National Bankshares, Inc. — Form 10-Q Summary
Business context and reporting period
National Bankshares, Inc. is a Virginia financial holding company operating primarily through The National Bank of Blacksburg, a community bank serving southwest Virginia through 24 branches and a loan production office. The filing covers the three and six months ended June 30, 2018. Financial statements are unaudited.
Financial performance and condition
| Metric | Three months ended June 30, 2018 | Six months ended June 30, 2018 |
|---|---|---|
| Net interest income | $9.6 million | $19.0 million |
| Net income | $4.0 million | $7.3 million |
| Basic and diluted EPS | $0.58 | $1.05 |
| Dividends declared per share | $0.58 | $0.58 |
| Return on average assets | 1.34% | 1.30% |
| Return on average equity | 9.13% | 8.81% |
| Net interest margin | 3.35% | 3.36% |
- Second-quarter net income increased 13.2% from $3.6 million in the prior-year quarter; six-month net income increased 1.6% from $7.2 million.
- Total assets were $1.267 billion at June 30, 2018, up 0.9% from December 31, 2017. Net loans were $683.3 million, up 3.5%; total deposits were $1.069 billion, up 0.9%.
- Loan growth was concentrated in commercial non-real-estate, public-sector and industrial-development-authority, and consumer non-real-estate loans. Commercial real estate loans were essentially unchanged.
- Net interest margin declined from 3.42% to 3.35% for the quarter and from 3.46% to 3.36% for the six-month period. Management attributed the decline primarily to lower income from nontaxable securities, lower loan yields and higher deposit costs.
- Noninterest income was $1.9 million for the quarter and $3.9 million for the six months, compared with $1.7 million and $3.6 million, respectively, in the prior-year periods. Credit and debit card fees and bank-owned life insurance income were notable contributors.
- Noninterest expense increased 7.5% for the quarter and 19.0% for the six months. The six-month increase primarily reflected a $2.0 million write-down of an insurance receivable, higher data-processing and ATM costs, and higher other-real-estate-owned costs.
- The effective income tax rate declined to 13.71% for the quarter and 12.83% for the six months, compared with 21.37% and 22.02%, respectively, reflecting the Tax Cuts and Jobs Act reduction in the statutory rate to 21%.
- Net cash provided by operating activities was $9.3 million for the six months. Investing activities used $14.7 million, principally for securities purchases, loan originations and loan participations; financing activities provided $5.0 million. Cash and due from banks ended at $12.5 million.
- The company reported no long-term debt, discount-window borrowings, short-term borrowings or Federal Home Loan Bank advances at June 30, 2018. The loan-to-deposit ratio was 64.64%, below the company’s stated 65%-75% policy range.
- Capital was strong: common equity Tier 1 and Tier 1 capital ratios were each 23.01%, total capital was 23.92%, and the leverage ratio was 15.36%. Management considered the company well capitalized.
Material changes versus comparable periods
- Quarterly profitability improved despite lower net interest margin, supported by higher noninterest income and a substantially lower income tax rate.
- Six-month profitability was broadly stable because stronger net interest income, noninterest income and lower taxes were substantially offset by the insurance receivable write-down and higher operating expenses.
- The allowance for loan losses declined to $7.6 million, or 1.10% of loans, from $7.9 million, or 1.19%, at year-end 2017. The company recorded a $130,000 recovery for the six months, compared with a $523,000 provision in the prior-year period.
- Asset quality improved overall: nonperforming assets declined to $5.3 million, or 0.76% of loans plus other real estate owned, from $5.6 million, or 0.83%, at year-end 2017. Net charge-offs were $216,000 for the six months, compared with $451,000 in the prior-year period.
- Total troubled debt restructurings increased to $11.0 million from $7.9 million at year-end 2017; $8.3 million were accruing and $2.7 million were nonaccrual.
- During the second quarter, all securities previously classified as held to maturity were reclassified to available for sale. The transferred securities had a fair value of $119.8 million and generated a $1.1 million unrealized gain recorded in accumulated other comprehensive income.
- Accumulated other comprehensive loss increased to $12.0 million from $9.7 million at year-end 2017, primarily because of unrealized securities losses.
Outlook, risks, contingencies and unusual items
- No specific earnings, revenue or balance-sheet guidance was provided. Management stated that liquidity was sufficient under tested scenarios and that the company was well capitalized.
- The company experienced cyber intrusions in May 2016 and January 2017 involving $2.4 million of stolen funds. Customers were reimbursed, and the company is pursuing litigation against its insurer after the insurer offered $50,000. The filing records a total $2.0 million write-down of the related insurance receivable in the first half of 2018. Any recovery above the recorded receivable would be recognized when realized.
- Management identifies interest rates, economic conditions, regulatory changes, unemployment, deposit flows, loan demand, real estate conditions, competition, technology and cybersecurity as material risks.
- Unrealized losses on available-for-sale securities totaled $10.0 million at June 30, 2018. Management considered the securities temporarily impaired and stated that it did not intend, and was not expected, to sell them before recovery or maturity.
- Loans secured by residential and commercial real estate totaling $492,000 were in various stages of foreclosure and could affect future other-real-estate-owned balances.
- The company adopted revenue-recognition guidance and other accounting standards in 2018 without a material impact on net income. It is assessing the future impact of the current expected credit loss standard, leases guidance and other pending standards.
- Management stated that disclosure controls were effective and that no material changes occurred in internal control over financial reporting. No material legal proceedings were reported other than the insurance litigation discussed above.
Important facts for investors to verify
- Resolution, timing and potential recovery from the insurer related to the cybersecurity breaches.
- Whether loan growth, higher interest rates and deposit repricing cause further compression in net interest margin.
- Credit performance of the commercial real estate, construction and public-sector loan portfolios, including the increase in troubled debt restructurings.
- Potential changes to the allowance for loan losses and the effect of adopting the expected credit loss standard.
- Future realized losses or gains from the available-for-sale securities portfolio and the impact of accumulated other comprehensive loss on capital.
- Progress in reducing other real estate owned and loans in foreclosure.
- The sustainability of earnings after excluding the favorable tax-rate change and considering the nonrecurring insurance receivable write-down and loan-loss recovery.