NATIONAL BANKSHARES INC quarterly report, Q2 FY2013

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National Bankshares, Inc. — Q2 2013 Form 10-Q Summary

Business context and reporting period

National Bankshares, Inc. is a Virginia financial holding company whose principal subsidiary, The National Bank of Blacksburg, operates 25 community-bank offices in southwest Virginia. The filing covers the unaudited quarter and six months ended June 30, 2013, compared primarily with the corresponding 2012 periods and December 31, 2012 balance sheet data. Unless otherwise noted, amounts are in thousands, except per-share data.

Financial performance and condition

  • Second-quarter net income: $4,435, compared with $4,340 in Q2 2012. Diluted earnings per share were $0.64 versus $0.62.
  • Six-month net income: $8,651, compared with $8,769 in the first half of 2012. Diluted earnings per share were $1.24 versus $1.26.
  • Net interest income: $10,045 in Q2, down from $10,164; $19,930 year to date, down from $20,161. The six-month net interest margin was 4.27%, compared with 4.39% in the prior-year period and 4.38% for 2012.
  • Credit costs: Provision for loan losses was $355 in Q2 and $1,026 year to date, compared with $1,104 and $1,776, respectively, in the prior-year periods.
  • Noninterest income and expense: Q2 noninterest income was $2,186 versus $2,283; year-to-date noninterest income was $4,296 versus $4,435. Q2 noninterest expense increased to $6,115 from $5,731; year-to-date expense increased to $12,061 from $11,442.
  • Profitability: Annualized six-month return on average assets was 1.59% and return on average equity was 11.42%, compared with 1.64% and 12.01%, respectively, for 2012.
  • Balance sheet: Total assets were $1,091,086 at June 30, down 1.20% from year-end 2012. Net loans were $580,109, down 0.63%; securities were $374,277, up 6.32%; and deposits were $938,521, down 0.87%.
  • Liquidity and funding: Cash and due from banks were $13,474, while interest-bearing deposits were $63,731. The bank had no purchased deposits, discount-window borrowings, short-term borrowings, or Federal Home Loan Bank advances. The loan-to-deposit ratio was 62.66%, below the company’s stated 65%–75% policy range. Management stated that liquidity was sufficient under tested scenarios.
  • Debt and capital: The company had no long-term debt, capital lease obligations, or material purchase obligations. Tier 1 and Tier 2 risk-based capital ratios were 21.8% and 22.9%, respectively, and the company was considered well capitalized.
  • Cash flow: Year-to-date operating activities provided $11,771. Investing activities used $1,083, and financing activities used $11,997, primarily due to declines in time deposits and $3,752 of dividends paid. Cash and due from banks declined $1,309 from year-end.

Material changes versus comparable periods

  • Lower loan and securities yields reduced net interest income and the net interest margin, although lower deposit funding costs partly offset the pressure.
  • Credit trends improved versus year-end 2012: nonperforming loans declined to $11,950 from $13,021, nonperforming assets declined to $12,919 from $14,456, and loans past due 90 days or more and still accruing declined to $125 from $170.
  • The allowance for loan losses declined to $7,952 from $8,349, equal to 1.35% of loans versus 1.41% at year-end. The annualized net charge-off ratio was 0.49%, unchanged from year-end and below 0.57% in the first half of 2012.
  • Despite the improvement from year-end, nonperforming loans and nonperforming assets remained higher than at June 30, 2012, when they were $7,390 and $8,261, respectively.
  • Total troubled debt restructurings increased to $7,756 from $4,156 at year-end, including $6,234 of accruing TDRs and $1,522 in nonaccrual status.
  • Accumulated other comprehensive loss increased substantially to $12,208 from $2,738, primarily because of after-tax unrealized losses on available-for-sale securities. Total comprehensive income was a loss of $4,070 in Q2 and a loss of $819 for the first six months, despite positive net income.
  • Available-for-sale securities increased to $205,948 from $189,815, but carried $13,115 of gross unrealized losses at June 30. Management classified the related securities as temporarily impaired and stated that it did not intend, and was not required, to sell them before recovery or maturity.

Outlook, commentary, risks, contingencies, and unusual items

  • The filing provides no formal earnings or revenue guidance. Management described the economic recovery as mixed, with continued elevated unemployment and diminished real estate values, although local real estate values appeared to have stabilized through the first half of 2013.
  • Key risks include interest-rate changes, economic and employment conditions, state funding for local universities, real estate values, loan and investment portfolio quality, deposit flows, competition, regulatory changes, technology-related fraud, and securities-market volatility.
  • Approximately $647 of properties were in various stages of foreclosure at June 30, 2013, which could affect future other real estate owned balances. Management stated that future levels cannot be predicted accurately.
  • The allowance for loan losses depends materially on borrower condition, collateral values, internal risk ratings, loss rates, economic assumptions, and management judgment. Actual losses may differ from estimates.
  • In March 2013, the company identified a material weakness in internal control over timely classification of certain loans as impaired and nonaccrual following a regulatory examination. Management implemented revised review procedures, segregated duties, and a task force review of commercial relationships over $500. Management considered the corrective changes effective as of June 30, 2013.
  • No material legal proceedings, defaults, material subsequent events, or material changes in off-balance-sheet arrangements were reported. Normal lines of credit and standby letters of credit remain part of ordinary banking operations.

Investor verification checklist

  • Verify the sustainability of earnings given declining asset yields, a 12-basis-point year-over-year reduction in the six-month net interest margin, and increased operating expenses.
  • Monitor nonperforming loans, TDRs, foreclosure activity, classified loans, charge-offs, and the 66.54% allowance coverage ratio for nonperforming loans.
  • Assess exposure to unrealized securities losses, particularly the $20,036 of gross unrealized losses identified as temporary, and the resulting accumulated other comprehensive loss.
  • Review remediation and subsequent effectiveness of controls over impaired and nonaccrual loan classification.
  • Evaluate deposit migration from time deposits, liquidity sources, the below-target loan-to-deposit ratio, and the absence of outstanding borrowings.
  • Confirm future dividend capacity and capital trends after $3,752 of dividends paid year to date and the decline in reported stockholders’ equity to $145,538.