National Bankshares, Inc. 2019 Q1 Form 10-Q Summary
Business context and reporting period
National Bankshares, Inc. is a Virginia bank holding company whose primary operating subsidiary, National Bank of Blacksburg, operates as a community bank serving southwest Virginia through 25 office locations and one loan production office. National Bankshares Financial Services provides investment, insurance, and related services, but contributes an immaterial portion of revenue. This unaudited report covers the three months ended March 31, 2019, with comparisons to the three months ended March 31, 2018 and December 31, 2018 balance-sheet data. Unless stated otherwise, amounts are in thousands except per-share data and ratios.
Financial performance and condition
| Metric | Q1 2019 | Comparable period or prior date |
|---|---|---|
| Total assets | $1,258,003 | $1,256,032 at December 31, 2018 |
| Loans, net | $711,011 | $702,409 at December 31, 2018 |
| Total deposits | $1,060,205 | $1,051,942 at December 31, 2018 |
| Net interest income | $9,345 | $9,403 in Q1 2018 |
| Net income | $4,443 | $3,296 in Q1 2018 |
| Basic and diluted EPS | $0.65 | $0.47 in Q1 2018 |
| Operating cash flow | $5,096 | $5,524 in Q1 2018 |
| Net interest margin | 3.34% | 3.38% in Q1 2018 |
| Return on average assets | 1.34% | 1.32% in Q1 2018 |
| Return on average equity | 8.92% | 8.85% in Q1 2018 |
Interest income increased 6.2% to $11,138, principally reflecting higher loan balances and yields. Interest expense increased 65.9% to $1,793 as deposit pricing rose, causing net interest income to decline 0.6% and the net interest margin to contract by four basis points.
Noninterest income increased 23.0% to $2,489, including a $538 recovery of a previously recognized insurance loss and a $12 realized securities gain. Noninterest expense declined 20.8% to $6,465, primarily because Q1 2018 included a $1,724 write-down of an insurance receivable related to cybersecurity incidents. Excluding that write-down and the 2019 insurance recovery and securities gain, management's non-GAAP net noninterest expense increased modestly and the noninterest margin was 1.47%, compared with 1.44% in Q1 2018.
Income before taxes was $5,169 and income tax expense was $726, producing an effective tax rate of 14.05%, compared with 11.73% in Q1 2018. Net income increased 34.8%, but reported earnings benefited from unusual insurance-related items and the absence of the prior-year insurance write-down.
Cash and due from banks totaled $15,332 at March 31, 2019. Operating activities provided $5,096 of cash, investing activities provided $7,088, and financing activities used $9,734, primarily due to the $17,997 share repurchase. Ending cash increased $2,450 from year-end 2018.
The company reported no long-term debt, discount-window borrowings, short-term borrowings, or Federal Home Loan Bank advances at March 31, 2019. Liquidity sources include deposits, loan repayments, securities sales and maturities, Federal Reserve facilities, and Federal Home Loan Bank borrowing capacity. The loan-to-deposit ratio was 67.76%, within management's stated policy range of 65% to 75%.
The subsidiary bank was well capitalized. Its Common Equity Tier 1, Tier 1, total capital, and leverage ratios were 21.76%, 21.76%, 22.66%, and 14.39%, respectively, substantially above applicable minimums including the capital conservation buffer.
Material changes versus prior periods
- Loans, net of unearned income and deferred fees, increased 1.21% from year-end 2018 to $718,371 before the allowance; commercial real estate loans increased 2.27% and real estate construction loans increased 8.75%.
- Total deposits increased 0.79%. Time deposits increased 7.91%, savings deposits increased 3.26%, and interest-bearing demand deposits declined 1.35%. The company reported no brokered deposits.
- Securities available for sale declined to $404,645 from $425,010 at year-end 2018. Favorable market movements reduced accumulated other comprehensive loss from $12,085 to $7,541.
- Stockholders' equity declined 4.74% to $181,228, primarily because the company repurchased 452,400 shares for $17,997 during March. Shares outstanding declined to 6,505,574 at March 31, 2019 from 6,957,974 at December 31, 2018.
- The allowance for loan losses declined to $7,360, or 1.02% of loans, from $7,390, or 1.04%, at year-end 2018. Q1 2019 included a $200 provision, compared with a $472 recovery in Q1 2018.
- Nonperforming loans increased to $3,734 from $3,420 at year-end 2018, while total nonperforming assets increased to $5,759 from $5,472. The nonperforming-asset ratio rose to 0.80% from 0.77%.
- The company adopted the new lease standard prospectively on January 1, 2019, recognizing a $2,190 right-of-use asset and $2,192 lease liability at March 31, 2019, with no cumulative-effect adjustment.
Outlook, risks, contingencies, and unusual items
The filing does not provide quantitative earnings or revenue guidance. Management states that results are sensitive to interest rates, economic conditions, regulatory and monetary policy, unemployment, deposit flows, loan demand, competition, real estate markets, technology initiatives, and accounting requirements. Management reported sufficient liquidity under tested scenarios and no significant change in interest-rate risk from the December 31, 2018 assessment.
Credit risks include commercial and residential real estate exposure, local economic conditions, higher interest costs on variable-rate loans, delinquencies, foreclosures, and changes in collateral values. Classified loans increased to $1,350 from $735 at year-end 2018, while special-mention loans declined to $1,391 from $1,455. Loans totaling $496 were in various stages of foreclosure and could increase future other real estate owned.
Cybersecurity remains a material operational and reputational risk. The company experienced intrusions in 2016 and 2017, maintains cybersecurity insurance and additional controls, and incurred $67 of cybersecurity-related costs in Q1 2019. Litigation against the insurance carrier settled during Q1 2019 subject to a nondisclosure agreement. The company recognized a $538 insurance recovery in 2019 and had recorded a $1,724 insurance-receivable write-down in Q1 2018.
The company had $5,435 of troubled debt restructurings at March 31, 2019, including $3,440 in nonaccrual status. No loans were modified into TDR status during Q1 2019. Off-balance-sheet exposure consists primarily of loan commitments and letters of credit; management states that no material changes occurred and that the related mortgage-loan recourse reserve was not material.
The company is preparing for adoption of the current expected credit loss standard, effective for the company after December 15, 2019. Management is developing models and assessing the eventual effect; the filing does not provide a quantified impact.
Most important facts for investors to verify
- Whether reported earnings growth persists after removing the $538 insurance recovery and comparing against the $1,724 prior-year insurance write-down.
- Whether rising deposit costs continue to pressure the 3.34% net interest margin.
- Trends in nonperforming loans, classified loans, charge-offs, foreclosures, and the adequacy of the $7,360 allowance.
- The eventual effect of the current expected credit loss standard on reserves, capital, and earnings.
- The pace and funding impact of the share repurchase program, which had 547,600 shares remaining under its authorization at March 31, 2019 and expired May 31, 2019.
- The terms and financial implications of the settled cybersecurity insurance litigation, which remain subject to a nondisclosure agreement.
- Whether loan growth, deposit mix, liquidity, and capital ratios remain consistent with management's stated policies and risk limits.