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 in southwest Virginia. The company provides retail and commercial banking, trust, investment, insurance, and related financial services. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared primarily with the three months ended March 31, 2016 and December 31, 2016 balance-sheet data.
Key Financial Metrics
| Metric | Q1 2017 | Comparable Period |
|---|---|---|
| Total assets | $1.243 billion | $1.234 billion at Dec. 31, 2016 |
| Loans, net | $644.1 million | $639.5 million at Dec. 31, 2016 |
| Total deposits | $1.046 billion | $1.043 billion at Dec. 31, 2016 |
| Net interest income | $9.210 million | $9.416 million in Q1 2016 |
| Noninterest income | $2.504 million | $2.341 million in Q1 2016 |
| Noninterest expense | $6.937 million | $6.684 million in Q1 2016 |
| Net income | $3.649 million | $3.779 million in Q1 2016 |
| Basic and diluted EPS | $0.52 | $0.54 in Q1 2016 |
| Return on average assets | 1.21% | 1.28% in Q1 2016 |
| Return on average equity | 8.20% | 8.64% in Q1 2016 |
| Net interest margin | 3.49% | 3.66% in Q1 2016 |
| Net cash from operating activities | $3.540 million | $6.678 million in Q1 2016 |
Financial Condition, Credit and Liquidity
- Loans, net of unearned income and deferred fees, increased 0.70% from December 31, 2016, led by an 11.22% increase in public sector and IDA loans. Total deposits increased 0.29%; noninterest-bearing demand deposits increased 6.28%, while time deposits declined 3.73%.
- The allowance for loan losses was $8.261 million, or 1.27% of loans, compared with $8.300 million, or 1.28%, at year-end 2016. The provision for loan losses was $59 thousand, down from $203 thousand in Q1 2016.
- Net charge-offs were $98 thousand, or 0.06% annualized of average loans, compared with $393 thousand, or 0.26%, in Q1 2016.
- Nonperforming assets totaled $8.632 million, including $5.680 million of nonperforming loans and $2.952 million of other real estate owned. The nonperforming-asset ratio was 1.32%, down from 1.38% at December 31, 2016 and 1.64% in Q1 2016.
- Cash and due from banks totaled $13.654 million, while interest-bearing deposits totaled $85.552 million. The company reported no purchased deposits, discount-window borrowings, short-term borrowings, or Federal Home Loan Bank advances at March 31, 2017.
- The loan-to-deposit ratio was 62.33%, below the company’s internal policy range of 65% to 75%. Management stated that liquidity was sufficient under tested scenarios.
- The company had no long-term debt or capital lease obligations. Operating lease obligations were not material.
- Capitalization was strong: Common Equity Tier 1 and Tier 1 capital ratios were each 26.30%, the total capital ratio was 27.47%, and the leverage ratio was 15.30%. The company was considered well capitalized.
Material Changes Versus Prior Comparable Period
- Net income declined 3.4% and EPS declined from $0.54 to $0.52, primarily reflecting lower net interest income and higher operating expenses.
- Net interest income decreased 2.2% as the net interest margin contracted 17 basis points. Management attributed the decline to lower yields on loans and securities, partly offset by lower funding costs.
- Noninterest income increased 7.0%, driven mainly by higher deposit service charges and trust income. Deposit service charges benefited from a new overdraft privilege program implemented in the third quarter of 2016.
- Noninterest expense increased 3.8%. Data processing and ATM expense rose 37.5%, and other operating expenses rose 31.8%, including cybersecurity investigation and remediation costs and $125 thousand of bankcard losses.
- Average loans increased 6.4% year over year, while the average yield on loans declined from 4.94% to 4.75%. Average taxable securities increased, but their yield declined from 2.66% to 1.83%.
- Accumulated other comprehensive loss improved from $8.659 million at year-end 2016 to $7.584 million, reflecting a $1.075 million after-tax unrealized gain on available-for-sale securities.
- Operating cash flow declined from $6.678 million to $3.540 million. Investing cash outflow improved to $6.898 million from $8.570 million, while financing activities provided $3.038 million versus using $347 thousand in Q1 2016.
Guidance, Outlook, Risks and Unusual Items
- The filing does not provide formal earnings or revenue guidance. Management cautioned that first-quarter results are not necessarily indicative of full-year results.
- Principal forward-looking risks include interest-rate movements, economic conditions, unemployment, real-estate-market conditions, deposit flows, loan demand, competition, regulatory and accounting changes, technology initiatives, and the concentration of economic activity around state-funded universities in the company’s market area.
- The company disclosed digital-system intrusions in May 2016 and January 2017. The incidents involved unauthorized access to certain customer accounts and ATM-related losses. Reported thefts totaled $570 thousand in May 2016 and $1.838 million in January 2017; the company restored customer funds so that customers did not incur losses.
- The January 2017 incident remained under investigation at the filing date. Insurance coverage, litigation exposure, and investigation and remediation costs had not been fully determined or reliably estimated.
- Other real estate owned declined to $2.952 million, but $1.376 million of real-estate-secured loans were in various stages of foreclosure and could increase future OREO.
- Total troubled debt restructurings were $8.387 million, including $4.640 million in nonaccrual status. No loans were modified as TDRs during either comparable first-quarter period.
- The company reported 314 temporarily impaired securities with fair value of $292.607 million and total unrealized losses of $5.343 million. Management concluded that these securities were not other-than-temporarily impaired.
- Recently issued accounting standards, including the current expected credit loss standard, leases, and other financial-instrument guidance, were under assessment. The filing does not provide a quantified adoption impact.
- Management stated that disclosure controls were effective as of March 31, 2017 and that no material changes occurred in internal control over financial reporting.
Important Facts for Investors to Verify
- Progress and final costs associated with the January 2017 cybersecurity intrusion, including insurance recoveries and any litigation or remediation obligations.
- Whether the lower net interest margin persists as loans and securities reprice and as interest rates change.
- Future credit losses, nonperforming loans, criticized loans, troubled debt restructurings, foreclosure activity, and the adequacy of the $8.261 million allowance.
- The disposition of $1.376 million of loans in foreclosure and any resulting increase in other real estate owned.
- Deposit mix trends, particularly continued migration away from time deposits, and the effect on funding costs and liquidity.
- The company’s ability to maintain strong capital ratios while supporting loan growth and making any future distributions.
- The eventual financial and regulatory impact of pending accounting standards, particularly the expected-credit-loss model.