Business Context and Reporting Period
National Bankshares, Inc. is a Virginia financial holding company whose primary operating subsidiary, The National Bank of Blacksburg, operates 26 full-service banking locations and one loan production office 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, 2017, compared primarily with the corresponding 2016 periods and December 31, 2016 balance-sheet data.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Total interest income | $10,301 | $10,157 | $30,834 | $30,933 |
| Net interest income | $9,280 | $9,138 | $27,737 | $27,783 |
| Provision for loan losses | $201 | $291 | $724 | $1,148 |
| Noninterest income | $2,598 | $2,481 | $7,557 | $7,440 |
| Noninterest expense | $6,745 | $6,620 | $20,380 | $19,542 |
| Net income | $3,785 | $3,828 | $11,004 | $11,472 |
| Diluted EPS | $0.54 | $0.55 | $1.58 | $1.65 |
| Net interest margin | 3.44% | 3.48% | 3.45% | 3.55% |
| Return on average assets | 1.22% | 1.27% | 1.19% | 1.28% |
| Return on average equity | 8.07% | 8.36% | 8.02% | 8.55% |
All dollar amounts are in thousands except per-share data. Cash provided by operating activities was $11,039 for the first nine months of 2017, compared with $13,352 in 2016. Investing activities provided $2,419, while financing activities used $15,366, including $3,897 of cash dividends. Cash and due from banks ended at $12,066, down from $13,974 at December 31, 2016.
At September 30, 2017, total assets were $1.232 billion, net loans were $651.9 million, deposits were $1.032 billion and stockholders’ equity was $187.7 million. The company reported no long-term debt, purchased deposits, discount-window borrowings, short-term borrowings or Federal Home Loan Bank advances. The loan-to-deposit ratio was 63.99%, below the company’s stated 65% to 75% internal policy range. Management reported sufficient liquidity under tested scenarios.
Capital remained strong: Common Equity Tier 1 and Tier 1 capital ratios were each 26.06%, the total capital ratio was 27.22% and the leverage ratio was 15.47%. The company was considered well capitalized.
Material Changes Versus Comparable Periods
- Third-quarter net income declined 1.1% and nine-month net income declined 4.1%, primarily reflecting higher compensation and operating expenses and lower net interest margins.
- Net interest income increased 1.6% in the third quarter but decreased 0.2% for the first nine months. Management attributed margin compression to lower yields on loans and securities, partially offset by lower funding costs.
- The net interest margin declined 4 basis points in the quarter and 10 basis points year to date. The nine-month loan yield declined 18 basis points, while the cost of interest-bearing liabilities declined 2 basis points.
- Loans, net of unearned income and deferred fees, increased 1.95% from year-end to $660.4 million, led by consumer real estate and commercial non-real-estate lending.
- Deposits decreased 1.10% from year-end. Interest-bearing demand and time deposits declined, partly offset by growth in noninterest-bearing demand and savings deposits. Management cited seasonal municipal deposit movements and historically low rates.
- Noninterest income increased 1.6% for the quarter and 1.6% year to date. Deposit service charges, card fees, trust income and bank-owned life insurance income increased, while other income and securities gains declined.
- Noninterest expense increased 1.9% for the quarter and 4.3% year to date. Salaries and benefits increased 7.9% year to date, while FDIC assessments and intangible amortization declined.
- Asset quality improved overall. Nonperforming assets declined to $6.1 million from $9.0 million at year-end, and the nonperforming-asset ratio declined to 0.92% from 1.38%. The allowance for loan losses was $8.5 million, or 1.28% of loans, compared with 1.28% at year-end and 1.30% at September 30, 2016.
- Accumulated other comprehensive loss improved to $6.4 million from $8.7 million at year-end, primarily because of unrealized gains on available-for-sale securities.
Outlook, Risks, Contingencies and Unusual Items
- The filing provides no formal earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year performance.
- Principal risks include interest-rate changes, economic conditions, unemployment, real estate markets, deposit flows, loan demand and quality, competition, regulatory changes, technology and cybersecurity exposures.
- The company disclosed digital-system intrusions in May 2016 and January 2017. Reported thefts totaled $570 and $1,838, respectively; affected customers were fully reimbursed. The company filed an insurance claim and was awaiting a response. Litigation and certain investigation and remediation costs could not yet be estimated accurately.
- Available-for-sale securities had $3.235 million of gross unrealized losses at September 30, 2017. Management classified the securities as temporarily impaired and stated it did not intend, and was not likely, to sell them before recovery or maturity.
- Other real estate owned was $2.9 million, and an additional $649 thousand of real-estate-secured loans was in foreclosure processes. Future OREO levels cannot be predicted precisely.
- Total troubled debt restructurings were $8.0 million, including $3.1 million in nonaccrual status. Seven loans totaling $1.4 million were restructured during the first nine months; no principal or interest was forgiven.
- The company purchased $10 million of additional bank-owned life insurance during the second quarter, increasing BOLI assets to $33.5 million and expected to support future BOLI income.
- Management stated that there were no material pending or threatened legal proceedings and that disclosure controls were effective as of September 30, 2017.
- Recently issued accounting standards, including the current expected credit loss standard, leases and financial-instrument guidance, were under evaluation. Management did not expect certain identified standards to have a material impact, but the ultimate effect of the credit-loss standard was not yet quantified.
Investor Verification Points
- Verify whether loan growth and improved credit metrics are sustainable, particularly within the commercial real estate portfolio, which totaled $337.2 million.
- Monitor net interest margin, loan and securities yields, deposit pricing and the effect of future interest-rate changes.
- Assess the impact of higher salaries, technology spending and other operating expenses on future efficiency and profitability.
- Follow the status and recoverability of the cybersecurity insurance claim, related litigation exposure and remaining remediation costs.
- Review unrealized securities losses, securities duration and the company’s ability and intent to hold affected securities through recovery or maturity.
- Evaluate liquidity if deposits continue to decline or loan demand accelerates, including available borrowing capacity and unpledged securities.
- Confirm the eventual allowance impact and implementation costs of the expected credit loss standard.