NATIONAL BANKSHARES INC quarterly report, Q1 FY2024

National Bankshares, Inc. — Form 10-Q Summary

Business context and reporting period

National Bankshares, Inc. is a Virginia-based financial holding company whose principal subsidiary, The National Bank of Blacksburg, operates as a community bank through 24 offices and two loan production offices. The filing covers the unaudited three months ended March 31, 2024, compared with the three months ended March 31, 2023. Unless otherwise stated, amounts are in thousands, except per-share data and percentages.

The company entered into an agreement on January 23, 2024 to acquire Frontier Community Bank. The transaction remains subject to customary regulatory, shareholder and other closing conditions. Construction of a new Roanoke, Virginia branch is expected to be completed in the latter half of 2024.

Financial performance and condition

Metric	Q1 2024	Q1 2023 or prior period	Change
Total interest income	$16,021	$14,044	14.1%
Total interest expense	$7,776	$3,098	151.0%
Net interest income	$8,245	$10,946	(24.7%)
Noninterest income	$2,199	$2,199	Flat
Noninterest expense	$7,762	$7,664	1.3%
Income before taxes	$2,692	$5,479	(50.9%)
Net income	$2,174	$4,531	(52.0%)
Basic and diluted EPS	$0.37	$0.77	(51.9%)
Net interest margin, FTE	2.08%	2.79%	(71 basis points)
Efficiency ratio	68.10%	54.14%	Higher ratio indicates lower efficiency

Interest income benefited from higher loan yields, securities yields and interest-bearing deposit balances. However, deposit pricing pressure substantially increased funding costs, particularly for time deposits and other interest-bearing deposits. The company reported a 19.24% effective tax rate versus 17.30% in the prior-year quarter, primarily because merger-related expenses were nondeductible.

Adjusted return on average assets was 0.59%, compared with 1.16% in Q1 2023, and adjusted return on average equity was 7.19%, compared with 15.25%. The company declared no dividend during Q1 2024; it declared a $1.00 per-share dividend in Q1 2023.

Balance sheet, capital and liquidity

Total assets were $1.689 billion at March 31, 2024, up 2.04% from December 31, 2023.
Loans, net, were $854.5 million, up 0.82%; gross loans increased 0.81% to $863.5 million. Loan demand remained restrained by the higher interest-rate environment.
Deposits were $1.538 billion, up 2.25%. Time deposits increased 7.46%, while savings deposits declined 1.28%.
Cash and cash equivalents increased to $121.2 million from $85.6 million. Interest-bearing deposits increased 50.1% to $110.5 million.
Securities available for sale declined 1.40% to $610.0 million and carried $83.4 million of gross unrealized losses. Management attributed the losses to interest-rate and market factors rather than credit deterioration and recorded no securities credit-loss allowance.
Stockholders’ equity was $139.4 million, down 0.81%, primarily because accumulated other comprehensive loss increased to $68.2 million from $64.9 million.
The Bank remained well capitalized, with a common equity Tier 1 ratio of 17.29%, total capital ratio of 18.15% and leverage ratio of 11.02% at March 31, 2024.
The company had no long-term debt, short-term borrowings, purchased deposits or Federal Reserve discount-window borrowings at quarter-end. FHLB borrowing capacity was $308.9 million, the unsecured federal funds line was $10.0 million, and unused discount-window capacity was $180.8 million.
The loan-to-deposit ratio was 56.15%. Management stated that liquidity was sufficient under projected trends and stress-testing scenarios.

Cash flow and asset quality

Net cash provided by operating activities was $3.8 million, compared with $4.3 million in Q1 2023.
Investing activities used $3.1 million, versus $16.1 million provided in the prior-year quarter, primarily reflecting lower securities proceeds and increased loan participation purchases.
Financing activities provided $33.8 million, compared with $37.2 million used in Q1 2023. The change primarily reflected deposit growth and the absence of dividend payments.
Cash and cash equivalents increased by $34.6 million during the quarter to $121.2 million.
The allowance for credit losses on loans was $9.1 million, or 1.05% of loans, compared with 1.06% at December 31, 2023 and 1.24% at March 31, 2023.
Nonaccrual loans were $2.6 million, compared with $2.8 million at March 31, 2023 and $2.6 million at December 31, 2023. Loans 90 days or more past due and still accruing were $162,000.
The net charge-off ratio was 0.02%, and the allowance covered nonperforming loans by 349.48%.
Two loans totaling $6.4 million were modified for borrowers experiencing financial difficulty; both were current at March 31, 2024. Three residential real estate loans totaling $126,000 were in foreclosure.

Material changes versus prior comparable periods

Net income declined 52.0% because interest expense increased much faster than interest income, reducing net interest income by 24.7%.
Net interest margin contracted from 2.79% to 2.08% as deposit competition and higher funding costs offset asset-yield improvement.
Interest expense on time deposits rose to $2.6 million from $359,000, while interest expense on other deposits rose to $5.2 million from $2.5 million. The company had no borrowing interest expense in Q1 2024 versus $285,000 in Q1 2023.
Merger-related expenses of $484,000 were recorded in Q1 2024. Q1 2023 included $441,000 of professional services expense related to a threatened proxy contest.
FDIC assessment expense increased 59.8% to $187,000. Professional services expense declined 68.1% to $240,000, largely because of the prior-year proxy-related costs.
Noninterest income was unchanged overall. Higher deposit service charges and trust income offset lower card fees, other income and the absence of the prior-year $12,000 securities gain.
Loans to borrowers experiencing financial difficulty modified during the quarter increased from none in Q1 2023 to two loans totaling $6.4 million in Q1 2024, although both remained current.

Guidance, outlook, risks and unusual items

The filing does not provide formal earnings or revenue guidance. Management expects adjustable-rate loan repricing to support interest income if rates remain elevated, but expects deposit competition and funding costs to continue pressuring the net interest margin. Management also stated that higher forecast unemployment increased the required credit-loss allowance, while loan demand remains restrained by higher rates.

The planned Frontier Community Bank merger may involve integration difficulties, higher-than-expected costs, unrealized synergies, revenue disruption, customer or employee attrition, and delays in regulatory or shareholder approvals.
Key risks include interest-rate movements, deposit outflows, liquidity needs, economic and real estate conditions, unemployment, credit losses, regulatory changes, competition, cybersecurity and technology risks, vendor or counterparty performance, and natural disasters or geopolitical events.
The securities portfolio remains exposed to interest-rate-related fair-value volatility. Substantially all securities in unrealized loss positions had been impaired for 12 months or more, although management identified no credit-related impairment and does not intend to sell them before recovery or maturity.
The company had no pending or threatened legal proceedings that management believes could materially affect financial condition.
The company made a $3.0 million contribution to its defined benefit plan in April 2024, after quarter-end.
Management concluded that disclosure controls were effective as of March 31, 2024, with no material changes to internal control over financial reporting.

Important facts for investors to verify

Whether deposit pricing pressure moderates sufficiently to stabilize or improve the 2.08% net interest margin.
The pace and cost of deposit growth, including the mix and repricing of time deposits and the level of uninsured non-municipal deposits.
Progress toward closing and integrating the Frontier Community Bank merger, including regulatory and shareholder approvals, expenses and expected synergies.
Credit performance in commercial real estate and owner-occupied commercial real estate, including the $6.4 million modified loan and classified balances.
Changes in unemployment forecasts, variable-rate loan repricing and the adequacy of the $9.1 million allowance for credit losses.
Potential capital effects from further changes in the $83.4 million unrealized securities loss and accumulated other comprehensive loss.
Completion and cost of the planned Roanoke branch and any resulting effect on operating expenses and growth.