Business Context and Reporting Period
National Bankshares, Inc. is a Virginia financial holding company whose principal operating subsidiary, National Bank of Blacksburg, is a community bank serving southwest Virginia. The bank provides commercial, real estate, consumer, deposit, trust, insurance and investment services through 25 branches and a loan production office. National Bankshares Financial Services is not a significant contributor to earnings.
This Form 10-K covers the fiscal year ended December 31, 2016, with comparative information for 2015 and 2014. Amounts are in thousands except per-share data. The filing was signed March 8, 2017.
Key Financial Metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total assets | $1,233,942 | $1,203,519 | +2.53% |
| Loans, net | $639,452 | $610,711 | +4.71% |
| Total securities | $440,409 | $389,288 | +13.13% |
| Total deposits | $1,043,442 | $1,018,859 | +2.41% |
| Stockholders’ equity | $178,263 | $172,114 | +3.57% |
| Net interest income | $36,764 | $38,731 | -5.08% |
| Noninterest income | $9,932 | $9,486 | +4.70% |
| Noninterest expense | $26,152 | $25,635 | +2.02% |
| Provision for loan losses | $1,650 | $2,009 | -17.87% |
| Net income | $14,942 | $15,833 | -5.63% |
| Diluted earnings per share | $2.15 | $2.28 | -5.70% |
| Cash dividends per share | $1.16 | $1.14 | +1.75% |
- Return on average assets was 1.24%, compared with 1.37% in 2015; return on average equity was 8.30%, compared with 9.22%.
- Net interest margin declined to 3.51% from 3.86%. The efficiency ratio increased to 52.17% from 49.41%.
- Net cash provided by operating activities was $17,533, compared with $20,529 in 2015. Investing activities used $32,223 and financing activities provided $16,512. Cash and due from banks increased to $13,974 from $12,152.
- The company had no discount-window borrowings, short-term borrowings or Federal Home Loan Bank advances at year-end and no material commitments for long-term debt or capital expenditures.
- At December 31, 2016, the loan-to-deposit ratio was 62.08%, below the company’s stated policy range of 65% to 75%. Management reported adequate liquidity under stress scenarios.
- Regulatory capital remained very strong. The consolidated common equity Tier 1, Tier 1, total capital and leverage ratios were 25.420%, 25.420%, 26.575% and 15.121%, respectively. The bank was categorized as well capitalized.
Material Changes Versus the Prior Comparable Period
- Profitability weakened primarily because interest income fell by $1,984 and net interest income declined by $1,967. Management attributed the pressure to the low-rate environment, lower loan and securities yields, and reinvestment of called securities at lower rates.
- Loan growth was concentrated in commercial real estate and consumer real estate. Commercial real estate loans increased to $336,457 from $309,378, while real estate construction loans declined to $36,345 from $48,251.
- Noninterest income increased by $446, led by higher deposit service charges, trust fees and realized gains on called securities. Credit card fees declined modestly.
- Noninterest expense increased by $517. Data processing and ATM expense increased 31.93% to $2,186 due to infrastructure upgrades, while intangible amortization fell 74.27% to $257 as certain intangibles became fully amortized.
- Asset quality improved overall: nonperforming loans declined to $5,855 from $6,682, nonperforming assets declined to $9,011 from $10,847, and net charge-offs declined to $1,647 from $1,975.
- The allowance for loan losses was essentially unchanged at $8,300 versus $8,297, but declined as a percentage of loans to 1.28% from 1.34%. Special mention loans increased to $13,519 from $6,144, while classified loans decreased to $3,052 from $6,071.
- Total troubled debt restructurings declined to $8,456 from $13,453, and accruing restructured loans declined to $3,769 from $8,814.
- The securities portfolio increased substantially, including securities available for sale of $304,282 versus $236,131. Unrealized losses on available-for-sale securities contributed to accumulated other comprehensive loss of $8,659 at year-end.
Guidance, Outlook, Risks and Unusual Items
- Management expected some benefit to 2017 net interest income from the Federal Reserve’s December 2016 rate increase and anticipated that future rate increases could improve earnings. The filing provides no formal earnings or revenue guidance.
- Management stated that liquidity was sufficient and that stress testing indicated adequate liquidity. The company relies primarily on customer deposits and has additional borrowing and securities-liquidity resources available.
- The loan portfolio is concentrated in the company’s southwest Virginia market and in commercial real estate. College housing and professional office building loans totaled $236,552, or approximately 36% of the loan portfolio, creating sensitivity to local real estate conditions and higher-education funding.
- Key risks include recession or unemployment increases, declining real estate values, small-business credit deterioration, interest-rate repricing risk, securities valuation changes, regulatory and compliance costs, competition, cybersecurity, third-party service-provider failures, pension obligations and changes in accounting standards.
- The company experienced cyber intrusions in May 2016 and January 2017. The filing states that customer information was compromised and that ATM-related thefts totaled $570 in May 2016 and $1,838 in January 2017. The company restored affected customer funds. The January 2017 investigation and insurance claims process were ongoing, and related litigation, investigation and remediation costs could not yet be reasonably estimated.
- There were $130,252 of commitments to extend credit, $20,499 of standby letters of credit and $17,526 of mortgage loans sold with potential recourse. Management considered the recourse reserve immaterial and stated that no recourse provisions had been invoked.
- The company had $321 of loans in process of foreclosure and expects some additional foreclosures, which could increase other-real-estate-owned costs.
- New current expected credit loss guidance was expected to apply beginning January 1, 2021. Management stated that implementation could significantly affect credit reserves and other financial metrics, but had not quantified the effect.
- The independent auditor issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal control over financial reporting were effective at December 31, 2016.
Most Important Facts for Investors to Verify
- Whether the decline in net interest margin and earnings stabilizes as interest rates rise, including the timing of deposit repricing relative to loan and securities yields.
- The credit performance of the expanding commercial real estate portfolio, particularly college housing and professional office exposures.
- Whether increased special mention loans lead to higher nonperforming assets, provisions or charge-offs despite current asset-quality improvements.
- The ultimate insurance recovery and total financial, legal and remediation costs from the May 2016 and January 2017 cyber incidents.
- The impact of CECL implementation on the allowance for loan losses, capital and earnings.
- The sustainability of dividends given the 54.02% 2016 payout ratio and regulatory restrictions on dividends from the subsidiary bank.
- The company’s ability to maintain strong capital and liquidity while supporting loan growth without increasing reliance on higher-cost funding.