NATIONAL BANKSHARES INC quarterly report, Q1 FY2022

National Bankshares, Inc. — 2022 First-Quarter Form 10-Q

Business Context and Reporting Period

National Bankshares, Inc. is a Virginia financial holding company whose primary subsidiary, The National Bank of Blacksburg, operates as a community bank through 24 offices and one loan production office. The company also operates investment and insurance services subsidiaries, which are not significant contributors to revenue. This unaudited report covers the three months ended March 31, 2022, compared primarily with the three months ended March 31, 2021 and December 31, 2021.

Financial Results and Key Metrics

Metric	Q1 2022	Comparable period
Total interest income	$11.050 million	$10.882 million in Q1 2021
Net interest income	$10.395 million	$10.027 million in Q1 2021
Provision for loan losses	$134 thousand	$50 thousand in Q1 2021
Noninterest income	$2.291 million	$2.334 million in Q1 2021
Noninterest expense	$6.613 million	$6.536 million in Q1 2021
Net income	$4.886 million	$4.766 million in Q1 2021
Basic and diluted EPS	$0.81	$0.74 in Q1 2021
Net interest margin	2.66%	2.89% in Q1 2021
Return on average assets	1.11%	1.19% in Q1 2021
Return on average equity	10.26%	9.30% in Q1 2021
Efficiency ratio	52.71%	53.87% in Q1 2021

Net income increased approximately 2.5%, while EPS increased approximately 9.5%, supported by a lower share count from repurchases. Net interest income increased approximately 3.7%, primarily because deposit funding costs declined, although the net interest margin fell as loan yields declined and the asset mix shifted toward lower-yielding taxable securities. The effective tax rate was 17.73%, compared with 17.47% in Q1 2021.

Net cash provided by operating activities was $6.685 million. Investing activities used $50.850 million, including $70.341 million of securities purchases, while financing activities provided $47.644 million, primarily from deposit growth. Cash and due from banks increased to $12.247 million from $8.768 million at year-end 2021.

Balance Sheet, Liquidity, Capital and Credit Quality

• Total assets were $1.722 billion, up 1.14% from December 31, 2021.
• Net loans were $811.540 million, up 2.01%; gross loans increased 2.00% to $819.328 million. Real estate construction loans increased 22.32%, while commercial non-real-estate loans declined 12.39%.
• Securities available for sale were $699.354 million, up from $686.080 million. Rising interest rates caused gross unrealized losses to increase to $40.595 million from $7.067 million at year-end.
• Total deposits were $1.544 billion, up 3.29%; the company reported no brokered deposits.
• The company had no long-term debt, Federal Home Loan Bank advances, discount-window borrowings or short-term borrowings at March 31, 2022.
• The loan-to-deposit ratio was 53.07%, below management’s target range of 65% to 75%. Management described liquidity as sufficient under tested scenarios.
• Bank regulatory capital remained strong: common equity Tier 1 and Tier 1 capital ratios were each 18.15%, total capital was 18.90%, and the leverage ratio was 11.22%. The bank was considered well capitalized.
• The allowance for loan losses was $7.788 million, or 0.95% of loans, compared with 0.96% at year-end 2021 and 1.10% at March 31, 2021. Net charge-offs were $20 thousand, and the provision was $134 thousand.
• Nonperforming loans were $2.862 million and nonperforming assets were $3.819 million, representing 0.47% of loans plus other real estate owned. Other real estate owned remained $957 thousand.
• Total troubled debt restructurings were $5.834 million, including $2.833 million in nonaccrual status. No new TDRs were designated during the quarter.
• Stockholders’ equity declined 15.89% to $161.289 million, principally because of the $33.826 million after-tax other comprehensive loss from declining available-for-sale securities values and $1.522 million of share repurchases.

Material Changes Versus Prior Comparable Period

• Net income rose from $4.766 million to $4.886 million despite a lower net interest margin and slightly lower noninterest income.
• Interest income increased modestly, while interest expense declined from $855 thousand to $655 thousand as deposit costs fell.
• Loan interest and fees declined from $8.550 million to $8.100 million; Q1 2021 benefited from approximately $650 thousand of PPP interest and fees.
• Noninterest income declined 1.8%. Higher service charges, trust income and BOLI income were more than offset by lower mortgage-loan sale gains and other income.
• Noninterest expense increased 1.2%, including higher salaries, FDIC assessments and franchise taxes, partly offset by lower other real estate owned costs and other operating expenses.
• Loan growth and deposit growth continued, while interest-bearing deposits declined as excess liquidity was redeployed into securities and loans.
• Accumulated other comprehensive loss worsened substantially because of interest-rate-driven declines in available-for-sale securities fair values; management stated the securities were temporarily impaired and did not expect to sell them before recovery or maturity.

Guidance, Outlook, Commentary, Risks and Unusual Items

The filing does not provide formal earnings or revenue guidance. Management stated that the pandemic appeared to be receding and that COVID-19-related payment extensions had returned to normal terms, but a resurgence could adversely affect operations, credit risk, asset values, cash flows and capital.

• Interest-rate risk is material. Further rate increases or market volatility could reduce securities values and affect net interest income, loan demand and credit quality.
• Management reduced the COVID-19 unemployment-related allowance factor to zero because national unemployment claims had returned to pre-pandemic levels, but retained an unallocated allowance surplus of $171 thousand to address residual uncertainty.
• Credit risks include higher rates, rising market-area unemployment, potentially understated bankruptcy data, real estate values, foreclosure activity and increased high-risk loans. Loans in various stages of foreclosure totaled $407 thousand.
• The company is preparing to adopt the current expected credit loss standard, ASU 2016-13, for fiscal years beginning after December 15, 2022. Management had not yet quantified the impact.
• The company is assessing ASU 2022-02 regarding troubled debt restructurings and vintage disclosures. It also has a small number of participation loans referencing LIBOR and is evaluating the transition.
• Cybersecurity is identified as one of the company’s greatest risks. Q1 cybersecurity costs were $94 thousand; insurance does not cover all potential financial or reputational losses.
• Management reported effective disclosure controls and no material changes in internal control over financial reporting. No material legal proceedings were disclosed.

Important Facts for Investors to Verify

• Whether the large accumulated other comprehensive loss from securities will reverse as bonds mature or rates stabilize, and whether any securities could require impairment recognition.
• The effect of future Federal Reserve rate increases on net interest margin, deposit pricing, securities values and borrower credit quality.
• The eventual balance-sheet impact of CECL adoption and related assumptions, including forecasts and qualitative adjustments.
• Trends in commercial real estate concentrations, criticized loans, nonaccrual TDRs, past-due loans and foreclosure activity.
• Whether excess liquidity and the 53.07% loan-to-deposit ratio will support additional loan growth or pressure future asset yields.
• The continuation or expiration of the 1,000,000-share repurchase authorization, which was scheduled to expire May 31, 2022; 852,694 shares remained available at March 31, 2022.
• Any subsequent COVID-19 developments, geopolitical events, cyber incidents or vendor disruptions that could materially change the reported outlook.