Business Context and Reporting Period
National Bankshares, Inc. is a Virginia financial holding company whose principal subsidiary, The National Bank of Blacksburg, operates 25 offices in southwest Virginia. The company provides retail and commercial banking, lending, trust, investment and insurance services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, with comparisons to September 30, 2013 and December 31, 2013. Amounts are in thousands except per-share data.
Financial Performance and Position
| Metric | Three Months Ended September 30, 2014 | Prior Comparable Period | Nine Months Ended September 30, 2014 | Prior Comparable Period |
|---|---|---|---|---|
| Net interest income | $9,837 | $10,156 | $29,434 | $30,028 |
| Provision for loan losses | $356 | $303 | $1,160 | $1,329 |
| Noninterest income | $2,242 | $2,150 | $6,786 | $6,544 |
| Noninterest expense | $6,136 | $6,143 | $18,378 | $18,244 |
| Net income | $4,263 | $4,517 | $12,776 | $13,168 |
| Basic earnings per share | $0.61 | $0.65 | $1.84 | $1.90 |
| Diluted earnings per share | $0.61 | $0.65 | $1.84 | $1.89 |
- Net interest margin was 4.05% for the first nine months, compared with 4.27% for the prior-year period and 4.25% for full-year 2013. Management attributed the decline primarily to lower loan and securities yields, partly offset by lower funding costs.
- Annualized return on average assets was 1.53% and return on average equity was 10.99%, compared with 1.63% and 11.90%, respectively, for 2013.
- Total assets were $1.116 billion at September 30, 2014, up 0.51% from year-end 2013. Net loans were $587.8 million, essentially unchanged from year-end, while securities increased 6.18% to $368.6 million.
- Total deposits were $948.9 million, down 1.16% from year-end. Time deposits declined 7.36%, while non-time deposits increased $6.7 million.
- Stockholders’ equity was $162.8 million, up 11.60% from year-end, primarily reflecting earnings and an improvement in accumulated other comprehensive loss. Tier 1 and total risk-based capital ratios were 23.85% and 25.02%, respectively.
- The company reported no long-term debt, purchased deposits, discount-window borrowings, short-term borrowings or Federal Home Loan Bank advances at September 30, 2014.
Cash Flow, Liquidity and Capital
- Net cash provided by operating activities was $15.4 million for the first nine months, compared with $19.2 million in the prior-year period.
- Investing activities used $1.0 million, compared with $6.8 million provided in the prior-year period, reflecting lower securities purchases and modest net loan funding.
- Financing activities used $14.9 million, principally because of a $17.8 million decrease in time deposits and $3.8 million of dividends paid.
- Cash and due from banks ended the period at $12.8 million, compared with $13.3 million at December 31, 2013.
- Management stated that liquidity was sufficient under tested scenarios. The loan-to-deposit ratio was 62.79%, below the company’s internal target range of 65% to 75%.
- The company was considered well capitalized under current regulatory standards and expected to remain well capitalized when revised Basel III-related requirements became effective January 1, 2015.
Material Changes Versus Prior Periods
- First-nine-month net income decreased 3.0%, while diluted earnings per share declined from $1.89 to $1.84. Third-quarter net income decreased 5.6%.
- Net interest income declined 2.0% for the first nine months and 3.1% for the quarter, despite lower interest expense. The decline reflected lower earning-asset yields and continued competitive pressure on loan pricing.
- Noninterest income increased 3.7% for the first nine months, led by a 10.7% increase in credit card fees and a 6.2% increase in trust income. Realized securities results improved from a $44 loss to a $5 gain.
- Noninterest expense increased 0.7%, primarily because of higher other real estate owned costs, franchise taxes and occupancy expense. Data processing and ATM costs declined 8.2%.
- Asset quality improved relative to September 30, 2013 but weakened modestly from year-end. Nonperforming loans were $7.7 million versus $11.2 million at September 30, 2013 and $6.6 million at December 31, 2013.
- The allowance for loan losses declined to $8.0 million, or 1.35% of loans, from 1.38% at year-end. The annualized net charge-off ratio was 0.31%, compared with 0.36% for the prior-year period.
- Other real estate owned increased to $5.1 million from $4.7 million at year-end and $1.0 million at September 30, 2013. Approximately $933 thousand of properties were in various stages of foreclosure.
- Troubled debt restructurings increased to $8.3 million from $7.0 million at year-end. Two loans totaling $2.7 million were restructured during the first nine months; none were restructured during the third quarter.
- Accumulated other comprehensive loss improved to $9.0 million from $17.0 million at year-end, primarily because of after-tax unrealized gains on available-for-sale securities.
Guidance, Outlook, Risks and Unusual Items
- The filing does not provide formal earnings or revenue guidance. Management expects results to remain sensitive to interest rates, deposit flows, loan demand, competition and economic conditions in southwest Virginia.
- Management described the economic recovery as mixed, with continued unemployment and real estate-market challenges. Reduced state funding for local colleges and universities could adversely affect employment and credit quality in the company’s market.
- Principal risks include interest-rate sensitivity, declining earning-asset yields, loan and real estate credit losses, foreclosure activity, deposit attrition, regulatory and capital changes, technology-based fraud, competition and changes in accounting requirements.
- The company held $209.9 million of temporarily impaired available-for-sale securities with total unrealized losses of $12.8 million. Management concluded the securities were not other-than-temporarily impaired because it did not intend, and was not expected, to sell them before recovery or maturity.
- There were no material pending or threatened legal proceedings, no defaults on senior securities and no material changes in off-balance-sheet arrangements. Ordinary-course lending commitments and standby letters of credit remain subject to customer drawdowns.
- Management evaluated disclosure controls as effective and reported no material changes in internal control over financial reporting.
Important Facts for Investors to Verify
- Whether the decline in net interest margin persists as loans and securities reprice at lower yields.
- Trends in commercial real estate exposure, nonperforming loans, troubled debt restructurings and other real estate owned, particularly the approximately $933 thousand in foreclosure pipeline.
- Whether the allowance coverage ratio remains adequate if unemployment, real estate values or local economic conditions deteriorate.
- The stability and pricing of deposits as time deposits mature and migrate to lower-cost products or leave the bank.
- The effect of unrealized securities losses and future interest-rate movements on accumulated other comprehensive income and regulatory capital.
- Implementation effects of Basel III capital rules and the accounting standards identified as pending adoption.
- The company’s ability to sustain dividends of $0.55 per share for the first nine months while earnings and cash flow remain under pressure.