National Bankshares(NKSH) - 2018 Q4 - Annual Report

Part I Business 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] - 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] 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][32] - 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] - 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][55] Risk Factors 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] - 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] - 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] - 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][89][91] - 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] - 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] Unresolved Staff Comments The company reports no unresolved staff comments from the Securities and Exchange Commission - There are no unresolved staff comments[107] Properties 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] Legal Proceedings 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] - A lawsuit to recover damages from an insurance carrier related to two cybersecurity incidents was settled in Q1 2019[109] Mine Safety Disclosures This item is not applicable to the company - Not applicable[110] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 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] - 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] 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 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 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 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 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] Net Interest Income 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] - 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][169] - 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] Noninterest Income and Expense 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] Cybersecurity Risks and Incidents 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][216] - 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] - Litigation against the insurance carrier was settled during the first quarter of 2019, subject to a non-disclosure agreement[216] Balance Sheet Analysis 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 $1.26 billion at year-end 2018, a slight decrease of 0.06% from 2017[239] Loan Portfolio Composition (2017-2018) | ($ 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] - Total deposits decreased by 0.74% to $1.052 billion in 2018, primarily due to a decline in time deposits[285] Liquidity and Capital Resources 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] - 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][498] 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 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] Financial Statements and Supplementary Data This section presents the company's audited consolidated financial statements for 2016-2018, including balance sheets, income statements, and comprehensive notes Consolidated Financial Statements 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 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][397] - 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] - 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] - 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][551][381] Changes In and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants regarding accounting principles, financial disclosure, or auditing scope - None reported[579] Controls and Procedures 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] - Management believes the Company maintained effective internal control over financial reporting as of December 31, 2018, based on the COSO 2013 framework[584] Other Information The company reports no other information for this item - None[587] Part III Directors, Executive Officers and Corporate Governance 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] - The Board of Directors has a standing audit committee composed entirely of independent directors, with Dr. Lewis identified as the financial expert[590] - Information regarding directors, Section 16(a) compliance, and corporate governance is incorporated by reference from the 2019 Proxy Statement[593] Executive Compensation 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] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 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] Certain Relationships and Related Transactions, and Director Independence 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] - As of December 31, 2018, there are no equity compensation plans in effect[596] Principal Accounting Fees and Services 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] Part IV Exhibits, Financial Statement Schedules 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][600] Summary Information This item is not applicable to the company - Not applicable[603]