --- |   |
| Total nonperforming loans                                                                                                             |   |          | **1,319** |             |   | 1,132 |   |   | 1,150 |   |
| Foreclosed property                                                                                                                   |   |          | **270**   |             |   | 251 |   |   | 263 |   |
| Total nonperforming assets                                                                                                            |   | **$**         | **1,589** |             | $ | 1,383 |   | $ | 1,413 |   |
| Ratio of nonperforming assets to loans, net of unearned                        income and deferred fees, plus other real estate owned |   |          | **0.30**  | **%**            |   | .27 | % |   | .27 | % |

 

 

|                                                                                                                                 |   | **March 31,** | **December 31,** |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|---------------|------------------|
| **($ in thousands, except % data)**                                                                                                  |   | **2008**      |             | **2007** |   | **2007** |   |
| Loans past due 90 days or more and still accruing                                                                                    |   | **$**         | **1,392**        |   | $ | 327 |   | $ | 1,181 |   |
| Ratio of loans past due 90 days or more and still accruing                        to loans, net of unearned income and deferred fees |   |          | **0.26**         | **%** |   | 0.06 | % |   | 0.23 | % |
| Impaired loans                                                                                                                       |   |          |             |   |   |   |   |   |   |   |
| Total impaired loans                                                                                                                 |   | **$**         | **1,319**        |   | $ | 1,132 |   | $ | 1,144 |   |
| Impaired loans with a valuation allowance                                                                                            |   |          | **---**          |   |   | --- |   |   | --- |   |
| Valuation allowance                                                                                                                  |   |          | **---**          |   |   | --- |   |   | --- |   |
| Impaired loans, net of allowance                                                                                                     |   |          | **---**          |   |   | --- |   |   | --- |   |
| Impaired loans with no valuation allowance                                                                                           |   | **$**         | **1,319**        |   | $ | 1,132 |   |   | 1,144 |   |
| Average recorded investment in impaired loans                                                                                        |   | **$**         | **1,235**        |   | $ | 818 |   | $ | 1,138 |   |
| Income recognized on impaired loans                                                                                                  |   | **$**         | **---**          |   | $ | --- |   | $ | --- |   |
| Amount of income recognized on a cash basis                                                                                          |   | **$**         | **---**          |   | $ | --- |   | $ | --- |   |

 

There were        no nonaccrual loans excluded from impaired disclosure under SFAS 114 at March 31, 2008. No        income was recognized on these loans for the period ended March 31, 2007. At December 31,        2007 there were $6 in nonaccrual loans excluded from impaired disclosure under SFAS        114.

 

11

         

 

**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 March 31,        2008 are as follows:

 

|                                      |   | **March 31, 2008**       |        |
|-------------------------------------------|--------|--------------------------|-------------|
| **($ in thousands)**                      |   | **Amortized**

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

**Unrealized**

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

**Unrealized**

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

**Values** |   |
| Available for sale:                       |   |                     |        |   |   |   |   |   |   |   |   |   |   |
| U.S. Treasury                             |   | **$**                    | **3,028**   |   | **$** | **182** |   | **$** | **---** |   | **$** | **3,210** |   |
| U.S. Government Agencies and Corporations |   |                     | **11,980**  |   |   | **485** |   |   | **---** |   |   | **12,465** |   |
| State and political subdivisions          |   |                     | **82,402**  |   |   | **1,722** |   |   | **133** |   |   | **83,991** |   |
| Mortgage-backed securities                |   |                     | **24,796**  |   |   | **594** |   |   | **5** |   |   | **25,385** |   |
| Corporate debt securities                 |   |                     | **31,398**  |   |   | **234** |   |   | **239** |   |   | **31,393** |   |
| Federal Reserve Bank stock-restricted     |   |                     | **92**      |   |   | **---** |   |   | **---** |   |   | **92** |   |
| Federal Home Loan Bank stock-restricted   |   |                     | **1,693**   |   |   | **---** |   |   | **---** |   |   | **1,693** |   |
| Other securities                          |   |                     | **3,062**   |   |   | **96** |   |   | **85** |   |   | **3,073** |   |
| Total securities available for sale       |   | **$**                    | **158,451** |   | **$** | **3,313** |   | **$** | **462** |   | **$** | **161,302** |   |

 

The amortized costs, gross unrealized gains, gross unrealized losses and        fair values for securities held to maturity by major security type as of March 31, 2008 are        as follows:

 

 

|                                      |   | **March 31, 2008**     |        |
|-------------------------------------------|--------|------------------------|-------------|
| **($ in thousands)**                      |   | **Amortized****Costs** |        | **Gross****Unrealized****Gains** |   | **Gross****Unrealized****Losses** |   | **Fair****Values** |   |
| Held to Maturity:                         |   |                   |        |   |   |   |   |   |   |   |   |   |   |
| U.S. Government Agencies and Corporations |   | **$**                  | **36,959**  |   | **$** | **713** |   | **$** | **9** |   | **$** | **37,663** |   |
| State and political subdivisions          |   |                   | **65,126**  |   |   | **1,542** |   |   | **120** |   |   | **66,548** |   |
| Mortgage-backed securities                |   |                   | **2,006**   |   |   | **53** |   |   | **---** |   |   | **2,059** |   |
| Corporate securities                      |   |                   | **12,099**  |   |   | **129** |   |   | **211** |   |   | **12,017** |   |
| Total securities held to maturity         |   | **$**                  | **116,190** |   | **$** | **2,437** |   | **$** | **340** |   | **$** | **118,287** |   |

 

 

Information        pertaining to securities with gross unrealized losses at March 31, 2008 and December 31,        2007, aggregated by investment category and length of time that individual securities have        been in a continuous loss position, follows:

 

|                                      |   | **March 31, 2008**      |       |
|-------------------------------------------|--------|-------------------------|------------|
|                                      |   | **Less Than 12 Months** |       | **12 Months or More** |   |
| **($ in thousands)**                      |   | **Fair****Value**       |       | **Unrealized****Loss** |   | **Fair****Value** |   | **Unrealized****Loss** |   |
| U.S. Government agencies and corporations |   | $                       | **990**    |   | **$** | **9** |   | **$** | **---** |   | **$** | **---** |   |
| State and political subdivisions          |   |                    | **14,896** |   |   | **239** |   |   | **1,449** |   |   | **13** |   |
| Mortgage-backed securities                |   |                    | **1**      |   |   | **---** |   |   | **723** |   |   | **5** |   |
| Corporate debt securities                 |   |                    | **6,460**  |   |   | **82** |   |   | **17,355** |   |   | **369** |   |
| Other                                     |   |                    | **221**    |   |   | **85** |   |   | **---** |   |   | **---** |   |
| Total temporarily impaired securities     |   | $                       | **22,568** |   | **$** | **415** |   | **$** | **19,527** |   | **$** | **387** |   |

 

 

12

         

 

|                                      |   | **December 31, 2007**   |                  |
|-------------------------------------------|--------|-------------------------|-----------------------|
|                                      |   | **Less Than 12 Months** | **12 Months or More** |
| **($ in thousands)**                      |   | **Fair**

**Value**     |                  | **Unrealized****Loss** |   | **Fair**

**Value** |   | **Unrealized****Loss** |   |
| U.S. Treasury                             |   | $                       | ---                   |   | $ | --- |   | $ | 949 |   | $ | 6 |   |
| U.S. Government agencies and corporations |   |                    | ---                   |   |   | --- |   |   | 8,162 |   |   | 25 |   |
| State and political subdivisions          |   |                    | 12,622                |   |   | 255 |   |   | 29,085 |   |   | 239 |   |
| Mortgage-backed securities                |   |                    | ---                   |   |   | --- |   |   | 10,455 |   |   | 79 |   |
| Corporate debt securities                 |   |                    | 1,893                 |   |   | 77 |   |   | 34,965 |   |   | 865 |   |
| Total temporarily impaired securities     |   | $                       | 14,516                |   | $ | 332 |   | $ | 83,661 |   | $ | 1,214 |   |

 

The Company had 55 securities with a fair value of $42,095 which were        temporarily impaired at March 31, 2008. The total unrealized loss on these securities was        $802. 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 cost is recovered. Therefore, the        losses associated with these securities are considered temporary at March 31, 2008. All        securities shown are above investment grade.

 

**Note (5)        Recent Accounting Pronouncements**

 

In December 2007, the Financial Accounting Standards Board (FASB) issued        Statement of Financial Accounting Standards No. 141(R),*Business        Combinations*(SFAS 141(R)). The Standard will significantly        change the financial accounting and reporting of business combination transactions. SFAS        141(R) establishes the criteria for how an acquiring entity in a business combination        recognizes the assets acquired and liabilities assumed in the transaction; establishes the        acquisition date fair value as the measurement objective for all assets acquired and        liabilities assumed; and requires the acquirer to disclose to investors and other users all        of the information they need to evaluate and understand the nature and financial effect of        the business combination. Acquisition related costs including finder's fees, advisory,        legal, accounting valuation and other professional and consulting fees are required to be        expensed as incurred. SFAS 141(R) is effective for fiscal years beginning after December        15, 2008 and early implementation is not permitted. The Company does not expect the        implementation to have a material impact on its consolidated financial        statements.

In December 2007, the FASB issued Statement of Financial Accounting        Standards No.160,*Noncontrolling Interests in Consolidated        Financial Statements*(SFAS 160) SFAS 160 requires an entity to        establish accounting and reporting standards for the noncontrolling interest in a        subsidiary and for the deconsolidation of a subsidiary. This Statement is effective for        fiscal years, and interim periods within those fiscal years, beginning on or after December        15, 2008. Earlier adoption is prohibited. The Company does not expect the implementation of        SFAS 160 to have a material impact on its consolidated financial statements.

In March 2008, the FASB issued Statement of Financial Accounting Standards        No. No. 161,*Disclosures about Derivative Instruments and Hedging        Activities - an amendment of FASB Statement*No. 133(SFAS 161)        SFAS 161 changes the disclosure requirements for derivative instruments and hedging        activities. Entities are required to provide enhanced disclosures about how and why an        entity uses derivative instruments, how derivative instruments and related hedged items are        accounted for under Statement 133 and its related interpretations, and how derivative        instruments and related hedged items affect an entity’s financial position, financial        performance and cash flows. SFAS 161 is effective for fiscal years and interim periods        beginning after November 15, 2008, with early application permitted. The Company does not        expect the implementation of SFAS 161 to have a material impact on its consolidated        financial statements.

 

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

 

Components        of Net Periodic Benefit Cost

 

|                               |   | **Pension Benefits**             |     |
|------------------------------------|--------|----------------------------------|----------|
|                               |   | **Three Months Ended March 31,** |     |
| **($ in Thousands)**               |   | **2008**                         |     | **2007** |   |
| Service cost                       |   | **$**                            | **107**  |   | $ | 152 |   |
| Interest cost                      |   |                             | **154**  |   |   | 175 |   |
| Expected return on plan assets     |   |                             | **(167** | **)** |   | (159 | ) |
| Amortization of prior service cost |   |                             | **(25**  | **)** |   | 2 |   |

 

 

13

         

 

 

| Amortization of net obligation at transition |   |   | **(3**  | **)**  |   | (3  | )      |
|----------------------------------------------|--------|--------|---------|--------|--------|-----|--------|
| Recognized net actuarial loss                |   |   | **39**  |   |   | 45  |   |
| Net periodic benefit cost                    |   | **$**  | **105** |   | $      | 212 |   |

 

Employer        Contributions

 

|   | NBI’s required minimum pension plan contribution for                        2008 is $395. The contribution will be paid in quarterly                        installments. |
|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

**Note        (7) Fair Value Measurements**

SFAS No. 157,*Fair Value        Measurements*, defines fair value, establishes a framework for        measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair        value measurement and enhances disclosure requirements for fair value measurements. The        valuation hierarchy is based upon the transparency of inputs to the valuation of an asset        or liability as of the measurement date. The three levels are defined as follow:

 

|               |   |         |         |                                                                                                                                                                                                                                                                                                                                        |
|--------------------|--------|--------------|--------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| •   |   | Level 1 |    | inputs to the valuation methodology are quoted prices                        (unadjusted) for identical assets or liabilities in active                        markets.                                                                                                                                                                     |
|               |   |         |
| •             |   | Level 2 |    | inputs to the valuation methodology include quoted prices                        for similar assets and liabilities in active markets, and inputs that are                        observable for the asset or liability, either directly or indirectly, for                        substantially the full term of the financial instrument. |
|               |   |         |
| •             |   | Level 3 |    | inputs to the valuation                        methodology are unobservable and significant to the fair value

measurement.                                                                                                                                                                                                                 |

 

Following        is a description of the valuation methodologies used for instruments measured at fair        value, as well as the general classification of such instruments pursuant to the valuation        hierarchy:

Securities

Where quoted prices are available in an active market, securities are        classified within level 1 of the valuation hierarchy. Level 1 securities would include        highly liquid government bonds, mortgage products and exchange traded equities. If quoted        market prices are not available, then fair values are estimated by using pricing models,        quoted prices of securities with similar characteristics, or discounted cash flow. Level 2        securities would include U.S. agency securities, mortgage-backed agency securities,        obligations of states and political subdivisions and certain corporate, asset backed and        other securities. In certain cases where there is limited activity or less transparency        around inputs to the valuation, securities are classified within level 3 of the valuation        hierarchy. Currently, all of the Company’s securities are considered to be Level 2        securities.

         

Loans held for sale

Loans held for sale which is required to be measured in a lower of cost or        fair value. Under SFAS No. 157, market value is to represent fair value. Management        obtains quotes or bids on all or part of these loans directly from the purchasing financial        institutions. Premiums received or to be received on the quotes or bids are indicative of        the fact that cost is lower than fair value. At March 31, 2008, the entire balance of        loans held for sale was recorded at its cost.

Impaired loans 

SFAS No. 157 applies to loans measured for impairment using the practical        expedients permitted by SFAS No. 114,*Accounting by Creditors for        Impairment of a Loan*, including impaired loans measured at an        observable market price (if available), or at the fair value of the loan’s collateral        (if the loan is collateral dependent). Fair value of the loan’s collateral, when the        loan is dependent on collateral, is determined by appraisals or independent valuation which        is then adjusted for the cost related to liquidation of the collateral.

Other Real Estate Owned 

Certain assets such as other real estate owned (OREO) are measured at fair        value less cost to sell. We believe that the fair value component in its valuation follows        the provisions of SFAS No. 157.

 

14

         

 

 

**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 Three Months Ended March 31,        2008**

 

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 2007 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 includes two basic components: estimated        credit losses on individually evaluated loans that are determined to be impaired, and        estimated credit losses inherent in the remainder of the loan portfolio. Under SFAS 114, an        individual loan is impaired when, based on current information and events, it is probable        that a creditor will be unable to collect all amounts due according to the contractual        terms of the loan agreement. An individually evaluated loan that is determined not to be        impaired under SFAS 114 is evaluated under SFAS 5 when specific characteristics of the loan        indicate that it is probable there would be estimated credit losses in a group of loans        with those characteristics.

SFAS 114 does not specify how an institution should identify loans that are        to be evaluated for collectibility nor does it specify how an institution should determine        that a loan is impaired. National Bank uses its standard loan review procedures in making        those judgments so that allowance estimates are based on a comprehensive, well-documented,        and consistently applied analysis of the loan portfolio. Also the loan loss allowance takes        into consideration all available information existing as of the financial statement date,        including environmental factors such as industry, geographical, economic, and political        considerations. For loans within the scope of SFAS 114 that are individually evaluated and        found to be impaired, the associated allowance is based on upon one of the three impairment        measurement methods specified in SFAS 114.

All other loans, including individually evaluated loans determined not to be        impaired under SFAS 114, are included in a group of loans that are measured under SFAS 5 to        provide for estimated credit losses that have been incurred on groups of loans with similar        risk characteristics. Our methodology for measuring estimated credit losses on groups of        loans with similar risk characteristics in accordance with SFAS 5 is based on each        group’s historical net charge-off rate, adjusted for the effects of the qualitative        or environmental factors that are likely to cause estimated credit losses as of the        evaluation date to differ from the group’s historical loss experience.

 

15

         

 

Finally, a component of the allowance may be labeled        “unallocated” and is appropriate when it reflects estimated credit losses        determined in accordance with GAAP, and when it is properly supported and        documented.

 

**Core        deposit intangibles**

 

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

In October 2002, the Financial Accounting Standards Board issued Statement        No. 147,*Acquisitions of Certain Financial        Institutions.*The Statement amends previous interpretive guidance        on the application of the purchase method of accounting to acquisitions of financial        institutions, and requires the application of Statement No. 141,*Business Combinations,*and Statement No. 142 to        branch acquisitions if such transactions meet the definition of a business combination. The        provisions of the Statement do not apply to transactions between two or more mutual        enterprises. In addition, the Statement amends Statement No. 144,*Accounting for the Impairment of Long-Lived Assets,*to include in its scope core deposit intangibles of financial institutions.        Accordingly, such intangibles are subject to a recoverability test based on undiscounted        cash flows, and to the impairment recognition and measurement provisions required for other        long-lived assets held and used. The Company has determined that the acquisitions that        generated the intangible assets 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 incorporated        under the laws of Virginia. Located in southwest Virginia, NBI has two wholly-owned        subsidiaries, the National Bank of Blacksburg (NBB) and National Bankshares Financial        Services, Inc. (NBFS). The National Bank of Blacksburg, which does business as National        Bank from twenty-six office locations, is a community bank. NBB is the source of nearly all        of the Company’s revenue. National Bankshares Financial Services, Inc. does business        as National Bankshares Investment Services and National Bankshares Insurance Services.        Income from NBFS is not significant at this time, nor is it expected to be so in the near        future.

 

**Performance Summary**

 

|   | The following table shows NBI’s key performance ratios                        for the period ended March 31, 2008 and December 31, 2007. |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------|

 

|                                 |   | **March 31,****2008** |   | **December 31,****2007** |   |
|--------------------------------------|--------|-----------------------|--------|--------------------------|--------|
| Return on average assets             |   |                  | 1.44   | %                        |   | 1.46 | % |
| Return on average equity             |   |                  | 11.95  | %                        |   | 12.60 | % |
| Net interest margin (1)              |   |                  | 3.93   | %                        |   | 3.98 | % |
| Noninterest margin (2)               |   |                  | 1.56   | %                        |   | 1.41 | % |
| Basic net earnings per share         |   | $                     | 0.46   |                     | $      | 1.82 |   |
| Fully diluted net earnings per share |   | $                     | 0.46   |                     | $      | 1.82 |   |

 

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

|   | (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. |
|--------|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

         

The return on average assets for the first quarter of 2008 was 1.44%, down 2        basis points from the 1.46% in the period ended December 31, 2007, as asset growth outpaced        growth in earnings. The return on average equity dropped from 12.60% at year-end to 11.95%        at the end of the first quarter.

 

 

16

         

 

 

 

**Growth**

 

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

 

|         |   | **March 31, 2008** |    | **December 31, 2007** |   |
|--------------|--------|--------------------|---------|-----------------------|--------|
| Securities   |   | $                  | 277,492 |                  | $      | 273,343 |   |
| Loans, net   |   |               | 522,343 |                  |   | 518,435 |   |
| Deposits     |   |               | 795,085 |                  |   | 776,339 |   |
| Total assets |   |               | 911,721 |                  |   | 887,647 |   |

 

Each of the Company’s key growth indicators improved in the first        quarter of 2008. Growth in net loans and deposits was internally generated and was managed        with the goal of minimizing the negative impact on the net interest margin and to maintain        loan portfolio quality.

 

**Asset        Quality**

 

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

 

|                               |   | **March 31, 2008** |   | **December 31,2007** |   |
|------------------------------------|--------|--------------------|--------|----------------------|--------|
| Nonperforming loans                |   | $                  | 1,319  |                 | $      | 1,150 |   |
| Loans past due over 90 days        |   |               | 1,392  |                 |   | 1,181 |   |
| Other real estate owned            |   |               | 270    |                 |   | 263 |   |
| Allowance for loan losses to loans |   |               | 0.99   | %                    |   | 1.00 | % |
| Net charge-off ratio               |   |               | 0.07   | %                    |   | 0.07 | % |

 

Nonperforming loans at March 31, 2008, all of which were nonaccrual loans,        were $1,319, or 0.25% of loans net of unearned income. One loan accounted for the majority        of the nonperforming loans total. Nonperforming loans increased by $169 over the $1,150        reported on December 31, 2007. Loans past due over 90 days at the end of the first quarter        of 2008 were $1,392, up by $211 over the total at year-end. After quarter-end, one        additional loan of $900 was placed in nonaccrual. The loan is well secured, and management        does not anticipate a significant loss at this time. Although there were increases in both        categories from year-end, totals remained good when compared with peers and when viewed        from the Company’s own historical perspective.

 

**Net        Interest Income**

 

Net interest income for the period ended March 31, 2008 was $7,304 an        increase of $190, or 2.67%, when compared with the same period in 2007. This increase is        attributable to an increase in the volume of earning assets.

The amount of net interest income earned is affected by various factors.        These include changes in market interest rates due to the Federal Reserve Board’s        monetary policy, as well as the level and composition of the earning assets and        interest-bearing liabilities. The Company has some ability to respond to interest rate        movements and reduce volatility in the net interest margin. However, the frequency and        magnitude of changes in market interest rates are difficult to predict, and these changes        may have a greater impact on net interest income than any adjustments by        management.

Interest rates have declined recently, and if interest rates stabilize at        their current level or drop further in the future, it will have a positive effect.        Offsetting the effect of declining interest rates are higher rate investment securities,        which can be called when interest rates fall, so that the issuer can refinance its debt at        a lower rate. In addition, in order to retain loans in a competitive market, interest rates        must sometimes be lowered on existing loans. If interest rates rise, particularly if they        increase quickly, there could be a negative effect on earnings. The Company’s        interest-bearing liabilities reprice more quickly than its interest-earning assets. In the        current uncertain economy, it is difficult to predict the direction and timing of future        interest rate changes.

The primary source of funds used to support the Company’s        interest-earning assets is deposits. Deposits are obtained in the Company’s trade        area through traditional marketing techniques. Other funding sources, such as the Federal        Home Loan Bank, while available, are only used occasionally. The cost of funds is dependent        on interest rate levels and competitive factors. This limits the ability of the Company to        react to interest rate movements.

 

17

         

 

 

 

**Provision and Allowance for Loan Losses**

The provision for loan losses for the three-month period ended March 31,        2008 was $100. The ratio of the allowance for loan losses to total loans at the end of the        first three months of 2008 was 0.99%, which compares to 1.00% at December 31, 2007. The net        charge-off ratio was 0.07% at March 31, 2008 and 0.07% at December 31, 2007.

During the first quarter of 2008, management added to the provision for loan        losses in an amount sufficient to account for the growth in the loan portfolio. Loan        quality indicators are closely monitored, and management regularly evaluates the        sufficiency of the allowance for loan losses based upon its opinion of current asset        quality and the rate of loan growth.

 

**Noninterest Income**

 

|                               |   | **March 31, 2008** |   | **March 31, 2007** |   | **Percent Change** |   |
|------------------------------------|--------|--------------------|--------|--------------------|--------|--------------------|--------|
| Service charges on deposits        |   | $                  | 768    |               | $      | 810                |   |   | (5.19 | %) |
| Other service charges and fees     |   |               | 84     |               |   | 83                 |   |   | 1.20 | % |
| Credit card fees                   |   |               | 637    |               |   | 598                |   |   | 6.52 | % |
| Trust fees                         |   |               | 303    |               |   | 373                |   |   | (18.77 | %) |
| Other income                       |   |               | 221    |               |   | 264                |   |   | (16.29 | %) |
| Realized securities gains (losses) |   |               | 283    |               |   | 51                 |   |   | 454.90 | % |

 

Service charges on deposit accounts totaled $768 at March 31, 2008. This is        a decline of $42, or 5.19%, from the end of the first quarter of 2007. This category is        affected by the number of deposit accounts, the level of service charge fees and the number        of checking account overdrafts. The decline resulted from a drop in checking account        overdrafts.

Other service charges and fees includes charges for official checks, income        from the sale of checks to customers, safe deposit rent, fees for letters of credit and the        income earned from commission on the sale of credit life, accident and health insurance.        These fees increased slightly, from $83 at March 31, 2007, to $84 at March 31,        2008.

Internal growth from a higher volume of credit card accounts, transactions        and merchant transactions resulted in credit card fees of $637 at March 31, 2008. This was        an increase of 6.52% over the $598 total reported at the same period last year.

Trust fees, at $303, were down by 18.77% from the $373 earned in the first        quarter of 2007. Trust income varies depending on the number of Trust accounts, the types        of accounts under management and financial market conditions. The decline in Trust fees is        attributable to a combination of all three factors. The financial markets declined during        the first quarter of 2008, negatively affecting income. In addition, there are fewer        accounts under management. The mix of account types also affected Trust fees during the        quarter.

Other income is income that cannot be classified in another category. Some        examples include net gains from the sales of fixed assets, rent from foreclosed properties,        income from the increase in the cash value of life insurance and revenue from investment        and insurance sales. Other income at March 31, 2008 was $221. This represents a decline of        $43, or 16.29%, when compared with March 31, 2007. In 2007, the Company received a $45        refund of an overpayment of 2006 West Virginia franchise tax, and there was none in 2007.        This accounts for most of the difference in other income between the two        periods.

During the first quarter of 2008, the Company recognized $290 in gains from        the initial public offering of Visa, Inc. When the credit card processor went public, the        Company was required to sell a portion of its Class B shares. This gain, offset by minor        losses in called investment securities, is the source of the $283 in realized securities        gains at March 31, 2008.

 

**Noninterest Expense**

 

|                                  |   | **March 31, 2008** |   | **March 31, 2007** |   | **Percent Change** |   |
|---------------------------------------|--------|--------------------|--------|--------------------|--------|--------------------|--------|
| Salaries and employee benefits        |   | $                  | 2,857  |               | $      | 2,841              |   |   | 0.56 | % |
| Occupancy and furniture and fixtures  |   |               | 456    |               |   | 485                |   |   | (5.98 | %) |
| Data processing and ATM               |   |               | 349    |               |   | 258                |   |   | 35.27 | % |
| Credit card processing                |   |               | 460    |               |   | 447                |   |   | 2.91 | % |
| Intangibles and goodwill amortization |   |               | 284    |               |   | 284                |   |   | --- |   |
| Net costs of other real estate owned  |   |               | 14     |               |   | 58                 |   |   | (75.86 | %) |
| Other operating expenses              |   |               | 1,037  |               |   | 884                |   |   | 17.31 | % |

 

 

18

         

 

Salary and benefits expense increased a nominal 0.56%, from $2,841 March 31,        2007 to $2,857 at March 31, 2008. The Company has made a concerted effort to control these        costs.

Occupancy and furniture and fixtures expense was $456 at the end of the        first quarter of 2008, a decline of $29, or 5.98%, from the same period last year. The drop        reflects the Company’s emphasis on containing controllable expenses.

Data processing and ATM expense was $349 for the period ended March 31,        2008, an increase of $91, or 35.27% over March 31, 2007. Most of the change is attributable        to increased costs associated with an upgrade of the Company’s data and        telecommunications infrastructure and to increased maintenance expense for an investment in        data processing software and hardware for branch capture check processing.

Credit card processing expense was $460 at March 31, 2008, an increase of        $13, or 2.91%, over the total on March 31, 2007. This increase came about because of a        higher volume of credit card, debit card and merchant accounts and transactions.

The expense for intangibles and goodwill amortization is related to        acquisitions. There were no acquisitions in the past year, so the expense of $284 is        unchanged from March 31, 2007 to March 31, 2008.

Net costs of other real estate owned have decreased from $58 at March 31,        2007 to $14 at March 31, 2008. This expense category varies with the number of other real        estate owned properties and the expenses associated with each. In the first quarter of        2007, there were $30 in foreclosure costs which were not incurred in the first quarter of        2008.

The category of other operating expenses includes non-interest expense items        such as franchise taxes, stationery and supplies, telephone costs, postage and charitable        donations. Other operating expenses at March 31, 2008 were $1,037. This reflects an        increase of $153, or 17.31%, when compared with the same period in 2007. The increased        expense is the result of West Virginia franchise tax accruals of $100, $22 in higher        postage expense and an increase in charitable donations made during the quarter.

 

**Balance Sheet**

 

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

 

| **Assets**                          |   |   | **March 31, 2008** |   |   | **December 31, 2007** | **Percent Change** |   |
|-------------------------------------|--------|--------|--------------------|--------|--------|-----------------------|--------------------|--------|
| Interest-bearing deposits           |   | $      | 33,517             |   | $      | 14,180                | 136.37             | %      |
| Securities available for sale       |   |   | 161,426            |   |   | 163,210               | (1.09              | %)     |
| Securities held to maturity         |   |   | 114,461            |   |   | 119,524               | (4.24              | %)     |
| Mortgage loans held for sale        |   |   | 423                |   |   | 661                   | (36.01             | %)     |
| Real estate construction loans      |   |   | 49,415             |   |   | 41,620                | 18.73              | %      |
| Real estate mortgage loans          |   |   | 146,943            |   |   | 135,584               | 8.38               | %      |
| Commercial and industrial loans     |   |   | 216,138            |   |   | 214,387               | 0.82               | %      |
| Loans to individuals                |   |   | 112,584            |   |   | 119,626               | (5.89              | %)     |
| Total Assets                        |   |   | 889,104            |   |   | 867,061               | 2.54               | %      |
|                                |   |   |               |   |   |                  |               |   |
| Liabilities and stockholders equity |   |   |               |   |   |                  |               |   |
| Noninterest-bearing demand deposits |   | $      | 108,435            |   | $      | 108,854               | (0.38              | %)     |
| Interest-bearing demand deposits    |   |   | 240,111            |   |   | 223,771               | 7.30               | %      |
| Savings deposits                    |   |   | 44,067             |   |   | 46,943                | (6.13              | %)     |
| Time deposits                       |   |   | 382,349            |   |   | 379,089               | 0.86               | %      |
| Other borrowings                    |   |   | 63                 |   |   | 626                   | (89.94             | %)     |
| Shareholders’ equity          |   |   | 107,036            |   |   | 100,597               | 6.40               | %      |

 

**Securities**

 

Securities available for sale were $161,302 at March 31, 2008, compared with        $158,594 at December 31, 2007. This represents an increase of $2,708 when the two periods        are compared.

Securities held to maturity totaled $116,190 at the end of the first quarter        of 2008, an increase of $1,441, or 1.26%, when compared to the December 31, 2007 total of        $114,749.

Management regularly monitors the credit quality of the investment        portfolio. The current uncertainty in the economy and the volatility in the financial        markets is closely followed by Company management.

 

 

19

         

 

 

 

**Loans**

 

|                      |   |   | **At period ended** |   |   | **At period ended**   |               |   |
|---------------------------|--------|--------|---------------------|--------|--------|-----------------------|--------------------|--------|
|                      |   |   | **March 31, 2008**  |   |   | **December 31, 2007** | **Percent Change** |   |
| Commercial and industrial |   | $      | 219,346             |   | $      | 216,830               | 1.16               | %      |
| Real estate mortgage      |   |   | 148,656             |   |   | 145,542               | 2.14               | %      |
| Real estate construction  |   |   | 52,287              |   |   | 46,697                | 11.97              | %      |
| Loans to individuals      |   |   | 108,395             |   |   | 115,704               | (6.32              | %)     |
| Total loans               |   | $      | 528,684             |   | $      | 524,773               | 0.53               | %      |

 

The Company’s total loans increased from $524,733 at year-end 2007 to        $528,684 at March 31, 2008. The $3,911, or 0.75% increase is the result of growth in the        commercial and industrial, real estate mortgage and real estate construction categories,        offset by a decline in loans to individuals.

Real estate mortgage loans and real estate construction loans have        experienced the greatest percentage of growth among the categories of loans. At December        31, 2007, there were $145,542 in real estate mortgage loans, and there was $148,656        outstanding at March 31, 2008, an increase of 2.14%. Since nearly all residential mortgage        loans are sold on the secondary market, most of the growth in this category has been in        commercial real estate loans. At December 31, 2007, real estate construction loans totaled        $46,697 compared with $52,287 at March 31, 2008. It is policy to require a commitment for        permanent mortgage financing from a secondary market mortgage lender prior to approving a        residential construction loan. Most commercial real estate construction loans are converted        to permanent mortgage loans and are held by the Company. This category of loans has        historically been seasonal.

The 6.32% decline in loans to individuals continues a trend that has been        evident over the past several years. The availability of low cost dealer auto loans and        other products, such as home equity lines of credit, make traditional consumer installment        loans less attractive to customers.

 

**Deposits**

 

|                             |   |   | **At period ended** |   |   | **At period ended**   |               |   |
|----------------------------------|--------|--------|---------------------|--------|--------|-----------------------|--------------------|--------|
|                             |   |   | **March 31, 2008**  |   |   | **December 31, 2007** | **Percent Change** |   |
| Noninterest-bearing deposits     |   | $      | 118,554             |   | $      | 113,361               | 4.58               | %      |
| Interest-bearing demand deposits |   |   | 247,411             |   |   | 237,772               | 4.05               | %      |
| Saving deposits                  |   |   | 45,010              |   |   | 44,349                | 1.49               | %      |
| Time deposits                    |   |   | 384,110             |   |   | 380,857               | 0.85               | %      |
| Total deposits                   |   | $      | 795,085             |   | $      | 776,339               | 2.41               | %      |
|                             |   |   |                |   |   |                  |               |   |

 

Total deposits have increased by 2.41%, from $776,339 at December 31, 2007        to $795,085 on March 31, 2008. The growth was internally generated and was not the result        of acquisitions. There has been solid growth in the noninterest bearing deposits category.        At March 31, 2008, this category totaled $118,554, an increase of $5,193, or 4.58%, over        the $113,361 total at the end of 2007.

 

**Liquidity**

 

Liquidity measures the Company’s ability to provide sufficient cash        flow to meet its financial commitments, to fund additional loan demand and to handle        withdrawals of existing deposits. Sources of liquidity include deposits, loan principal and        interest repayments, sales, calls and maturities of securities and short-term borrowing.        The Company has other available sources of liquidity. They include lines of credit with a        correspondent bank, advances from the Federal Home Loan Bank, and Federal Reserve Bank        discount window borrowings.

Net cash provided by operating activities for the quarter ended March 31,        2008 was $4,070, which compares to $3,849 at March 31, 2007.

Net cash used in investing activities in the first quarter of 2008 was        $19,938, compared to $15,021 at March 31, 2007.

 

20

         

 

Net cash provided by financing activities for the period ended March 31,        2008 was $18,286, and it was $9,515 in the same period last year.

At March 31, 2008, management is unaware of any commitment that would have a        material and adverse effect on liquidity.

 

**Capital Resources**

 

Total stockholders’ equity at March 31, 2008 was $108,957, an increase        of $4,157 from December 31, 2007. The Company repurchased stock totaling $457 in the first        quarter of 2007. The Tier I and Tier II risk-based capital ratio at March 31, 2008 were        15.29% and 16.14%, respectively.

 

**Off-Balance Sheet Arrangements**

 

In the normal course of business the Company’s banking affiliate        extends lines of credit to its customers. 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 can draw funds. A sale of loans would also be an option.

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

|   | There were no significant changes in these off-balance sheet                        arrangements during the first three months of 2008. |
|--------|-----------------------------------------------------------------------------------------------------------------------------------------|

| **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, 2007 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 March 31, 2008. Based on that evaluation, the        Company’s principal executive officer and principal financial officer have concluded        that these controls and procedures are effective to give reasonable assurance in alerting        them in a timely fashion to material information relating to the Company that is required        to be included in the reports the Company files under the Act. There were no changes in the        Company’s internal controls over financial reporting during the period covered by        this report that have materially affected, or are reasonably likely to materially affect,        the Company’s internal control over financial reporting.

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

 

**Part II**

**Other        Information**

 

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

         

There were no material legal proceedings for the three months ended March        31, 2008.

 

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

         

No material changes from risk factors as previously disclosed in the Form        10-K for the period ended December 31, 2007.

 

21

         

 

**** 

         

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

         

The following table provides information about our purchases during the        first quarter of 2008 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)** |   |
|-------------------|--------|-----------------------------------------|--------|----------------------------------------------|--------|--------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|--------|
| January 1-31      |   | 13,600                                  |   |                                         | 18.75  |                                                                                             | 13,600 |                                                                                               | 51,150 |   |
| February 1-29     |   | 6,900                                   |   |                                         | 20.73  |                                                                                             | 6,900  |                                                                                               | 44,250 |   |
| March 1-31        |   | 3,500                                   |   |                                         | 18.94  |                                                                                             | 3,500  |                                                                                               | 40,750 |   |

         

 

|   | 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 three months ended March 31, 2008. |
|--------|-------------------------------------------------|

         

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

         

None

         

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

 

None

 

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

 

|   | See Index of Exhibits. |  

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

 

**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: May 9, 2008 | NATIONAL BANKSHARES, INC. |
|-------------------|---------------------------|

 

 

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

 

 

22

         

 

 

**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 10K 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 10K for 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 the Form                        8K for filed on March 16, 2006)                                                                      |
| 3(ii)           | Amended By-laws of National Bankshares, Inc.                                                                                                                                           | (incorporated herein by reference to Exhibit 3(ii) of the                        Annual Report on Form 10K for fiscal year ended December 31,                        2007)               |
| 4(i)            | Specimen copy of certificate for National Bankshares, Inc.                        common stock                                                                                         | (incorporated herein by reference to Exhibit 4(a) of the                        Annual Report on Form 10K for fiscal year ended December 31,                        1993)                |
| 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 10K 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 10K 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) |
| *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 10Q for the period ended June 30, 2002)                                                           |
| *10(iii)(A)     | Employee Lease Agreement dated August 14, 2002, between                        National Bankshares, Inc. and The National Bank of Blacksburg                                           | (incorporated herein by reference to Exhibit 10 (iii) (A) of                        Form 10Q for the period ended September 30, 2002)                                                    |
| *10(iii)(A)     | 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 10K 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 10K 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                        the Form 8K 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                        the Form 8K filed on February 8, 2006)                                                                 |
| *10(iii)(A)     | Salary Continuation Agreement dated February 8, 2006,                        between The National Bank of Blacksburg and F. Brad Denardo                                               | (incorporated herein by reference to Exhibit 10(iii)(A) of                        the Form 8K filed on February 8, 2006)                                                                 |

 

 

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| *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                        the Form 8K filed on February 8, 2006)  |
|-------------|---------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------------------|
| *10(iii)(A) | First Amendment to The National Bank of Blacksburg Salary                        Continuation Agreement for James G. Rakes            | (incorporated herein by reference to Exhibit 10(iii)(A) of                        the Form 8K filed on December 19, 2007) |
| *10(iii)(A) | First Amendment to Bank of Tazewell County Salary                        Continuation Agreement for J. Robert Buchanan                | (incorporated herein by reference to Exhibit 10(iii)(A) of                        the Form 8K filed on December 19, 2007) |
| *10(iii)(A) | First Amendment to The National Bank of Blacksburg Salary                        Continuation Agreement for F. Brad Denardo           | (incorporated herein by reference to Exhibit 10(iii)(A) of                        the Form 8K filed on December 19, 2007) |
| *10(iii)(A) | First Amendment to National Bankshares, Inc. Salary                        Continuation Agreement for Marilyn B. Buhyoff              | (incorporated herein by reference to Exhibit 10(iii)(A) of                        the Form 8K filed on December 19, 2007) |
| 31(i)       | Section 906 Certification of Chief Executive                        Officer                                                           | Page 25                                                                                                                   |
| 31(ii)      | Section 906 Certification of Chief Financial                        Officer                                                           | Page 26                                                                                                                   |
| 32(i)       | 18 U.S.C. Section 1350 Certification of Chief Executive                        Officer                                                | Page 27                                                                                                                   |
| 32(ii)      | 18 U.S.C. Section 1350 Certification of Chief Financial                        Officer                                                | Page 27                                                                                                                   |

 

 

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

 

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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: May        9, 2008

 

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

                          |

 

 

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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: May        9, 2008

 

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

 

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Exhibit 32        (i)

 

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT        TO 18 U.S.C. SECTION 1350

 

In connection with the Form 10-Q of National Bankshares, Inc. for the        quarter ended March 31, 2008, 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 March 31, 2008,        fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange        Act of 1934; and

         

(2) the information contained in such Form 10-Q for the quarter ended March        31, 2008, 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 March 31, 2008, 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 March 31, 2008,        fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange        Act of 1934; and

         

(2) the information contained in such Form 10-Q for the quarter ended March        31, 2008, 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) |

 

 

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