Business Context and Reporting Period
Company: National Bankshares, Inc. (NBI)
Reporting Period: Fiscal Year Ended December 31, 2010
Business Overview: NBI is a financial holding company operating primarily through its wholly-owned subsidiary, the National Bank of Blacksburg (NBB), a community bank serving southwest Virginia. The company also owns National Bankshares Financial Services, Inc., which provides insurance and investment services but contributes insignificantly to net income. The bank operates 24 branch offices and focuses on retail and commercial banking, with lending concentrated in small and mid-sized businesses and individuals.
Key Financial Metrics
| Metric ($ in thousands, except per share) | 2010 | 2009 |
|---|---|---|
| Total Assets | $1,022,238 | $982,367 |
| Total Deposits | $884,583 | $852,112 |
| Net Loans (Net of Allowance) | $568,779 | $583,021 |
| Net Interest Income | $37,981 | $34,662 |
| Noninterest Income | $8,347 | $8,804 |
| Noninterest Expense | $23,127 | $23,853 |
| Net Income | $15,569 | $14,319 |
| Diluted EPS | $2.24 | $2.06 |
| Return on Average Assets (ROA) | 1.57% | 1.47% |
| Return on Average Equity (ROE) | 12.07% | 12.23% |
| Net Interest Margin | 4.52% | 4.23% |
| Stockholders' Equity | $129,187 | $122,076 |
Material Changes vs. Prior Period
- Profitability: Net income increased 8.7% to $15.57 million, driven by a 9.6% increase in net interest income and a reduction in FDIC assessments. Diluted earnings per share rose to $2.24 from $2.06.
- Interest Income/Expense: Total interest income decreased slightly ($1.35 million) due to lower yields on loans and securities. However, interest expense dropped significantly by $4.67 million (29.5%) as higher-priced certificates of deposit renewed at lower rates and noninterest-bearing deposits grew.
- Asset Quality: Nonperforming loans increased to $8.42 million (1.46% of loans) from $6.75 million in 2009. The allowance for loan losses increased to $7.66 million (1.33% of loans) from $6.93 million (1.17%). Net charge-offs rose to 0.46% of average loans from 0.10%.
- Balance Sheet: Total assets grew 4.1% to $1.02 billion. Deposits increased 3.8% to $884.6 million, while net loans declined 2.4% to $568.8 million. The excess liquidity was deployed into securities, which grew 6.2%.
- Expenses: Total noninterest expense decreased 3.0% to $23.13 million. This was primarily due to a $647,000 decrease in FDIC assessments (from $1.73 million to $1.08 million) and reduced salary and benefits costs.
Guidance, Outlook, Risks, and Contingencies
- Economic Outlook: Management notes that the local economy in southwest Virginia is experiencing higher unemployment and slow growth due to the prolonged national recession. State funding cuts to local universities (major employers) pose a risk to employment levels.
- Asset Quality Risks: The company anticipates that nonperforming assets may continue to increase as the economy recovers slowly. Management expects troubled debt restructurings (TDRs) to continue until the economy improves.
- Interest Rate Sensitivity: In a rising rate environment, the company's net interest margin could narrow in the short term because interest-bearing liabilities (deposits) reprice faster than interest-earning assets (loans). Conversely, if rates remain low, management does not anticipate further margin improvement.
- Regulatory Environment: The Dodd-Frank Act and new FDIC assessment rules have increased regulatory burdens and compliance costs. The company did not participate in TARP.
- Capital: The company is "well capitalized" with Tier 1 risk-based capital ratios of 18.2% (consolidated) and 17.8% (bank), significantly exceeding regulatory minimums.
Investor Verification Checklist
- Allowance Adequacy: Verify if the 1.33% allowance for loan losses is sufficient given the rise in nonperforming loans to $8.42 million and the 0.46% net charge-off ratio.
- Loan Concentration: Review the 59% concentration of the loan portfolio in commercial real estate, including significant exposure to college housing and professional office buildings.
- Deposit Stability: Assess the sustainability of deposit growth driven by municipal deposits and risk-averse individuals seeking safety in a volatile market.
- Interest Rate Risk: Evaluate the impact of a potential rapid rise in interest rates on the net interest margin, given the company's liability-sensitive position.
- FDIC Assessments: Monitor future FDIC assessment trends, as the company prepaid assessments for 2010-2012 in late 2009, and future special assessments remain a possibility.