Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2020 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ NATIONAL BANKSHARES, INC. (Exact name of registrant as specified in its charter) Commission File Number 0-15204 Virginia (State ...

Part I [Business](index=4&type=section&id=Item%201.%20Business) National Bankshares, Inc, a financial holding company, operates a community bank in southwest Virginia, deriving primary revenue from loan interest and fees - National Bankshares, Inc is a financial holding company whose main operation is its wholly-owned community bank subsidiary, the National Bank of Blacksburg (NBB), originally chartered in 1891[10](index=10&type=chunk)[11](index=11&type=chunk) - NBB is a community-oriented bank offering a full range of retail and commercial banking services through twenty-four branch offices in southwest Virginia and one loan production office in Roanoke, Virginia[12](index=12&type=chunk) Operating Revenue Composition (2017-2019) | Class of Service | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Interest and Fees on Loans | 62.79% | 61.49% | 61.22% | | Interest on Investments | 18.09% | 22.02% | 21.55% | | Noninterest Income | 16.30% | 15.17% | 15.62% | - The company's market area in southwest Virginia has a diverse economic base including education (Virginia Tech, Radford University), manufacturing, agriculture, tourism, and healthcare[32](index=32&type=chunk)[33](index=33&type=chunk) - The company has experienced two cybersecurity incidents and has implemented measures to mitigate risk, including limiting certain online transactions and requiring assurances from key vendors[37](index=37&type=chunk) - As a result of the EGRRCPA in 2018, the company, with consolidated assets under **$3 billion**, qualifies as a small bank holding company and is no longer subject to regulatory capital requirements on a consolidated basis since **August 2018**[45](index=45&type=chunk)[51](index=51&type=chunk) [Risk Factors](index=17&type=section&id=Item%201A.%20Risk%20Factors) The company faces significant risks from economic downturns, interest rate fluctuations, cybersecurity threats, competition, and regulatory changes - Economic downturns could lead to **higher loan delinquencies and defaults**, negatively impacting financial results, and a decline in the local real estate market would also deteriorate the value of loan collateral[80](index=80&type=chunk)[82](index=82&type=chunk) - The company's information systems are vulnerable to security breaches, having experienced **two cyber-intrusions in May 2016 and January 2017** where customer information was compromised[95](index=95&type=chunk)[97](index=97&type=chunk) - The company has incurred costs for forensic investigations, legal expenses, and system upgrades following past cyber-attacks and anticipates that future attacks are probable, which could result in additional costs[100](index=100&type=chunk) - The upcoming **Current Expected Credit Losses (CECL)** accounting standard, effective January 1, 2023 for the company, is expected to significantly impact required credit reserves and will incur costs for implementation[106](index=106&type=chunk) - The recent **coronavirus outbreak** is identified as a risk that could negatively impact employees and customers, potentially leading to increased loan delinquencies, defaults, and disruptions to operations[112](index=112&type=chunk)[113](index=113&type=chunk) [Unresolved Staff Comments](index=24&type=section&id=Item%201B.%20Unresolved%20Staff%20Comments) The company reports no unresolved staff comments from the SEC - There are no unresolved staff comments[115](index=115&type=chunk) [Properties](index=24&type=section&id=Item%202.%20Properties) The company's banking subsidiary owns its headquarters and seventeen branch offices, while leasing six branches and one loan production office - NBB owns its headquarters, main office, and 17 branch offices, while leasing 6 branch locations and a loan production office[116](index=116&type=chunk) [Legal Proceedings](index=24&type=section&id=Item%203.%20Legal%20Proceedings) The company and its subsidiaries are not currently involved in any material pending legal proceedings - The company is not involved in any material pending legal proceedings[117](index=117&type=chunk) [Mine Safety Disclosures](index=24&type=section&id=Item%204.%20Mine%20Safety%20Disclosures) This section is not applicable to the company's operations - Not applicable[118](index=118&type=chunk) Part II [Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities](index=24&type=section&id=Item%205.%20Market%20for%20Registrant's%20Common%20Equity%2C%20Related%20Stockholder%20Matters%20and%20Issuer%20Purchases%20of%20Equity%20Securities) The company's stock trades on Nasdaq under "NKSH" with an active share repurchase program, and its five-year return outperformed the Nasdaq Bank Index - The company's common stock is traded on the Nasdaq Capital Market under the symbol **"NKSH"**[119](index=119&type=chunk) - A share repurchase program authorized the buyback of up to **1,000,000 shares**, valid from June 1, 2019, to May 31, 2020; in 2019, the company repurchased **468,400 shares**[121](index=121&type=chunk)[123](index=123&type=chunk) Stock Performance Comparison (2014-2019) | Index | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | **NATIONAL BANKSHARES, INC.** | $100 | $121 | $153 | $165 | $136 | $173 | | **NASDAQ COMPOSITE INDEX** | $100 | $107 | $117 | $151 | $147 | $201 | | **NASDAQ BANK INDEX** | $100 | $108 | $150 | $158 | $133 | $167 | [Selected Financial Data](index=26&type=section&id=Item%206.%20Selected%20Financial%20Data) The company's five-year financial data shows total assets reaching $1.32 billion and net income of $17.5 million for the year ended December 31, 2019 Selected Financial Data (2015-2019) | ($ in thousands, except per share data) | 2019 | 2018 | 2017 | 2016 | 2015 | | :--- | :--- | :--- | :--- | :--- | :--- | | **Net income** | $17,466 | $16,151 | $14,092 | $14,942 | $15,833 | | **Diluted net income per share** | $2.65 | $2.32 | $2.03 | $2.15 | $2.28 | | **Cash dividends declared per share** | $1.39 | $1.21 | $1.17 | $1.16 | $1.14 | | **Total assets** | $1,321,837 | $1,256,032 | $1,256,757 | $1,233,942 | $1,203,519 | | **Total deposits** | $1,119,753 | $1,051,942 | $1,059,734 | $1,043,442 | $1,018,859 | | **Stockholders' equity** | $183,726 | $190,238 | $184,896 | $178,263 | $172,114 | | **Return on average assets** | 1.39% | 1.29% | 1.14% | 1.24% | 1.37% | | **Return on average equity** | 9.87% | 8.65% | 7.64% | 8.30% | 9.22% | [Management's Discussion and Analysis of Financial Condition and Results of Operations](index=27&type=section&id=Item%207.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) Net income rose to $17.5 million in 2019, driven by higher noninterest income and lower expenses, despite a slight compression in net interest margin Key Performance Ratios (2018-2019) | Ratio | 2019 | 2018 | | :--- | :--- | :--- | | Return on average assets | 1.39% | 1.29% | | Return on average equity | 9.87% | 8.65% | | Basic net earnings per common share | $2.65 | $2.32 | | Net interest margin (Non-GAAP) | 3.29% | 3.36% | - Total assets grew by **$65.8 million (5.24%)** to **$1.32 billion** at year-end 2019, while deposits increased by **$67.8 million (6.45%)**[168](index=168&type=chunk)[240](index=240&type=chunk) Asset Quality Indicators (as of Dec 31) | ($ in thousands) | 2019 | 2018 | | :--- | :--- | :--- | | Nonperforming loans | $3,375 | $3,420 | | Other real estate owned | $1,612 | $2,052 | | Allowance for loan losses to loans | 0.94% | 1.04% | | Net charge-off ratio | 0.09% | 0.07% | - Net interest income decreased slightly to **$37.8 million** in 2019 from $38.2 million in 2018, with the net interest margin compressing from **3.36% to 3.29%**[172](index=172&type=chunk)[176](index=176&type=chunk) - Noninterest income increased to **$8.8 million** in 2019 from $7.7 million in 2018, largely due to a **$0.5 million** insurance recovery and **$0.6 million** in realized securities gains[199](index=199&type=chunk)[204](index=204&type=chunk)[205](index=205&type=chunk) - Noninterest expense decreased to **$25.8 million** in 2019 from $27.3 million in 2018, as the prior year included a **$2.0 million** write-down related to cybersecurity breaches[208](index=208&type=chunk)[216](index=216&type=chunk) - The company experienced two cybersecurity intrusions in May 2016 and January 2017, resulting in total fund thefts of **$2.4 million**, partially offset by insurance recoveries[219](index=219&type=chunk)[220](index=220&type=chunk) [Quantitative and Qualitative Disclosures About Market Risk](index=57&type=section&id=Item%207A.%20Quantitative%20and%20Qualitative%20Disclosures%20About%20Market%20Risk) This section refers to the Management's Discussion and Analysis for information regarding market risk - Information regarding market risk is provided in the "Interest Rate Sensitivity" and "Derivatives and Market Risk Exposure" sections of the MD&A[316](index=316&type=chunk) [Financial Statements and Supplementary Data](index=58&type=section&id=Item%208.%20Financial%20Statements%20and%20Supplementary%20Data) This section contains the company's audited consolidated financial statements, notes, and the independent auditor's unqualified opinion Consolidated Balance Sheet Highlights (as of Dec 31) | ($ in thousands) | 2019 | 2018 | | :--- | :--- | :--- | | Total Assets | $1,321,837 | $1,256,032 | | Loans, net | $726,588 | $702,409 | | Total Deposits | $1,119,753 | $1,051,942 | | Total Liabilities | $1,138,111 | $1,065,794 | | Total Stockholders' Equity | $183,726 | $190,238 | Consolidated Income Statement Highlights (Year Ended Dec 31) | ($ in thousands) | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Net Interest Income | $37,767 | $38,177 | $37,135 | | Provision for (recovery of) loan losses | $126 | $(81) | $157 | | Noninterest Income | $8,790 | $7,729 | $7,636 | | Noninterest Expense | $25,754 | $27,276 | $24,229 | | Net Income | $17,466 | $16,151 | $14,092 | - The independent auditor, Yount, Hyde & Barbour, P.C., issued an **unqualified opinion** on the consolidated financial statements and on the effectiveness of the company's internal control over financial reporting as of December 31, 2019[562](index=562&type=chunk)[568](index=568&type=chunk) [Changes In and Disagreements With Accountants on Accounting and Financial Disclosure](index=109&type=section&id=Item%209.%20Changes%20In%20and%20Disagreements%20With%20Accountants%20on%20Accounting%20and%20Financial%20Disclosure) The company reports no changes in or disagreements with its accountants - None reported[575](index=575&type=chunk) [Controls and Procedures](index=109&type=section&id=Item%209A.%20Controls%20and%20Procedures) Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2019 - The company's principal executive officer and principal financial officer concluded that **disclosure controls and procedures were effective** as of December 31, 2019[575](index=575&type=chunk) - Management's assessment concluded that the company maintained **effective internal control over financial reporting** as of December 31, 2019, based on the COSO 2013 framework[580](index=580&type=chunk) [Other Information](index=110&type=section&id=Item%209B.%20Other%20Information) There is no other information to report in this section - None[582](index=582&type=chunk) Part III [Directors, Executive Officers and Corporate Governance](index=110&type=section&id=Item%2010.%20Directors%2C%20Executive%20Officers%20and%20Corporate%20Governance) Information regarding directors and corporate governance is incorporated by reference from the 2020 Proxy Statement, while executive officer information is in Part I - Required information is incorporated by reference to the Company's definitive Proxy Statement for the 2020 Annual Meeting of Stockholders[583](index=583&type=chunk) - Information about executive officers is included in Part I, Item 1 of this Form 10-K[583](index=583&type=chunk) [Executive Compensation](index=111&type=section&id=Item%2011.%20Executive%20Compensation) Required information on executive compensation is incorporated by reference from the company's 2020 Proxy Statement - Required information is incorporated by reference to the Company's Proxy Statement[587](index=587&type=chunk) [Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters](index=111&type=section&id=Item%2012.%20Security%20Ownership%20of%20Certain%20Beneficial%20Owners%20and%20Management%20and%20Related%20Stockholder%20Matters) Security ownership information is incorporated by reference from the 2020 Proxy Statement, and the company has no equity compensation plans - Required information is incorporated by reference to the Company's Proxy Statement[588](index=588&type=chunk) - As of December 31, 2019, the Company **does not have any equity compensation plans** in effect[588](index=588&type=chunk) [Certain Relationships and Related Transactions, and Director Independence](index=111&type=section&id=Item%2013.%20Certain%20Relationships%20and%20Related%20Transactions%2C%20and%20Director%20Independence) Information on related party transactions and director independence is incorporated by reference from the 2020 Proxy Statement - Required information is incorporated by reference to the Company's Proxy Statement[589](index=589&type=chunk) [Principal Accounting Fees and Services](index=111&type=section&id=Item%2014.%20Principal%20Accounting%20Fees%20and%20Services) Information regarding fees paid to the principal accountant is incorporated by reference from the 2020 Proxy Statement - Required information is incorporated by reference to the Company's Proxy Statement[590](index=590&type=chunk) Part IV [Exhibits, Financial Statement Schedules](index=112&type=section&id=Item%2015.%20Exhibits%2C%20Financial%20Statement%20Schedules) This section lists the financial statements and exhibits filed with the Form 10-K, including corporate governance and material contract documents - This item lists the consolidated financial statements included in Item 8 of the report[592](index=592&type=chunk) - A detailed list of exhibits filed with the Form 10-K is provided, including articles of incorporation, bylaws, and various management compensation agreements[593](index=593&type=chunk) [Form 10-K Summary](index=113&type=section&id=Item%2016.%20Form%2010-K%20Summary) This section is not applicable - Not applicable[595](index=595&type=chunk)

Part I – Financial Information [Financial Statements](index=3&type=section&id=Item%201.%20Financial%20Statements) This section presents the unaudited consolidated financial statements for National Bankshares, Inc. as of and for the periods ended September 30, 2019, including balance sheets, statements of income, comprehensive income, changes in stockholders' equity, and cash flows, along with accompanying notes [Consolidated Balance Sheets](index=4&type=section&id=Consolidated%20Balance%20Sheets) As of September 30, 2019, total assets were **$1.27 billion**, a slight increase from **$1.26 billion** at December 31, 2018, driven by interest-bearing deposits and loans, offset by a decrease in securities available for sale | (in thousands) | (Unaudited) Sep 30, 2019 | Dec 31, 2018 | | :--- | :--- | :--- | | **Total Assets** | **$1,272,721** | **$1,256,032** | | Loans, net | $715,025 | $702,409 | | Securities available for sale, at fair value | $334,150 | $425,010 | | Interest-bearing deposits | $135,490 | $43,491 | | **Total Liabilities** | **$1,084,733** | **$1,065,794** | | Total deposits | $1,068,027 | $1,051,942 | | **Total Stockholders' Equity** | **$187,988** | **$190,238** | [Consolidated Statements of Income](index=6&type=section&id=Consolidated%20Statements%20of%20Income) For Q3 2019, net income was **$4.25 million**, nearly flat year-over-year, while nine-month net income increased to **$12.69 million** from **$11.59 million**, driven by lower noninterest expenses | (in thousands, except per share data) | Three Months Ended Sep 30, 2019 | Three Months Ended Sep 30, 2018 | | :--- | :--- | :--- | | Net interest income | $9,423 | $9,700 | | Provision for loan losses | $95 | $223 | | Noninterest income | $2,098 | $1,914 | | Noninterest expense | $6,386 | $6,463 | | **Net Income** | **$4,252** | **$4,251** | | **Fully diluted net income per common share** | **$0.65** | **$0.61** | | (in thousands, except per share data) | Nine Months Ended Sep 30, 2019 | Nine Months Ended Sep 30, 2018 | | :--- | :--- | :--- |\ | Net interest income | $28,147 | $28,684 | | Provision for loan losses | $350 | $93 | | Noninterest income | $6,443 | $5,805 | | Noninterest expense | $19,304 | $21,051 | | **Net Income** | **$12,689** | **$11,588** | | **Fully diluted net income per common share** | **$1.92** | **$1.67** | [Consolidated Statements of Cash Flows](index=13&type=section&id=Consolidated%20Statements%20of%20Cash%20Flows) For the nine months ended September 30, 2019, net cash provided by operating activities was **$12.4 million**, with net cash used in investing activities of **$4.2 million** and financing activities of **$6.8 million**, primarily due to common stock repurchases and dividends | (in thousands) | Nine Months Ended Sep 30, 2019 | Nine Months Ended Sep 30, 2018 | | :--- | :--- | :--- | | Net cash provided by operating activities | $12,361 | $14,245 | | Net cash used in investing activities | ($4,238) | ($9,044) | | Net cash used in financing activities | ($6,799) | ($6,594) | | **Net change in cash and due from banks** | **$1,324** | **($1,393)** | [Notes to Consolidated Financial Statements](index=15&type=section&id=Notes%20to%20Consolidated%20Financial%20Statements) The notes provide detailed information on accounting policies and financial statement line items, including the adoption of new accounting standards for leases, loan portfolio analysis, and fair value measurements - The company adopted ASU No. **2016-02**, "Leases (Topic 842)" on January 1, 2019, using a prospective approach, resulting in the recognition of a right-of-use asset and a lease liability for leases with terms greater than 12 months, with no cumulative effect adjustment to retained earnings[36](index=36&type=chunk)[38](index=38&type=chunk) - The loan portfolio grew to **$722.3 million** as of September 30, 2019, from **$709.8 million** at year-end 2018, with commercial real estate representing the largest segment at **$360.5 million**[41](index=41&type=chunk) - Total troubled debt restructurings (TDRs) decreased to **$5.26 million** at September 30, 2019, from **$5.66 million** at December 31, 2018[95](index=95&type=chunk) [Management's Discussion and Analysis of Financial Condition and Results of Operations](index=44&type=section&id=Item%202.%20Management%27s%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) Management discusses the company's financial condition and results of operations, highlighting key performance metrics, asset quality, balance sheet changes, and income statement trends, with nine-month net income rising to **$12.69 million** from **$11.59 million** year-over-year [Performance Summary](index=55&type=section&id=Performance%20Summary) For the nine months ended September 30, 2019, the company's performance improved year-over-year, with Return on Average Assets increasing to **1.34%** and Return on Average Equity rising to **9.13%**, despite a slight compression in net interest margin to **3.31%** | Performance Ratios | Nine Months Ended Sep 30, 2019 | Nine Months Ended Sep 30, 2018 | | :--- | :--- | :--- | | Return on average assets | 1.34% | 1.28% | | Return on average equity | 9.13% | 8.61% | | Net interest margin | 3.31% | 3.37% | | Noninterest margin | 1.45% | 1.41% | [Asset Quality](index=57&type=section&id=Asset%20Quality) Asset quality remained stable as of September 30, 2019, with nonperforming loans increasing to **$4.1 million** from **$3.4 million** at year-end 2018, and the allowance for loan losses to total loans decreasing slightly to **1.01%** | Asset Quality Indicators | Sep 30, 2019 | Dec 31, 2018 | | :--- | :--- | :--- | | Nonperforming loans | $4,076 | $3,420 | | Other real estate owned | $1,470 | $2,052 | | Allowance for loan losses to loans | 1.01% | 1.04% | | Ratio of nonperforming assets to loans + OREO | 0.77% | 0.77% | | Ratio of allowance for loan losses to nonperforming loans | 178.16% | 216.08% | - The allowance for loan losses decreased to **$7.26 million** (**1.01%** of loans) at Sep 30, 2019, from **$7.39 million** (**1.04%** of loans) at Dec 31, 2018, influenced by improvements in certain loan ratings despite slight worsening in some economic indicators[239](index=239&type=chunk)[250](index=250&type=chunk) [Net Interest Income](index=61&type=section&id=Net%20Interest%20Income) For the nine months ended September 30, 2019, tax-equivalent net interest income was **$29.2 million**, a decrease from **$29.9 million** in the prior-year period, with the net interest margin compressing by **6 basis points** to **3.31%** due to higher deposit costs | (Nine Months Ended) | Sep 30, 2019 | Sep 30, 2018 | | :--- | :--- | :--- | | Average Yield on Earning Assets | 3.95% | 3.76% | | Average Rate on Interest-Bearing Liabilities | 0.87% | 0.54% | | **Interest Rate Spread** | **3.08%** | **3.22%** | | **Net Interest Margin** | **3.31%** | **3.37%** | - The cost of time deposits saw the most significant increase, rising **103 basis points** to **1.46%** for the nine months ended Sep 30, 2019, compared to the same period in 2018[272](index=272&type=chunk)[277](index=277&type=chunk) [Noninterest Income and Expense](index=65&type=section&id=Noninterest%20Income%20and%20Expense) For the nine months ended September 30, 2019, total noninterest income increased by **11.0%** to **$6.4 million**, while total noninterest expense decreased by **8.3%** to **$19.3 million**, primarily due to a prior-year write-down of an insurance receivable - Other income for the nine months ended Sep 30, 2019, increased by **$0.57 million**, or **70.8%**, primarily due to a **$0.54 million** recovery on a previously recognized insurance loss[279](index=279&type=chunk)[283](index=283&type=chunk) - Total noninterest expense for the nine months ended Sep 30, 2019, decreased by **$1.75 million**, largely because the comparable 2018 period included a **$2.01 million** write-down of an insurance receivable related to a cybersecurity breach[285](index=285&type=chunk)[292](index=292&type=chunk) - FDIC assessment expense decreased significantly due to the application of small bank assessment credits in Q3 2019[288](index=288&type=chunk) [Balance Sheet, Liquidity and Capital Resources](index=68&type=section&id=Balance%20Sheet%2C%20Liquidity%20and%20Capital%20Resources) Total assets grew **1.3%** to **$1.27 billion** from year-end 2018, with loans increasing **1.8%** to **$715 million** and deposits up **1.5%** to **$1.07 billion**, while stockholders' equity decreased to **$188.0 million** due to share repurchases - Loans, net of unearned income, increased by **1.76%** to **$722.3 million** at Sep 30, 2019, from Dec 31, 2018, with growth in real estate construction and consumer/commercial real estate loans[302](index=302&type=chunk) - Total deposits increased by **1.53%** to **$1.07 billion**, driven by growth in noninterest-bearing demand, savings, and time deposits, which offset a decrease in interest-bearing demand deposits[303](index=303&type=chunk) - The Company repurchased **468,400** shares during the first nine months of 2019, reducing stockholders' equity by **$18.5 million**, while the subsidiary bank's capital ratios remain well above regulatory minimums[310](index=310&type=chunk)[312](index=312&type=chunk) [Quantitative and Qualitative Disclosures About Market Risk](index=60&type=section&id=Item%203.%20Quantitative%20and%20Qualitative%20Disclosures%20About%20Market%20Risk) The company identifies interest rate risk as its most significant market risk and employs systems to measure exposure, with no significant changes to its market risk profile since the 2018 Form 10-K disclosures - The Company's primary market risk is interest rate risk, and there have been no significant changes to its risk exposure or management systems since the 2018 Form 10-K[321](index=321&type=chunk) [Controls and Procedures](index=60&type=section&id=Item%204.%20Controls%20and%20Procedures) Management, including the CEO and CFO, concluded that the company's disclosure controls and procedures were effective as of September 30, 2019, with no material changes to internal control over financial reporting during the third quarter - The principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective as of September 30, 2019[322](index=322&type=chunk) - No material changes were made to the company's internal control over financial reporting during the third quarter of 2019[323](index=323&type=chunk) Part II – Other Information [Legal Proceedings](index=62&type=section&id=Item%201.%20Legal%20Proceedings) The company reports that there are no pending or threatened legal proceedings expected to have a material impact on its financial condition - There are no pending or threatened legal proceedings that management believes may materially impact the company's financial condition[327](index=327&type=chunk) [Unregistered Sales of Equity Securities and Use of Proceeds](index=62&type=section&id=Item%202.%20Unregistered%20Sales%20of%20Equity%20Securities%20and%20Use%20of%20Proceeds) During the nine months ended September 30, 2019, the company repurchased a total of **468,400** shares at an average price of **$39.55** per share under its publicly announced repurchase program, which was renewed in May 2019 | Period | Total Shares Purchased | Average Price Paid Per Share | | :--- | :--- | :--- | | March 2019 | 452,400 | $39.78 | | August 2019 | 16,000 | $33.00 | | **Total YTD 2019** | **468,400** | **$39.55** | [Exhibits](index=62&type=section&id=Item%206.%20Exhibits) This section lists the exhibits filed with the Form 10-Q, including certifications by the CEO and CFO and XBRL data files - Exhibits filed include CEO and CFO certifications pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act, and financial statements formatted in XBRL[334](index=334&type=chunk)[336](index=336&type=chunk)

Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2019 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission File Number 0-15204 NATIONAL BANKSHARES, INC. (Exact name of registrant as specified in its charter) Virginia (State o ...

Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q [x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2019 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________ Commission File Number 0-15204 NATIONAL BANKSHARES, INC. (Exact name of registrant as specified in its charter) Virginia (State ...

Part I [Business](index=3&type=section&id=Item%201.%20Business) National Bankshares, Inc. operates as a financial holding company through its community bank subsidiary, offering retail and commercial banking services in southwest Virginia - National Bankshares, Inc. is a financial holding company whose main operation is its wholly-owned community bank subsidiary, the National Bank of Blacksburg ("NBB")[9](index=9&type=chunk) - NBB is a community-oriented bank offering a full range of retail and commercial banking services across twenty-four branch offices in southwest Virginia and one loan production office in Roanoke[11](index=11&type=chunk) Operating Revenue Composition (2016-2018) | Period | Class of Service | Percentage of Total Revenues | | :--- | :--- | :--- | | **Dec 31, 2018** | Interest and Fees on Loans | 61.49% | | | Interest on Investments | 22.02% | | | Noninterest Income | 15.17% | | **Dec 31, 2017** | Interest and Fees on Loans | 61.22% | | | Interest on Investments | 21.55% | | | Noninterest Income | 15.62% | | **Dec 31, 2016** | Interest and Fees on Loans | 61.12% | | | Interest on Investments | 22.96% | | | Noninterest Income | 14.81% | - The company's market area in southwest Virginia has a diverse economic base including education (Virginia Tech, Radford University), manufacturing, agriculture, tourism, healthcare, and retail[31](index=31&type=chunk)[32](index=32&type=chunk) - The company has experienced two cybersecurity incidents and has implemented measures to mitigate risk, such as limiting certain online transactions and requiring cybersecurity assurances from key vendors[37](index=37&type=chunk) - The Economic Growth, Regulatory Reform and Consumer Protection Act (EGRRCPA) of 2018 reduced or eliminated a number of regulatory requirements for smaller financial institutions like the Company[39](index=39&type=chunk)[55](index=55&type=chunk) [Risk Factors](index=10&type=section&id=Item%201A.%20Risk%20Factors) The company faces significant risks including credit losses from economic downturns, investment portfolio volatility, real estate market declines, and cybersecurity threats - Economic downturns could increase loan delinquencies and defaults, leading to higher loan losses and adversely affecting performance[72](index=72&type=chunk) - A focus on lending to small to mid-sized businesses increases credit risk, as these entities have fewer financial resources and are more vulnerable to economic downturns[75](index=75&type=chunk) - Rising market interest rates may negatively affect net interest income in the short term if interest-bearing liabilities reprice faster than interest-earning assets[76](index=76&type=chunk) - The company's information systems are vulnerable to interruptions and security breaches, having experienced two cyber-intrusions in May 2016 and January 2017 where customer information was compromised[87](index=87&type=chunk)[89](index=89&type=chunk)[91](index=91&type=chunk) - The company relies on third-party vendors for key operations like data processing and online banking, creating inherent risks related to vendor performance and stability[95](index=95&type=chunk) - New accounting guidance on Current Expected Credit Losses (CECL), effective January 1, 2020, is expected to significantly impact required credit reserves and incur additional costs for implementation[100](index=100&type=chunk) [Unresolved Staff Comments](index=14&type=section&id=Item%201B.%20Unresolved%20Staff%20Comments) The company reports no unresolved staff comments from the Securities and Exchange Commission - There are no unresolved staff comments[107](index=107&type=chunk) [Properties](index=14&type=section&id=Item%202.%20Properties) The banking subsidiary owns its headquarters and 17 branch offices, while leasing 6 branches and one loan production office - NBB owns its headquarters, main office, and 17 branch offices, while leasing 6 branch locations and one loan production office[108](index=108&type=chunk) [Legal Proceedings](index=14&type=section&id=Item%203.%20Legal%20Proceedings) The company is not involved in any material pending legal proceedings, having settled a lawsuit related to cybersecurity incidents in Q1 2019 - The Company is not currently involved in any material pending legal proceedings[109](index=109&type=chunk) - A lawsuit to recover damages from an insurance carrier related to two cybersecurity incidents was settled in Q1 2019[109](index=109&type=chunk) [Mine Safety Disclosures](index=14&type=section&id=Item%204.%20Mine%20Safety%20Disclosures) This item is not applicable to the company - Not applicable[110](index=110&type=chunk) Part II [Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities](index=14&type=section&id=Item%205.%20Market%20for%20Registrant's%20Common%20Equity%2C%20Related%20Stockholder%20Matters%20and%20Issuer%20Purchases%20of%20Equity%20Securities) National Bankshares, Inc.'s common stock trades on NASDAQ, with the company authorizing share repurchases in 2018 but executing none, and its stock underperformed market indices - The company's common stock is traded on the NASDAQ Capital Market under the symbol "NKSH"[111](index=111&type=chunk) - In 2018, the Board of Directors authorized the repurchase of a total of **250,000 shares** of equity securities, though no shares were repurchased during 2018 under this program[113](index=113&type=chunk) Stock Performance Comparison (2013-2018) | Index | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | **NATIONAL BANKSHARES, INC.** | 100 | 85 | 104 | 131 | 141 | 116 | | **NASDAQ COMPOSITE INDEX** | 100 | 115 | 123 | 134 | 174 | 169 | | **NASDAQ BANK INDEX** | 100 | 104 | 112 | 155 | 163 | 138 | [Selected Financial Data](index=16&type=section&id=Item%206.%20Selected%20Financial%20Data) Selected financial data for 2018 shows net income of **$16.15 million** and total assets of approximately **$1.26 billion**, with improved return ratios Selected Financial Data (2016-2018) | ($ in thousands) | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | | **Income Statement** | | | | | Net interest income | 38,177 | 37,135 | 36,764 | | Net income | 16,151 | 14,092 | 14,942 | | **Balance Sheet (End of Year)** | | | | | Total assets | 1,256,032 | 1,256,757 | 1,233,942 | | Total deposits | 1,051,942 | 1,059,734 | 1,043,442 | | Stockholders' equity | 190,238 | 184,896 | 178,263 | | **Selected Ratios** | | | | | Return on average assets | 1.29% | 1.14% | 1.24% | | Return on average equity | 8.65% | 7.64% | 8.30% | [Management's Discussion and Analysis of Financial Condition and Results of Operations](index=17&type=section&id=Item%207.%20Management's%20Discussion%20and%20Analysis%20of%20Financial%20Condition%20and%20Results%20of%20Operations) The company achieved improved profitability in 2018 with higher ROA and ROE, driven by a lower tax rate, despite a slight decline in net interest margin and flat total assets [Performance Summary and Growth](index=22&type=section&id=Performance%20Summary%20and%20Growth) The company's 2018 performance improved with increased ROA and ROE, while total assets remained stable at approximately **$1.26 billion**, supported by loan growth and reduced securities Key Performance Ratios (2017-2018) | Ratio | 2018 | 2017 | | :--- | :--- | :--- | | Return on average assets | 1.29% | 1.14% | | Return on average equity | 8.65% | 7.64% | | Net interest margin | 3.36% | 3.45% | | Noninterest margin | 1.40% | 1.34% | Balance Sheet Growth (2017-2018) | ($ in thousands) | 12/31/2018 | 12/31/2017 | | :--- | :--- | :--- | | Securities | 426,230 | 459,751 | | Loans, net | 702,409 | 660,144 | | Deposits | 1,051,942 | 1,059,734 | | Total assets | 1,256,032 | 1,256,757 | [Asset Quality](index=23&type=section&id=Asset%20Quality) Asset quality remained strong in 2018, with a low net charge-off ratio of **0.07%** and a decrease in other real estate owned, despite a slight rise in nonperforming loans Key Asset Quality Indicators (2017-2018) | ($ in thousands) | 12/31/2018 | 12/31/2017 | | :--- | :--- | :--- | | Nonperforming loans | 3,420 | 2,769 | | Other real estate owned | 2,052 | 2,817 | | Allowance for loan losses to loans | 1.04% | 1.19% | | Net charge-off ratio | 0.07% | 0.08% | - The allowance for loan losses was **$7.39 million** at year-end 2018, resulting in a recovery of **$81 thousand** for the year, compared to an allowance of **$7.93 million** and a provision of **$157 thousand** in 2017[165](index=165&type=chunk) [Net Interest Income](index=23&type=section&id=Net%20Interest%20Income) Net interest income increased by **2.81%** to **$38.2 million** in 2018, though the net interest margin declined to **3.36%** primarily due to the lower corporate tax rate impacting tax-equivalent yields - Net interest income increased by **$1.04 million** (**2.81%**) to **$38.18 million** in 2018[167](index=167&type=chunk) - The net interest margin decreased from **3.45%** in 2017 to **3.36%** in 2018, primarily due to a decline in the taxable-equivalent yield of tax-advantaged assets after the corporate tax rate fell from **35%** to **21%**[158](index=158&type=chunk)[169](index=169&type=chunk) - Interest expense increased by **$922 thousand** in 2018, partly due to competitive deposit pricing in a rising interest rate environment and short-term borrowings to meet loan demand[167](index=167&type=chunk) [Noninterest Income and Expense](index=27&type=section&id=Noninterest%20Income%20and%20Expense) Total noninterest income slightly increased to **$7.73 million** in 2018, while total noninterest expense significantly rose to **$27.28 million**, mainly due to a **$2.01 million** write-down of an insurance receivable Noninterest Income Comparison (2017-2018) | ($ in thousands) | 2018 | 2017 | | :--- | :--- | :--- | | Service charges on deposits | 2,678 | 2,776 | | Credit card fees | 1,431 | 1,205 | | Trust fees | 1,565 | 1,530 | | Bank-owned life insurance income | 901 | 758 | | **Total noninterest income** | **7,729** | **7,636** | Noninterest Expense Comparison (2017-2018) | ($ in thousands) | 2018 | 2017 | | :--- | :--- | :--- | | Salaries and employee benefits | 14,506 | 13,670 | | Data processing and ATM | 2,784 | 2,280 | | Write-down of insurance receivable | 2,010 | --- | | Other operating expenses | 3,891 | 4,507 | | **Total noninterest expense** | **27,276** | **24,229** | - A write-down of insurance receivables totaling **$2.01 million** was recognized in 2018, associated with two prior cybersecurity breaches[211](index=211&type=chunk) [Cybersecurity Risks and Incidents](index=29&type=section&id=Cybersecurity%20Risks%20and%20Incidents) The company experienced two cyber intrusions in 2016 and 2017, resulting in **$2.41 million** in total fund thefts, leading to a **$2.01 million** insurance receivable write-down in 2018 and subsequent security enhancements - The company experienced two cyber intrusions in May 2016 and January 2017, resulting in total fund thefts of **$2.41 million** (**$570 thousand** in 2016 and **$1.84 million** in 2017)[214](index=214&type=chunk)[216](index=216&type=chunk) - The company recognized an estimated loss of **$347 thousand** in 2016 and **$2.01 million** in 2018 related to the breaches, and currently has an insurance receivable of **$50 thousand**[216](index=216&type=chunk) - Litigation against the insurance carrier was settled during the first quarter of 2019, subject to a non-disclosure agreement[216](index=216&type=chunk) [Balance Sheet Analysis](index=33&type=section&id=Balance%20Sheet%20Analysis) Total assets remained stable at **$1.26 billion** in 2018, with a **6.3%** growth in the loan portfolio funded by a decrease in securities and a slight decline in total deposits - Total assets were **$1.26 billion** at year-end 2018, a slight decrease of **0.06%** from 2017[239](index=239&type=chunk) Loan Portfolio Composition (2017-2018) | ($ in thousands) | 2018 | 2017 | | :--- | :--- | :--- | | Real estate construction | 37,845 | 34,694 | | Consumer real estate | 175,456 | 166,965 | | Commercial real estate | 353,546 | 340,414 | | Commercial non real estate | 46,535 | 40,518 | | Public sector and IDA | 60,777 | 51,443 | | Consumer non real estate | 36,238 | 34,648 | | **Total loans** | **710,397** | **668,682** | - During the second quarter of 2018, the Company reclassified all held-to-maturity securities as available-for-sale[277](index=277&type=chunk) - Total deposits decreased by **0.74%** to **$1.052 billion** in 2018, primarily due to a decline in time deposits[285](index=285&type=chunk) [Liquidity and Capital Resources](index=43&type=section&id=Liquidity%20and%20Capital%20Resources) The company maintains strong liquidity and capital, with the subsidiary bank categorized as "well capitalized" and the holding company no longer subject to consolidated capital requirements due to regulatory changes - The company's loan to deposit ratio was **67.48%** at December 31, 2018, within its policy range of **65%** to **75%**[298](index=298&type=chunk) - As of August 2018, the Company qualifies as a small bank holding company under the EGRRCPA and is no longer subject to regulatory capital requirements on a consolidated basis[303](index=303&type=chunk)[498](index=498&type=chunk) Subsidiary Bank Capital Ratios (December 31, 2018) | Ratio | Actual Ratio | Minimum Requirement (with Buffer) | | :--- | :--- | :--- | | Common Equity Tier I Capital Ratio | 23.856% | 6.375% | | Tier I Capital Ratio | 23.856% | 7.875% | | Total Capital Ratio | 24.764% | 9.875% | | Leverage Ratio | 15.788% | 4.000% | [Quantitative and Qualitative Disclosures About Market Risk](index=45&type=section&id=Item%207A.%20Quantitative%20and%20Qualitative%20Disclosures%20About%20Market%20Risk) This section refers to market risk information detailed within the Management's Discussion and Analysis, specifically regarding interest rate sensitivity and derivatives - Information regarding market risk is provided in the "Interest Rate Sensitivity" and "Derivatives and Market Risk Exposure" sections of Item 7[313](index=313&type=chunk) [Financial Statements and Supplementary Data](index=46&type=section&id=Item%208.%20Financial%20Statements%20and%20Supplementary%20Data) This section presents the company's audited consolidated financial statements for 2016-2018, including balance sheets, income statements, and comprehensive notes [Consolidated Financial Statements](index=46&type=section&id=Consolidated%20Financial%20Statements) The consolidated financial statements show total assets of **$1.26 billion**, net loans of **$702.4 million**, and net income of **$16.2 million** for 2018 Consolidated Balance Sheet Highlights (December 31, 2018) | ($ in thousands) | Amount | | :--- | :--- | | Total Assets | 1,256,032 | | Loans, net | 702,409 | | Total Deposits | 1,051,942 | | Total Liabilities | 1,065,794 | | Total Stockholders' Equity | 190,238 | Consolidated Income Statement Highlights (Year Ended Dec 31, 2018) | ($ in thousands) | Amount | | :--- | :--- | | Net Interest Income | 38,177 | | Provision for (recovery of) loan losses | (81) | | Noninterest Income | 7,729 | | Noninterest Expense | 27,276 | | **Net Income** | **16,151** | [Notes to Consolidated Financial Statements](index=51&type=section&id=Notes%20to%20Consolidated%20Financial%20Statements) The notes provide detailed disclosures on accounting policies, including the allowance for loan losses, securities reclassification, employee benefit plans, and the adoption of new revenue recognition standards - In 2018, the company re-designated all of its held-to-maturity securities as available-for-sale to provide opportunities to maximize asset utilization (Note 3)[330](index=330&type=chunk)[397](index=397&type=chunk) - The allowance for loan losses methodology incorporates individual evaluation of impaired loans and collective evaluation of non-impaired loans based on historical loss rates and various risk factors (Note 5)[410](index=410&type=chunk) - The company's defined benefit pension plan had a funded status deficit of **$1.9 million** at year-end 2018, compared to a deficit of **$64 thousand** at year-end 2017 (Note 8)[479](index=479&type=chunk) - The company adopted the new revenue recognition standard (Topic 606) on January 1, 2018, which did not materially change revenue recognition methods but resulted in the reclassification of certain credit card processing expenses to be netted against fee income (Note 18)[550](index=550&type=chunk)[551](index=551&type=chunk)[381](index=381&type=chunk) [Changes In and Disagreements With Accountants on Accounting and Financial Disclosure](index=93&type=section&id=Item%209.%20Changes%20In%20and%20Disagreements%20With%20Accountants%20on%20Accounting%20and%20Financial%20Disclosure) The company reports no changes in or disagreements with its accountants regarding accounting principles, financial disclosure, or auditing scope - None reported[579](index=579&type=chunk) [Controls and Procedures](index=93&type=section&id=Item%209A.%20Controls%20and%20Procedures) Management concluded that the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2018 - The principal executive officer and principal financial officer concluded that the Company's disclosure controls and procedures are effective as of December 31, 2018[579](index=579&type=chunk) - Management believes the Company maintained effective internal control over financial reporting as of December 31, 2018, based on the COSO 2013 framework[584](index=584&type=chunk) [Other Information](index=94&type=section&id=Item%209B.%20Other%20Information) The company reports no other information for this item - None[587](index=587&type=chunk) Part III [Directors, Executive Officers and Corporate Governance](index=94&type=section&id=Item%2010.%20Directors%2C%20Executive%20Officers%20and%20Corporate%20Governance) This section lists executive officers and incorporates information on directors, audit committee, and corporate governance by reference from the 2019 Proxy Statement - F. Brad Denardo serves as President and Chief Executive Officer, David K. Skeens as Treasurer and Chief Financial Officer, and Lara E. Ramsey as Corporate Secretary[589](index=589&type=chunk) - The Board of Directors has a standing audit committee composed entirely of independent directors, with Dr. Lewis identified as the financial expert[590](index=590&type=chunk) - Information regarding directors, Section 16(a) compliance, and corporate governance is incorporated by reference from the 2019 Proxy Statement[593](index=593&type=chunk) [Executive Compensation](index=95&type=section&id=Item%2011.%20Executive%20Compensation) All required information regarding executive compensation is incorporated by reference from the company's Proxy Statement - Information is incorporated by reference from the Company's Proxy Statement[594](index=594&type=chunk) [Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters](index=95&type=section&id=Item%2012.%20Security%20Ownership%20of%20Certain%20Beneficial%20Owners%20and%20Management%20and%20Related%20Stockholder%20Matters) All required information regarding security ownership is incorporated by reference from the company's Proxy Statement - Information is incorporated by reference from the Company's Proxy Statement[595](index=595&type=chunk) [Certain Relationships and Related Transactions, and Director Independence](index=95&type=section&id=Item%2013.%20Certain%20Relationships%20and%20Related%20Transactions%2C%20and%20Director%20Independence) All required information on related party transactions and director independence is incorporated by reference from the company's Proxy Statement, with no equity compensation plans in effect - Information is incorporated by reference from the Company's Proxy Statement[596](index=596&type=chunk) - As of December 31, 2018, there are no equity compensation plans in effect[596](index=596&type=chunk) [Principal Accounting Fees and Services](index=95&type=section&id=Item%2014.%20Principal%20Accounting%20Fees%20and%20Services) All required information regarding fees paid to independent public accountants is incorporated by reference from the company's Proxy Statement - Information is incorporated by reference from the Company's Proxy Statement[597](index=597&type=chunk) Part IV [Exhibits, Financial Statement Schedules](index=96&type=section&id=Item%2015.%20Exhibits%2C%20Financial%20Statement%20Schedules) This section lists the financial statements included in Item 8 and provides a list of all exhibits filed with or incorporated by reference into the Annual Report - This section lists the consolidated financial statements included in Item 8 and provides an index of exhibits filed with the report, such as articles of incorporation, bylaws, and various certifications[599](index=599&type=chunk)[600](index=600&type=chunk) [Summary Information](index=97&type=section&id=Item%2016.%20Summary%20Information) This item is not applicable to the company - Not applicable[603](index=603&type=chunk)