National Bankshares, Inc. — Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018; filing dated March 13, 2019. Amounts are in thousands, except per-share data. National Bankshares is a Virginia financial holding company whose operations are conducted primarily through community bank subsidiary National Bank of Blacksburg, serving southwest Virginia and nearby areas.
Financial Performance and Position
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Interest income | $43,224 | $41,260 | +$1,964 |
| Interest expense | $5,047 | $4,125 | +$922 |
| Net interest income | $38,177 | $37,135 | +2.81% |
| Provision for loan losses | Recovery of $81 | $157 provision | Improved |
| Noninterest income | $7,729 | $7,636 | +$93 |
| Noninterest expense | $27,276 | $24,229 | +$3,047 |
| Net income | $16,151 | $14,092 | +14.61% |
| Basic and diluted EPS | $2.32 | $2.03 | +14.29% |
| Net interest margin, tax-equivalent | 3.36% | 3.45% | Down 9 bps |
| Return on average assets | 1.29% | 1.14% | Up 15 bps |
| Return on average equity | 8.65% | 7.64% | Up 101 bps |
| Efficiency ratio | 53.20% | 50.41% | Less efficient |
- Revenue mix: Interest and fees on loans represented 61.49% of operating revenue, interest on investments 22.02%, and noninterest income 15.17%.
- Loans: Net loans increased 6.40% to $702,409. Gross loans were $710,397, with commercial real estate loans of $353,546, approximately 50% of the portfolio.
- Deposits and assets: Total deposits declined 0.74% to $1,051,942, primarily due to maturing time deposits. Total assets were essentially flat at $1,256,032.
- Liquidity: Operating cash flow was $19,775, compared with $10,994 in 2017. Investing activities used $3,608 and financing activities used $16,211, principally reflecting $8,419 of dividends and a $13,085 decline in time deposits. The year-end cash and due-from-banks balance was $12,882.
- Funding and debt: The Bank had no discount-window borrowings, short-term borrowings, or Federal Home Loan Bank advances at December 31, 2018. The filing states that the Company had no material commitments for long-term debt or capital expenditures.
- Capital: Stockholders’ equity increased 2.89% to $190,238. National Bank of Blacksburg was well capitalized, with a 24.764% total risk-based capital ratio, 23.856% Tier 1 and CET1 ratios, and a 15.788% leverage ratio.
- Dividends: Cash dividends declared increased to $1.21 per share from $1.17; the payout ratio was 52.13%. Dividend capacity depends substantially on distributions from the Bank and remains subject to regulatory restrictions.
Material Changes Versus the Prior Comparable Period
- Net income increased by $2,059, driven primarily by higher net interest income, a lower effective tax rate, and a loan-loss recovery.
- The effective tax rate declined to 13.68% from 30.87%, following the Tax Cuts and Jobs Act reduction of the statutory federal rate to 21%. The 2017 period included a $1,560 deferred-tax-asset revaluation charge.
- Net interest income increased on loan growth and higher taxable-security yields, but the tax-equivalent net interest margin declined because deposit costs rose and yields on tax-advantaged assets declined.
- Interest expense increased 22.35%, reflecting higher deposit pricing in a rising-rate environment and $164 of interest on short-term borrowings.
- Noninterest expense increased 12.58%, including a $2,010 write-down of an insurance receivable related to cybersecurity incidents, higher salaries and benefits, greater data-processing costs, and higher other-real-estate-owned costs.
- Loans grew while securities declined 7.29% to $426,230, with securities maturities helping fund loan growth. During the second quarter, all held-to-maturity securities were reclassified as available for sale.
- Asset quality was mixed: nonperforming loans increased to $3,420, or 0.48% of loans, from $2,769, while total nonperforming assets declined to $5,472 from $5,586. Net charge-offs improved to 0.07% of average loans from 0.08%.
- The allowance for loan losses declined to $7,390, or 1.04% of loans, from $7,925, or 1.19%.
Outlook, Risks, Contingencies, and Unusual Items
- Management expected gradual increases in interest rates to benefit future net interest income, but acknowledged that rapid or adverse rate changes could pressure margins because deposits may reprice faster than loans.
- The Company’s primary credit risks are concentrated in its southwest Virginia market, commercial real estate, small and mid-sized businesses, and real-estate-secured lending. Economic weakness, declining property values, university funding reductions, coal-industry weakness, unemployment, and borrower defaults could increase losses.
- Commercial real estate represented approximately 50% of the loan portfolio. College housing and professional office loans totaled $184,203 at year-end, creating exposure to local education, employment, and real-estate conditions.
- Cybersecurity remains a material operational and reputational risk. The Company experienced intrusions in May 2016 and January 2017; customer information was compromised and funds were stolen or exposed. Customers were restored and no customer ultimately experienced a loss. The Company recorded a $2,010 insurance-receivable write-down in 2018 and retained a $50 insurance receivable. Litigation with the insurer was settled in the first quarter of 2019 under a nondisclosure agreement.
- Off-balance-sheet exposure included $145,635 of commitments to extend credit, $16,092 of standby letters of credit, and $13,013 of mortgage loans sold with potential recourse. Management stated that the related reserve was not material and no recourse provisions had been invoked.
- The Company expects to adopt the current expected credit loss standard, or CECL, beginning January 1, 2020. Management expects implementation could materially affect credit reserves, capital, earnings, and related financial metrics, although the ultimate impact was not yet clear.
- The Company adopted new revenue-recognition and financial-instrument standards in 2018 without a material impact on net income. The lease standard adopted January 1, 2019 increased assets and liabilities by approximately $684.
- There were no material pending legal proceedings, unresolved SEC staff comments, or reported material weaknesses in internal control. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Most Important Facts for Investors to Verify
- Confirm the sustainability of loan growth and whether commercial real estate concentration remains consistent with credit-risk limits.
- Monitor deposit retention, deposit pricing, and the effect of further interest-rate changes on the net interest margin.
- Review trends in nonperforming loans, accruing and nonaccruing troubled debt restructurings, collateral values, charge-offs, and the adequacy of the allowance.
- Assess the recurring versus nonrecurring nature of the $2,010 cybersecurity-related insurance-receivable write-down and the outcome of the insurer settlement.
- Evaluate the eventual CECL impact on reserves, earnings, capital ratios, and dividend capacity.
- Verify liquidity sources and the potential funding requirements associated with $145,635 of unfunded credit commitments and other off-balance-sheet exposures.
- Review the effect of available-for-sale securities reclassification and unrealized losses on accumulated other comprehensive income and capital.
- Confirm regulatory capital status, Bank dividend capacity, and the Company’s ability to maintain its $1.21 per-share dividend.