National Bankshares, Inc. — Q1 2018 Form 10-Q Summary
Business context and reporting period
National Bankshares, Inc. is a Virginia financial holding company operating primarily through The National Bank of Blacksburg, a community bank serving southwest Virginia through 24 branches and a loan production office. The company provides commercial, real estate, consumer, deposit, trust, insurance and investment services. This unaudited Form 10-Q covers the three months ended March 31, 2018, with comparisons to the three months ended March 31, 2017 and December 31, 2017 balance-sheet amounts.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Total assets | $1.271 billion | Not provided | +1.1% from Dec. 31, 2017 |
| Net interest income | $9.403 million | $9.210 million | +2.1% |
| Noninterest income | $2.023 million | $1.850 million | +9.4% |
| Noninterest expense | $8.164 million | $6.283 million | +29.9% |
| Net income | $3.296 million | $3.649 million | -9.7% |
| Basic and diluted EPS | $0.47 | $0.52 | -$0.05 |
| Net interest margin | 3.38% | 3.49% | -11 basis points |
| Return on average assets | 1.32% | 1.21% | +11 basis points |
| Return on average equity | 8.85% | 8.20% | +65 basis points |
Interest income increased to $10.484 million from $10.238 million, while interest expense increased to $1.081 million from $1.028 million. The company recorded a $472,000 recovery of loan losses in Q1 2018, compared with a $59,000 provision in Q1 2017.
The effective tax rate declined to 11.73% from 22.66%, primarily reflecting the Tax Cuts and Jobs Act reduction in the federal statutory rate from 35% to 21%. The lower tax rate partially offset lower pre-tax income.
Financial condition, liquidity and capital
- Loans, net of unearned income and deferred fees, were $658.663 million at March 31, 2018, down 1.41% from December 31, 2017. Commercial real estate loans declined $7.049 million and real estate construction loans declined $2.613 million.
- Total deposits were $1.073 billion, up 1.25% from year-end. Demand and savings deposits increased, while time deposits declined $3.249 million.
- Available-for-sale and held-to-maturity securities totaled $460.116 million at carrying value. Interest-bearing deposits increased to $76.571 million from $51.233 million at year-end.
- Stockholders’ equity was $185.537 million, up 0.35% from December 31, 2017. Accumulated other comprehensive loss increased to $12.350 million, primarily because of a $2.655 million after-tax unrealized loss on available-for-sale securities.
- The company reported no long-term debt, capital lease obligations, short-term borrowings or Federal Home Loan Bank advances at March 31, 2018.
- Cash and due from banks totaled $10.598 million. Management stated that liquidity was sufficient under tested scenarios and that the bank was well capitalized.
- The loan-to-deposit ratio was 61.39%, below the company’s stated policy range of 65% to 75%.
- Regulatory capital ratios were substantially above minimums: Common Equity Tier 1 capital 23.97%, Tier 1 capital 23.97%, total capital 24.88% and leverage 15.58%.
Material changes versus comparable periods
- Reported net income decreased 9.7% despite higher net interest income, higher noninterest income, the loan-loss recovery and the lower tax rate.
- Noninterest expense increased $1.881 million, primarily because of a $1.724 million write-down of an insurance receivable related to prior cybersecurity incidents, higher data-processing and ATM costs, and higher other real estate owned costs.
- Credit and debit card fees increased 41.0%, partly because the company sold its merchant-processing business in late 2017, reducing related interchange expense. Bank-owned life insurance income increased 59.4% following a $10 million BOLI purchase in June 2017.
- The allowance for loan losses declined to $7.391 million, or 1.12% of loans, from $7.925 million, or 1.19%, at year-end. Net charge-offs were $62,000, compared with $98,000 in Q1 2017.
- Nonperforming loans declined to $2.764 million from $5.680 million at March 31, 2017 and were similar to year-end 2017. Nonperforming assets were $5.505 million, or 0.83% of loans plus other real estate owned.
- Total troubled debt restructurings increased to $10.648 million from $7.897 million at year-end, including $2.758 million in nonaccrual TDRs.
- The company adopted revenue-recognition, financial-instrument and pension-presentation standards effective January 1, 2018. Management reported no material impact on net income or the consolidated financial statements, although certain credit-card costs were reclassified.
Guidance, outlook, risks and unusual items
The filing does not provide formal earnings or revenue guidance. Management noted that results for the quarter are not necessarily indicative of full-year results. Interest-rate movements, economic conditions, competition, loan demand, deposit flows, real estate values, unemployment, regulatory changes and technology initiatives may materially affect future performance.
The most significant unusual item was the $1.724 million pre-tax write-down of the insurance receivable associated with two 2016 and 2017 cybersecurity intrusions. Funds stolen in the incidents totaled $2.408 million and were restored to customers. Based on correspondence received in April 2018, the insurer may limit coverage to $500,000, implying a likely reimbursement of approximately $337,000. The company stated that it intends to pursue litigation for additional recovery; any recovery above the recorded receivable would be recognized when received.
Cybersecurity remains an ongoing risk despite implemented remediation measures. The company incurred $41,000 of cybersecurity-related costs in Q1 2018 and maintained insurance, while acknowledging that insurance may not cover financial, reputational or customer-goodwill losses.
Other risks include potential deterioration in commercial and residential real estate, higher unemployment or bankruptcies, rising rates affecting variable-rate borrowers and securities values, deposit outflows, interest-rate sensitivity and the judgment required in estimating the allowance for loan losses. The company is assessing forthcoming lease, current expected credit loss, debt-security premium amortization and hedging-accounting standards; the filing does not provide a quantified implementation impact.
Important facts for investors to verify
- Confirm the ultimate insurance recovery and legal resolution related to the cybersecurity incidents; the recorded receivable was reduced to approximately $337,000.
- Assess whether the recovery of loan losses and lower tax rate are sustainable, and separate them from recurring operating performance.
- Monitor commercial real estate and construction exposure, TDR growth, criticized loans and changes in the allowance for loan losses.
- Evaluate the effect of declining net interest margin and rising deposit costs under further interest-rate changes.
- Review the company’s substantial securities portfolio, including $9.260 million of unrealized losses on temporarily impaired securities at March 31, 2018.
- Confirm liquidity and capital remain strong if deposits decline, loan demand increases or securities become less liquid.
- Review the eventual impact of the pending credit-loss and lease accounting standards, which management had not quantified.