Local Bank. Personal Service. National Bankshares 2014 AnnuAl RepoRt National Bankshares, Inc. is committed to providing the people of Southwest Virginia with truly personalized community banking. We always strive to provide friendly service and a combination of traditional and innovative banking products to meet our customers’ diverse needs. We also believe in giving back to our community by supporting local people and organizations who make our hometowns a better place to live. Thank you for choosing us for your financial needs and for placing your trust in National Bankshares, Inc. CoNTeNTS Financial Highlights Message to Shareholders 1 2 National Bankshares Board of Directors 3 Consolidated Balance Sheets Consolidated Statements of Income National Bank Board of Directors our Region Corporate Information 4 5 6 7 8 aNNual MeeTINg The National Bankshares, Inc. annual Meeting of Stockholders will be held on Tuesday, May 12, 2015 at 3:00 p.m. at Custom Catering Center, 902 Patrick Henry Drive, Blacksburg, Virginia. National Bankshares, Inc. National Bankshares, Inc. is the Blacksburg, Virginia based holding company of the 124-year old National Bank. Founded in 1986 with the mission of providing a solid community banking investment that benefits our region, Bankshares is a nationally-recognized leader in community banking performance. In addition to National Bank, National Bankshares also operates a financial services subsidiary, National Bankshares Financial Services, Inc., that provides investment and insurance services in a community bank setting. Financial Highlights ($ in thousands, except ratios, share and per share data) For the year 2014 2013 2012 2011 2010 Net income Basic net income per share Diluted net income per share Cash dividends per share Return on average assets Return on average equity Net interest margin Efficiency ratio Average equity to average assets At year-end Loans, net Total securities Total assets Total deposits Stockholders’ equity Book value per share $ 16,914 2.43 2.43 1.13 1.51% 10.72% 4.01% 47.17% 14.08% 2014 597,203 385,385 1,154,731 982,428 166,303 23.93 $ 17,790 2.56 2.55 1.12 1.63% 11.90% 4.24% 45.99% 13.71% 2013 587,463 347,109 1,110,630 960,036 145,892 21.00 $ 17,747 2.56 2.55 1.10 1.64% 12.01% 4.37% 43.77% 13.68% 2012 583,813 350,117 1,104,361 946,766 150,109 21.60 $ 17,638 2.54 2.54 1.00 1.71% 12.89% 4.59% 44.00% 13.26% 2011 580,402 317,075 1,067,102 919,333 141,299 20.36 $ 15,569 2.25 2.24 0.91 1.57% 12.07% 4.52% 46.01% 13.03% 2010 568,779 314,092 1,022,238 884,583 129,187 18.63 Net income ($ millions) Cash dividends per share ($) Efficiency ratio (%) 17.6 17.7 17.8 16.9 15.6 20 15 10 5 0 1.10 1.12 1.13 1.00 0.91 1.2 0.9 0.6 0.3 0.0 50 40 30 20 10 0 ‘10 ‘11 ‘12 ‘13 ‘14 ‘10 ‘11 ‘12 ‘13 ‘14 46.01 44.00 43.77 45.99 47.17 ‘10 ‘11 ‘12 ‘13 ‘14 Loans, net ($ millions) Total assets ($ billions) Book value per share ($) 568.8 600 580.4 583.8 587.5 597.2 400 200 0 1.022 1.067 1.104 1.111 1.155 1.2 0.9 0.6 0.3 0.0 20.36 21.60 21.00 18.63 23.93 25 20 15 10 5 0 ‘10 ‘11 ‘12 ‘13 ‘14 ‘10 ‘11 ‘12 ‘13 ‘14 ‘10 ‘11 ‘12 ‘13 ‘14 1 To Our Shareholders In 2014, we were reminded that banking is a cyclical business. It comes as no surprise that given the continued economic weakness in our marketplace that our year-end results are not consistent with our record high financial performance in recent years. As true community bankers, we are committed to working with our customers to assist them through tough times but we remain focused on monitoring and dealing with deteriorating credits, as well as taking measures necessary to improve earnings capability. Net income after taxes for 2014 was $16.91 million, a decrease from the $17.79 million earned in 2013. Despite the fact that net income decreased as a result of the compression of margins and slow economic activity in our marketplace, your Company was able to report strong returns in some key areas. The 2014 return on average assets and return on average equity were 1.51% and 10.72%, respectively. The Company’s basic earnings per share in 2014 were $2.43. Stockholders’ equity was $166 million at year-end 2014, an increase of almost 14% from year-end 2013. Total assets at $1.15 billion grew over $44.10 million, or almost 4%, during 2014. Growing the loan portfolio with quality assets is important for our continued success. Loan officers and credit administration staff have been very focused on maintaining a loan portfolio with strong credit quality. While modest, we were able to improve loan growth in 2014 by increasing the loan portfolio to $597 million at December 31, 2014, a $9.74 million increase from December 31, 2013. We continue to focus on increasing assets and liabilities through growth in quality loans and core deposits. Again, by staying committed to our community banking philosophy, this growth objective will be accomplished through further development of our current customer relationships and identifying new customer relationships. We believe that through this process, we enhance our ability to serve our customers and communities while enhancing stockholder value. We continue to focus on increasing assets and liabilities through growth in quality loans and core deposits. The full detail of our financial performance is discussed in the Management’s Discussion and Analysis section found in the attached U.S. Securities and Exchange Commission Form 10-K. Please take the opportunity to read this information as it provides additional insights and discussion related to our 2014 financial performance. It also is important to note that after ongoing reviews of the Company’s earnings and capital position, your Board of Directors declared dividends in 2014 totaling $1.13 compared to $1.12 in 2013. This per share dividend payment amount resulted in an increase in the dividend payout ratio to 46.43% in 2014 compared to 43.74% in 2013. In April 2014, Brad Denardo was elected President & CEO of the Company’s subsidiary bank, The National Bank of Blacksburg. His election by the Bank’s board reflected his major contribution to the growth and development of the Bank. As many of you know, Brad joined the Bank in 1983, and his knowledge, experience and relationships inside and outside of the Bank have played a significant part in achieving our growth and success. In 2015, margin compression, potential credit weaknesses, competition for customers, and further regulatory burdens will all be at the forefront. Nonetheless, we continue to focus our efforts to have National Bankshares be a top performer responding to the needs of our customers, our stockholders, our employees, and our communities. On behalf of the Directors of the Company and of National Bank, the management team and all our employees, we thank you for your investment and support. James G. Rakes Chairman, President and Chief Executive Officer 2 National Bankshares, Inc. Board of Directors Fulfilling our community banking mission requires input from a diverse group of leaders who represent the region we serve. We are thankful for the talents and time of our directors, whose experience, vision and accountability help guide our Company forward. Standing, from left: Seated, from left: Glenn P. Reynolds President Reynolds Architects, Inc. Lawrence J. Ball President Moog Components Group William A. Peery President Cargo Oil Co., Inc. John E. Dooley Chief Executive Officer Virginia Tech Foundation, Inc. Charles E. Green, III Financial Planner AXA Advisors, L.L.C. Dr. Mary G. Miller President Interactive Design and Development, Inc. Dr. James M. Shuler Delegate, Retired Virginia House of Delegates Dr. Jack M. Lewis President New River Community College James G. Rakes Chairman, President and Chief Executive Officer National Bankshares, Inc. Executive Chairman National Bank Chairman, President and Chief Executive Officer National Bankshares Financial Services, Inc. 3 Consolidated Balance Sheets $ in thousands, except share and per share data Assets Cash and due from banks Interest-bearing deposits Securities available for sale, at fair value Securities held to maturity (fair value approximates $167,703 at December 31, 2014 and $159,337 at December 31, 2013) Restricted stock Total securities Mortgage loans held for sale Loans: Real estate construction loans Consumer real estate loans Commercial real estate loans Commercial non real estate loans Public sector and IDA loans Consumer non real estate loans Total loans Less unearned income and deferred fees Loans, net of unearned income and deferred fees Less allowance for loan losses Loans, net Premises and equipment, net Accrued interest receivable Other real estate owned, net Intangible assets and goodwill Bank-owned life insurance (BOLI) Other assets Total assets Liabilities and Stockholders’ Equity Noninterest-bearing demand deposits Interest-bearing demand deposits Savings deposits Time deposits Total deposits Accrued interest payable Other liabilities Total liabilities Commitments and contingencies Stockholders’ equity: December 31, 2014 December 31, 2013 $ $ $ $ $ $ 12,894 102,548 222,844 161,452 1,089 385,385 291 45,562 147,039 310,762 33,413 41,361 28,182 606,319 (853) 605,466 (8,263) 597,203 9,131 5,748 4,744 7,223 21,797 7,767 1,154,731 150,744 533,641 81,297 216,746 982,428 68 5,932 988,428 --- 13,283 98,066 181,712 163,983 1,414 347,109 1,276 45,925 145,499 311,266 31,262 34,220 28,423 596,595 (905) 595,690 (8,227) 587,463 9,951 5,949 4,712 8,299 21,181 13,341 1,110,630 142,645 501,541 74,141 241,709 960,036 92 4,610 964,738 --- Preferred stock, no par value, 5,000,000 shares authorized; none issued and outstanding Common stock of $1.25 par value. Authorized 10,000,000 shares; issued and outstanding, 6,950,474 shares in 2014 and 6,947,974 shares in 2013 Retained earnings Accumulated other comprehensive (loss), net Total stockholders’ equity Total liabilities and stockholders’ equity --- --- 8,688 163,287 (5,672) $ 166,303 1,154,731 $ 8,685 154,171 (16,964) 145,892 1,110,630 4 Consolidated Statements of Income $ in thousands, except share and per share data Interest Income Interest and fees on loans Interest on interest-bearing deposits Interest on securities – taxable Interest on securities – nontaxable Total interest income Interest Expense Interest on time deposits of $100 or more Interest on other deposits Total interest expense Net interest income Provision for loan losses Net interest income after provision for loan losses Noninterest Income Service charges on deposit accounts Other service charges and fees Credit card fees Trust income BOLI income Other income Realized securities gains (losses), net Total noninterest income Noninterest Expense Salaries and employee benefits Occupancy and furniture and fixtures Data processing and ATM FDIC assessment Credit card processing Intangible assets amortization Net costs of other real estate owned Franchise taxes Other operating expenses Total noninterest expense Income before income tax expense Income tax expense Net income Basic net income per common share Fully diluted net income per common share Years ended December 31, 2014 2013 2012 $ $ $ $ 31,217 262 6,798 5,826 44,103 570 4,329 4,899 39,204 1,641 37,563 2,434 187 3,631 1,213 711 868 2 9,046 11,691 1,722 1,643 533 2,593 1,075 369 1,182 3,709 24,517 22,092 5,178 16,914 2.43 2.43 $ $ $ $ 32,819 213 6,585 6,388 46,005 865 5,090 5,955 40,050 1,531 38,519 2,563 225 3,330 1,150 739 997 (46) 8,958 11,978 1,616 1,700 554 2,546 1,078 296 1,083 3,519 24,370 23,107 5,317 17,790 2.56 2.55 $ $ $ $ 35,354 240 6,460 6,463 48,517 1,491 6,396 7,887 40,630 3,134 37,496 2,594 243 3,278 1,313 814 669 60 8,971 12,005 1,589 1,593 475 2,442 1,083 208 901 3,179 23,475 22,992 5,245 17,747 2.56 2.55 5 National Bank Board of Directors From left to right: F. Brad Denardo Executive Vice President National Bankshares, Inc. President and Chief Executive Officer National Bank Treasurer National Bankshares Financial Services, Inc. James C. Thompson Chairman Thompson & Litton, Inc. James G. Rakes Chairman, President and Chief Executive Officer National Bankshares, Inc. Executive Chairman National Bank Chairman, President and Chief Executive Officer National Bankshares Financial Services, Inc. Dr. J. Lewis Webb, Jr. Retired Dentist Dr. James M. Shuler Delegate, Retired Virginia House of Delegates Michael E. Dye Pharmacist/Owner New Graham Pharmacy Mildred R. Johnson Associate Vice Provost for Enrollment Management and Director of Undergraduate Admissions Virginia Polytechnic Institute and State University Norman V. Fitzwater President A Cleaner World, Blacksburg National Bank Advisory Boards Montgomery County: Dan A. Dodson, Kathryn S. Oddo, James J. Owen, Arlene A. Saari, James C. Stewart, Marc A. Verniel Giles County: Dr. Terry E. Arbogast, Lisa W. Epperly, Dr. Robert C. McCracken Galax: Thomas L. McChesney, Dr. James A. Williams, Jr., David F. Wilson Christiansburg/Radford/Pulaski County: Charles R. Beller, III, William K. Cunningham, Dr. Kenneth E. Jones, Dr. Peter J. McDonald Richlands: Thurmon T. Hackworth, Dr. Marvin D. Harman, Peter M. Mulkey, John M. Warner 6 Welcome to Southwest Virginia Proudly serving a dynamic region The mountains and valleys of southwestern Virginia are well known for their scenic beauty. Look beyond the picture-postcard landscapes and you’ll find a diversified 21st century economy made possible by the talented and hardworking people who call this area home. Rich in agricultural, mineral and forest resources, our region’s economy has become a leader in higher education, research, medicine, high tech manufacturing and information technology. We’ve also embraced our cultural heritage by fostering a thriving art, music and food scene. National Bankshares, Inc. is proud to be a part of the communities we serve, and we’re dedicated to meeting the financial needs of our unique region with truly local, personalized banking. 7 Serving southwest Virginia with 25 convenient offices Corporate Information National Bankshares, Inc. Executive Officers Stockholder Services and Stock Transfer Agent James G. Rakes Chairman, President and Chief Executive Officer F. Brad Denardo Executive Vice President David K. Skeens Treasurer and Chief Financial Officer Annual Meeting The Annual Meeting of Stockholders will be held on Tuesday, May 12, 2015 at 3:00 p.m. at Custom Catering Center, 902 Patrick Henry Drive, Blacksburg, Virginia. Corporate Stock National Bankshares, Inc. common stock trades on the NASDAQ Capital Market under the symbol “NKSH”. Financial Information Investors and analysts seeking financial information about National Bankshares, Inc. should contact: James G. Rakes Chairman, President and Chief Executive Officer (540) 951-6300 or (800) 552-4123 jrakes@nbbank.com Written requests may be directed to: National Bankshares, Inc. P.O. Box 90002, Blacksburg, VA 24062-9002 Stockholders seeking information about stock transfer requirements, lost certificates, dividends and other stockholder matters should contact: Bryson J. Hunter Secretary and Counsel (540) 951-6300 or (800) 552-4123 bhunter@nbbank.com or Computershare, Inc. P.O. Box 30170 College Station, TX 77842 800-368-5948 www.computershare.com A copy of National Bankshares, Inc.’s annual report to the Securities and Exchange Commission on Form 10-K will be furnished without charge to any stockholder upon written request. The Form 10-K and other corporate publications are also available at www.nationalbankshares.com. Proxy materials for the Annual Meeting of Stockholders are available at www.nationalbanksharesproxy.com. Corporate Office National Bankshares, Inc. 101 Hubbard Street Blacksburg, Virginia 24060 P.O. Box 90002 Blacksburg, Virginia 24062-9002 www.nationalbankshares.com (540) 951-6300 or (800) 552-4123 8