Business Context and Reporting Period
National Bankshares, Inc. is a Virginia financial holding company whose principal subsidiary, The National Bank of Blacksburg, operates as a community bank through 25 offices in southwest Virginia. The company provides retail and commercial banking, lending, trust, investment, insurance, and related services. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2013, with comparisons to September 30, 2012 and December 31, 2012.
Key Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Net income | $4.517 million vs. $4.293 million | $13.168 million vs. $13.062 million |
| Basic diluted EPS | $0.65 vs. $0.62 | $1.90 / $1.89 vs. $1.88 |
| Net interest income | $10.177 million vs. $10.301 million | $30.107 million vs. $30.462 million |
| Provision for loan losses | $0.303 million vs. $0.778 million | $1.329 million vs. $2.554 million |
| Noninterest income | $2.109 million vs. $2.108 million | $6.405 million vs. $6.543 million |
| Noninterest expense | $6.123 million vs. $6.088 million | $18.184 million vs. $17.530 million |
| Income before taxes | $5.860 million vs. $5.543 million | $16.999 million vs. $16.921 million |
Quarterly net income increased 5.2%, while nine-month net income increased 0.8%. The implied quarterly net margin was approximately 39.1% in 2013 versus 35.1% in 2012; the nine-month implied net margin was approximately 37.9% versus 35.8%, based on net income divided by interest income plus noninterest income. The company reported annualized return on average assets of 1.61% and return on average equity of 11.70% for the nine months, compared with 1.64% and 12.01%, respectively, for 2012. Net interest margin was 4.27%, down from 4.38% for 2012 and 4.40% for the comparable 2012 nine-month period.
Balance Sheet, Capital, and Liquidity
- Total assets were $1.077 billion, down 2.44% from December 31, 2012.
- Loans, net of unearned income and before the allowance, were $590.664 million, down 0.25% from year-end. Net loans after the allowance were $582.574 million.
- Total deposits were $923.498 million, down 2.46%; time deposits declined 10.50%, reflecting customer migration away from low-rate certificates of deposit.
- Securities totaled $356.977 million at amortized cost, including $192.225 million of available-for-sale securities and $164.752 million of held-to-maturity securities.
- Stockholders’ equity was $146.294 million, down 2.54% from year-end, primarily because accumulated other comprehensive loss increased to $15.969 million, reflecting after-tax unrealized securities losses of $13.231 million.
- The company had no long-term debt, purchased deposits, discount-window borrowings, short-term borrowings, or Federal Home Loan Bank advances at September 30, 2013.
- Cash and due from banks were $13.806 million, and interest-bearing deposits were $62.776 million. Management stated that liquidity was sufficient under tested scenarios. The loan-to-deposit ratio was 63.96%, below the company’s internal 65% to 75% policy range.
- The company was considered well capitalized. Tier 1 and Tier 2 risk-based capital ratios were 22.70% and 23.89%, respectively.
Cash Flow and Dividends
- Net cash provided by operating activities was $19.003 million for the nine months, compared with $16.237 million in 2012.
- Investing activities provided $7.040 million, versus using $17.120 million in 2012, largely because of lower securities purchases and changes in interest-bearing deposits.
- Financing activities used $27.020 million, primarily from a $29.164 million decrease in time deposits and $3.752 million of dividends paid.
- Dividends declared were $0.54 per share for the nine months, compared with $0.53 in 2012. No dividend was declared in either reported third quarter.
Material Changes Versus Prior Comparable Period
- Interest income declined 5.0% for the quarter and 5.0% for the nine months, primarily because loan and securities yields decreased.
- Interest expense declined 28.3% for the quarter and 24.0% for the nine months as deposit pricing and time-deposit balances fell.
- Net interest income declined 1.2% for the quarter and 1.2% for the nine months, despite lower funding costs.
- The provision for loan losses declined 61.0% for the quarter and 47.9% for the nine months, reflecting improved credit trends and lower net charge-offs.
- Noninterest expense increased 0.6% for the quarter and 3.7% for the nine months. Increases included franchise taxes, other operating expenses, data processing, FDIC assessments, and credit-card processing costs.
- Nine-month trust income fell 16.4%, BOLI income fell 9.8%, and realized securities gains declined to $2,000 from $33,000. Other income increased 47.2%.
- Real estate construction loans increased 9.36% from year-end and public-sector loans increased 8.27%, while commercial non-real-estate loans fell 16.12% and consumer non-real-estate loans fell 10.03%.
- The company adopted revised allowance methodology and separately identified investor-owned residential real estate loans beginning in 2013. Management stated that these changes did not have a significant impact on the allowance calculation.
Credit Quality, Outlook, Risks, and Unusual Items
- Nonperforming loans were $11.236 million, down from $13.021 million at December 31, 2012 but above $6.130 million at September 30, 2012. Nonperforming assets were $12.209 million, or 2.06% of loans plus other real estate owned, versus 2.44% at year-end.
- The allowance for loan losses was $8.090 million, or 1.37% of loans, compared with 1.41% at year-end. The allowance covered 72.00% of nonperforming loans, down from 64.12% at year-end and 134.65% at September 30, 2012.
- Annualized net charge-offs were 0.36% of average loans, compared with 0.54% for the first nine months of 2012 and 0.49% for full-year 2012.
- Accruing troubled debt restructurings were $6.545 million, and total troubled debt restructurings were $7.587 million, up from $4.156 million at December 31, 2012. Six loans totaling $4.576 million were restructured during the first nine months.
- Properties totaling approximately $3.784 million were in various stages of foreclosure and could increase other real estate owned in future periods. Management stated that the eventual amount cannot be predicted accurately.
- Available-for-sale and held-to-maturity securities had substantial unrealized losses due primarily to interest-rate and market fluctuations. Management classified the securities as temporarily impaired and stated that it did not intend, and was not expected, to sell them before recovery of amortized cost.
- The company’s outlook remains exposed to interest rates, economic conditions, unemployment, real estate values, deposit flows, loan demand, competition, regulation, technology-related fraud, securities-market conditions, and the financial condition of borrowers. Management noted that the regional economy showed mixed recovery and continued elevated unemployment.
- There were no material legal proceedings, material subsequent events, long-term debt, or material changes in off-balance-sheet arrangements reported.
- Management identified a material weakness in internal control over the timely classification of certain loans as impaired and nonaccrual following a March 2013 regulatory examination. Additional review procedures, segregated duties, and a task force review of commercial relationships over $500,000 were implemented and deemed effective as of September 30, 2013.
Investor Verification Checklist
- Verify the sustainability of earnings as lower deposit costs offset declining loan and securities yields.
- Monitor nonperforming loans, troubled debt restructurings, foreclosure activity, charge-offs, and the 72% allowance coverage ratio.
- Assess the potential effect of the $26.208 million of unrealized losses on temporarily impaired securities if interest rates or liquidity conditions change.
- Review the remediation and ongoing effectiveness of controls over impaired and nonaccrual loan classification.
- Evaluate deposit runoff, particularly the decline in time deposits, and the company’s ability to maintain liquidity while keeping the loan-to-deposit ratio within policy.
- Assess exposure to southwest Virginia employment, university funding, commercial real estate, construction lending, and local real estate values.
- Confirm that future allowance requirements, regulatory capital levels, and dividend capacity remain consistent with current reported conditions.