NATIONAL BANKSHARES INC annual report, FY2014

National Bankshares, Inc. — FY2014 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2014; includes unaudited fourth-quarter results. Amounts are in thousands except per-share data. National Bankshares, Inc. is a Virginia financial holding company operating primarily through community bank subsidiary National Bank of Blacksburg, which served southwest Virginia through 24 branches and planned a 25th branch for 2015. NBFS provides investment and insurance services but contributed little to consolidated earnings.

Financial performance and condition

Metric	2014	2013	Change
Total assets	$1,154,731	$1,110,630	+3.97%
Total deposits	$982,428	$960,036	+2.33%
Loans, net	$597,203	$587,463	+1.66%
Total securities	$385,385	$347,109	+11.03%
Net interest income	$39,204	$40,050	-2.11%
Net income	$16,914	$17,790	-4.92%
Diluted EPS	$2.43	$2.55	Decrease
Cash dividends per share	$1.13	$1.12	Increase
Return on average assets	1.51%	1.63%	Decrease
Return on average equity	10.72%	11.90%	Decrease
Net interest margin	4.01%	4.24%	Decrease

Interest income declined to $44,103 from $46,005, principally because lower loan and securities yields outweighed modest asset growth. Interest expense fell to $4,899 from $5,955 as certificates of deposit repriced at lower rates and lower-cost deposits increased. Noninterest income was $9,046, up modestly from $8,958, led by higher credit-card and trust fees. Noninterest expense increased to $24,517 from $24,370. The effective tax rate was 23.44% versus 23.01%.

Fourth-quarter 2014 net income was $4,138, or $0.60 diluted EPS, compared with fourth-quarter 2013 net income of $4,622, or $0.66 diluted EPS. Fourth-quarter net interest income was $9,770 versus $10,021, while the provision for loan losses was $481 versus $202.

Cash flow, liquidity and capital

Net cash provided by operating activities was $20,338, compared with $24,450 in 2013.
Net cash used in investing activities was $35,324, including net loan funding and purchases of securities.
Net cash provided by financing activities was $14,597, primarily reflecting growth in demand and savings deposits, partly offset by lower time deposits and $7,853 of dividends paid.
Cash and due from banks ended at $12,894, compared with $13,283 at December 31, 2013.
The company had no discount-window borrowings, short-term borrowings or Federal Home Loan Bank advances at year-end. Management reported adequate liquidity under stress testing.
The loan-to-deposit ratio was 61.63%, below the company’s stated 65% to 75% policy range.
Stockholders’ equity increased 13.99% to $166,303, aided by $11,292 of other comprehensive income, primarily from improved unrealized securities gains.
NBI’s consolidated total risk-based capital ratio was 24.9%, Tier 1 risk-based capital was 23.7%, and Tier 1 leverage was 14.6%. NBB was categorized as well capitalized.

The filing does not report conventional long-term debt; contractual obligations primarily consisted of time deposits, purchase obligations and operating leases totaling $222,236.

Material changes versus the prior comparable period

Profitability weakened: net income declined 4.92%, diluted EPS declined from $2.55 to $2.43, ROAA declined 12 basis points, and ROAE declined 118 basis points.
Net interest margin fell 23 basis points to 4.01% as low rates reduced loan and securities yields. Rate-related pressure reduced taxable-equivalent net interest income by approximately $1,173, partly offset by favorable volume changes.
Balance-sheet growth continued without acquisitions or material borrowings: assets increased $44,101, deposits increased $22,392, loans increased $9,740 and securities increased $38,276.
Credit quality deteriorated in important respects. Nonperforming loans increased to $9,287 from $6,584, nonperforming assets increased to $14,031 from $11,296, and nonperforming assets as a percentage of loans plus OREO rose to 2.30% from 1.88%.
Nonaccrual loans excluding restructured loans declined to $3,999 from $5,732, but nonaccrual restructured loans increased to $5,288 from $852. Total troubled debt restructurings increased to $11,328 from $7,043.
The allowance for loan losses increased slightly to $8,263 from $8,227, but coverage of nonperforming loans declined to 88.97% from 124.95%. Net charge-offs improved slightly to 0.27% of average loans from 0.28%.
Accumulated other comprehensive loss improved to $5,672 from $16,964, primarily because of higher available-for-sale securities values; this increased reported equity but did not increase net income.

Guidance, outlook, risks and unusual items

Management did not provide numerical earnings or revenue guidance. It described a slow, uneven recovery in its southwest Virginia market, with improving real estate values and unemployment but continued concerns regarding vacancy rates, bankruptcies, university funding and loan demand. Management considered nonperforming assets manageable and the allowance adequate, but stated that the pace of local economic recovery made future asset-quality trends uncertain.

Interest-rate risk: Rates remained historically low. Management warned that rising rates could initially reduce net interest income because deposits may reprice faster than loans. The investment portfolio also faces reinvestment risk when higher-yielding securities are called.
Credit and concentration risk: Approximately 52% of the loan portfolio was commercial real estate, including $190,055 of college-housing and professional-office loans. Substantially all loans and collateral were concentrated in the local market.
Real estate and OREO: Continued weakness in local real estate could reduce collateral values, increase foreclosures and require additional loss provisions. Loans totaling $1,260 were in foreclosure at year-end.
Allowance uncertainty: The allowance depends on collateral valuations, cash-flow estimates, risk ratings and economic assumptions; actual losses or regulatory reviews could require higher provisions.
Regulatory risk: Basel III capital requirements became effective for the company on January 1, 2015 and will be phased in through 2019. Dodd-Frank, CFPB requirements and other regulatory changes may increase compliance costs and constrain products or fee income.
Off-balance-sheet exposure: Commitments to extend credit were $144,578, standby letters of credit were $14,677 and mortgage loans sold with potential recourse were $10,089. Management stated that historical draws and recourse losses had not been material.
Pension: The defined-benefit plan had a funded-status deficit of $2,194 at year-end. The required minimum 2015 contribution had not yet been determined.
Unusual or nonrecurring matters: No goodwill or intangible-asset impairment was recorded. Other comprehensive income was $11,292, primarily from securities valuation changes, and should be distinguished from recurring earnings.
Controls and litigation: The auditor issued unqualified opinions on the financial statements and internal control over financial reporting. The company reported no material pending legal proceedings and no unresolved SEC staff comments.

Important facts for investors to verify

Reconcile the increase in nonperforming loans, nonaccrual TDRs and total TDRs, particularly the concentration in commercial real estate.
Assess whether the $8,263 allowance adequately covers the $9,287 of nonperforming loans and the portfolio’s 52% commercial-real-estate exposure.
Monitor net interest margin, deposit repricing and the effect of eventual rate increases on earnings.
Review the fair value, duration and unrealized gains or losses of the $385,385 securities portfolio, including its municipal and agency concentrations.
Evaluate the sustainability of dividends given the $1.13 per-share dividend, 46.43% payout ratio and regulatory limits on dividends from NBB.
Track liquidity against the 65% to 75% loan-to-deposit policy range and the maturity of $216,746 in time deposits.
Verify the impact of Basel III implementation and subsequent accounting standards, for which the filing states that several effects were still being assessed.