NATIONAL BANKSHARES INC quarterly report, Q2 FY2016

National Bankshares, Inc. — 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 as a community bank in southwest Virginia through 26 full-service locations and one loan production office. The filing covers the unaudited quarter and six months ended June 30, 2016, compared with the corresponding 2015 periods. The company had 6,957,974 common shares outstanding as of August 3, 2016.

Key Financial Metrics

Metric	Three Months Ended June 30, 2016	Three Months Ended June 30, 2015	Six Months Ended June 30, 2016	Six Months Ended June 30, 2015
Total interest income	$10.292 million	$10.724 million	$20.776 million	$21.518 million
Net interest income	$9.229 million	$9.673 million	$18.645 million	$19.380 million
Provision for loan losses	$654 thousand	$355 thousand	$857 thousand	$556 thousand
Noninterest income	$2.618 million	$2.467 million	$4.959 million	$4.718 million
Noninterest expense	$6.238 million	$6.365 million	$12.922 million	$13.045 million
Net income	$3.865 million	$4.110 million	$7.644 million	$8.076 million
Basic and diluted EPS	$0.56	$0.59	$1.10	$1.16

Return on average assets was 1.28% for both the quarter and year-to-date period, versus 1.43% and 1.41%, respectively, in the prior-year periods.
Return on average equity was 8.66% for the quarter and 8.65% year to date, versus 9.61% and 9.55% in the prior-year periods.
Net interest margin declined to 3.52% for the quarter and 3.59% year to date, from 3.87% and 3.90%, respectively. Management attributed the decline primarily to lower earning-asset yields and a greater mix of securities relative to loans.
Dividends declared increased to $0.55 per share from $0.53 per share.
Total assets were $1.210 billion at June 30, 2016, up 0.88% from December 31, 2015. Net loans were $622.721 million, up 1.97%, while deposits were $1.022 billion, up 0.28%.
Securities increased to $442.836 million at carrying value, up 13.76% from year-end, while interest-bearing deposits declined 41.98% to $75.892 million.
Stockholders’ equity was $179.928 million, up 4.54% from December 31, 2015. Accumulated other comprehensive loss improved to $3.939 million from $7.936 million, principally because of unrealized securities gains.
Six-month operating cash flow was $7.819 million, compared with $8.949 million in 2015. Investing activities used $4.703 million, primarily reflecting purchases of available-for-sale securities. Financing activities used $948 thousand, including $3.827 million of dividends.

Material Changes Versus Comparable Periods

Quarterly net income decreased 5.96% and year-to-date net income decreased 5.35%, primarily reflecting lower net interest income and higher loan-loss provisions.
Net interest income declined 4.59% for the quarter and 3.79% year to date. The fully taxable-equivalent net interest margin fell 35 basis points for the quarter and 31 basis points year to date.
The provision for loan losses increased 84.2% for the quarter and 54.1% year to date.
Noninterest income increased 6.12% for the quarter and 5.11% year to date, supported by higher trust income, other income and realized securities gains.
Noninterest expense declined 2.00% for the quarter and 0.94% year to date. Lower intangible amortization and other real estate owned costs offset higher data-processing, technology, credit-card processing and other operating expenses.
Gross loans increased 1.92% from year-end. Commercial real estate loans increased 3.77% and commercial non-real-estate loans increased 11.06%, partially offset by declines in construction and public-sector lending.
Time deposits declined 6.68% from year-end as customers shifted funds toward demand and savings deposits in the low-rate environment.

Credit Quality, Liquidity, Capital and Risk Factors

The allowance for loan losses was $8.195 million, or 1.30% of loans, compared with $8.297 million, or 1.34%, at December 31, 2015. Net charge-offs were $959 thousand for the six months, producing an annualized net charge-off ratio of 0.31%.
Nonperforming loans were $6.205 million and total nonperforming assets were $9.630 million. The nonperforming-asset ratio was 1.52%, improved from 1.74% at year-end and 2.11% at June 30, 2015.
Other real estate owned declined to $3.425 million from $4.165 million at year-end. Properties totaling approximately $735 thousand were in various stages of foreclosure and could affect future OREO levels.
Total troubled debt restructurings were $9.183 million, including $4.454 million in nonaccrual status, compared with total TDRs of $13.453 million at year-end.
The company had no long-term debt, FHLB advances, purchased deposits, discount-window borrowings or short-term borrowings at June 30, 2016. The filing states that operating lease obligations were not material.
The loan-to-deposit ratio was 61.75%, below the company’s internal policy range of 65% to 75%. Management stated that liquidity was sufficient under tested scenarios and that the company was well capitalized.
Regulatory capital ratios were substantially above minimums: common equity Tier 1 and Tier 1 capital ratios were 24.18%, total capital was 25.28%, and the leverage ratio was 14.91%.
Principal risks include interest-rate movements, economic weakness, unemployment, real-estate values, deposit flows, loan demand and credit quality, competition, regulatory changes, technology initiatives and accounting changes. Management stated that there were no significant changes to the interest-rate-risk analysis from year-end 2015.
No material legal proceedings were reported. Management concluded that disclosure controls were effective as of June 30, 2016, with no material changes in internal control over financial reporting.

Guidance, Outlook and Unusual Items

The filing does not provide quantitative earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year results.
Management expects economic weakness, higher unemployment, reduced university funding or a reversal in the regional recovery to potentially increase delinquencies, foreclosures and credit losses.
Other income benefited from vendor signing incentives, while 2015 other real estate owned expense included a one-time write-down. Certain core deposit intangibles became fully amortized, reducing amortization expense in 2016.
Two commercial real estate loans totaling $3.008 million were modified in troubled debt restructurings during the quarter. The loans remained on nonaccrual status pending compliance with the company’s return-to-accrual policy.
The company is evaluating several recently issued accounting standards, including guidance on financial instruments, leases, share-based compensation and expected credit losses. The expected-loss standard is effective for SEC filers for fiscal years beginning after December 15, 2019; the filing does not quantify its potential impact.

Important Facts for Investors to Verify

Whether continued pressure on loan and securities yields further reduces net interest margin and earnings.
Whether the higher provision and net charge-off levels represent a temporary fluctuation or a developing credit trend.
The composition and performance of the growing commercial real estate and commercial non-real-estate portfolios.
Future foreclosure activity and potential changes in other real estate owned balances.
The sustainability of strong capital ratios and the $0.55-per-share dividend in relation to earnings and regulatory capital requirements.
The effect of future interest-rate changes on securities valuations, accumulated other comprehensive income, deposit costs and liquidity.
The eventual impact of the expected credit-loss accounting standard and other pending accounting pronouncements.