2016 Annual Report Our Story National Bankshares ontinues hese days, it’s easy to think that banking is essentially a technological activity. There is no doubt that innovations in digital finance have revolutionized the ease with which we can perform everyday banking functions. But at National Bankshares, we believe that banking is defined by the personal relationships we have with our customers. Without the communication, trust and friendships we have with our customers, our Company would not exist. We know that there will be a place for our brand of relationship-based community banking for many years to come. We know that our story continues. Financial Highlights 2012-2016 ($ in thousands, except ratios, share and per share data) For ThE yEar 2016 2015 2014 2013 2012 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 $ 14,942 2.15 2.15 1.16 1.24% 8.30% 3.51% 52.17% 14.92% $ 15,833 2.28 2.28 1.14 1.37% 9.22% 3.86% 49.41% 14.86% $ 16,914 2.43 2.43 1.13 1.51% 10.72% 4.00% 47.08% 14.08% $ 17,790 2.56 2.55 1.12 1.63% 11.90% 4.21% 45.99% 13.71% $ 17,747 2.56 2.55 1.10 1.64% 12.01% 4.34% 43.77% 13.68% aT yEar-ENd 2016 2015 2014 2013 2012 Loans, net Total securities Total assets Total deposits Stockholders’ equity Book value per share 639,452 440,409 1,233,942 1,043,442 178,263 25.62 610,711 389,288 1,203,519 1,018,859 172,114 24.74 597,203 385,385 1,158,798 982,428 166,303 23.93 587,463 347,109 1,114,561 960,036 145,892 21.00 583,813 350,117 1,107,964 946,766 150,109 21.60 Net income ($ millions) Cash dividends per share ($) Efficiency ratio (%) 17.7 17.8 16.9 15.8 14.9 1.10 1.12 1.13 1.14 1.16 52.2 49.4 43.8 46.0 47.1 ‘12 ‘13 ‘14 ‘15 ‘16 ‘12 ‘13 ‘14 ‘15 ‘16 ‘12 ‘13 ‘14 ‘15 ‘16 Loans, net ($ millions) Total assets ($ billions) Book value per share ($) 583.8 587.5 597.2 610.7 639.5 1.11 1.11 1.16 1.20 1.23 23.9 24.7 25.6 21.6 21.0 ‘12 ‘13 ‘14 ‘15 ‘16 ‘12 ‘13 ‘14 ‘15 ‘16 ‘12 ‘13 ‘14 ‘15 ‘16 To Our hareholders 2016 was another solid year for National Bankshares. Loans and core deposits both grew steadily, while we maintained good asset quality. Noninterest income showed modest growth in key areas. Earnings were down from 2015, but we remain a very profitable company. Our profitability and strong capital position enabled us to pay a very good dividend once again this year. Financial highlights of 2016 include: • Net loans up 4.71% • Total deposits up 2.41% • Nonperforming assets down 16.93% • Net charge-offs down 16.61% • Per share dividend grew from $1.14 to $1.16 • Book value per share up 3.56% 2016 was also a special year for our Company. National Bank celebrated its 125th anniversary, and our story continues by staying true to our community banking roots. Commitment to customer service, prudent lending, capital strength and community service are still the foundation of our approach to banking. There is no doubt that we faced challenges in 2016. Low interest rates governed by economic policy continued to reduce earnings on our loan and securities portfolios, driving down net income. An extremely competitive local loan market also reduced yields on loans. Regulatory compliance mandates required more time, money and staff than ever before. In 2016 we met these challenges by focusing on what we can control. We worked hard to generate new loans and were rewarded with nice growth in our loan portfolio. The quality of our loans also improved, with substantial reductions in nonperforming assets and net charge-offs. We took successful measures to increase noninterest income, including an overhaul of our overdraft privilege program. As always, we found ways to control costs and maintain our efficiency. Our Company also invested for the future in 2016. National Bank opened its first loan production office in downtown Roanoke, gaining access to an exciting new market. We hired talented, experienced professionals for several key positions and promoted others from within. We embarked on a project to review and improve our physical infrastructure, and we made ongoing investments in technology products that will make banking easier for our customers. Bankshares’ performance continues to be solid, and we look forward to a successful 2017 and beyond. As we move ahead, we will continue to execute a business plan that you can rely on. Strength, stability and superior customer service will always be at the heart of our community banking mission. This year we would like to recognize Dr. James M. Shuler for his distinguished service on the National Bankshares and National Bank Boards of Directors. Dr. Shuler will retire from the Bankshares Board in May with 40 years of service to our organization. Through countless hours, his knowledge, experience and leadership have contributed greatly to the success of our Company. On behalf of all of our officers, employees and Directors, we thank Dr. Shuler for his dedicated service. Looking back on our 125th year of business, we know that we would not be where we are today without our stockholders, customers and friends in the community. We thank you for your continued support. It is truly a privilege to serve you. The full detail of our financial performance is discussed in the Management’s Discussion and Analysis section found in the enclosed U.S. Securities and Exchange Commission Form 10-K. James G. Rakes Chairman, President and Chief Executive Officer National Bankshares, Inc. Board of Directors Lawrence J. Ball is President of Moog Components Group, a Blacksburg-based division of Moog, Inc. Prior to being named President, Mr. Ball was Vice President and General Manager of the group, which designs and manufactures products in motion, electronics and fiber optics. Mr. Ball joined the Bankshares Board in 2006. dr. John E. dooley is CEO and Secretary-Treasurer of the Virginia Tech Foundation, Inc., where he oversees the leadership and management of Virginia Tech’s private assets in support of university programs and initiatives. Prior to becoming CEO of the Foundation, Dr. Dooley served as Virginia Tech’s Vice President for Outreach and International Affairs. He joined the Bankshares Board in 2012. Charles E. Green, III is a Financial Planner with AXA Advisors, L.L.C. Mr. Green has nearly 30 years of experience as a community bank director having been elected to the National Bank Board in 2006 and to the board of a predecessor bank in 1986. A resident and former mayor of Tazewell, Virginia, he has extensive experience in insurance and investment matters. Mr. Green has served on the Bankshares Board since 2011. dr. Mary G. Miller is the founder and President of Interactive Design and Development, Inc., a Blacksburg-based full-service Internet technology firm specializing in custom software solutions, education and online content management. Dr. Miller has an in-depth knowledge of information technology issues and the region’s growing technology sector. She joined the Bankshares Board in 2003. dr. Jack M. Lewis is past President of New River Community College in Dublin, Virginia. Before being elevated to the President’s role, Dr. Lewis was Dean of the Community College and served as its Chief Financial Officer. He has been involved in local and regional economic development activities and serves on the boards of several nonprofit organizations. Dr. Lewis joined the Bankshares Board in 2004. Glenn P. reynolds is Founder and President of Reynolds Architects Incorporated, an architecture firm located in Blacksburg, Virginia. Mr. Reynolds has considerable experience with the area’s construction and development projects and with local building firms. A member of several area boards and Virginia Tech organizations, he joined the Bankshares Board in 2006. William a. Peery is President of Cargo Oil Co., Inc. The firm operates convenience stores and sells petroleum products out of its headquarters located in Tazewell, Virginia. Mr. Peery possesses extensive business and financial management experience as well as a close working knowledge of the western segments of Bankshares’ market area. He joined the Bankshares Board in 2005. James G. rakes is Chairman, President and CEO of National Bankshares, Inc. Mr. Rakes is an original director of Bankshares and has served as President and CEO since its founding in 1986. Mr. Rakes was the President and CEO of National Bank from 1983 until 2014 and currently serves as Executive Chairman of the Bank. He also currently serves as Chairman, President and CEO of National Bankshares Financial Services, Inc. dr. James M. Shuler is a retired veterinarian who represented the 12th legislative district in the Virginia House of Delegates from 1994 until January 2012. Prior to his retirement, Dr. Shuler founded and ran a veterinary practice in Blacksburg, Virginia. He has served on the Bankshares Board since 2002 and currently serves as Vice Chairman. Dr. Shuler retired from the National Bank Board at the end of 2016, where he had served since 1987. Standing, from left: Dr. John E. Dooley, William A. Peery, Lawrence J. Ball, Glenn P. Reynolds Seated from left: Charles E. Green, III, Dr. Mary G. Miller, Dr. Jack M. Lewis, Dr. James M. Shuler, James G. Rakes Consolidated Balance Sheets Consolidated Balance Sheets $ in thousands, except share and per share data december 31, 2016 December 31, 2015 assets Cash and due from banks Interest-bearing deposits Securities available for sale, at fair value Securities held to maturity (fair value of $137,692 at December 31, 2016 and $158,032 at December 31, 2015) 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: 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, 6,957,974 shares in 2016 and 2015 Retained earnings Accumulated other comprehensive loss, net Total stockholders’ equity Total liabilities and stockholders’ equity $ $ $ $ $ $ $ 13,974 80,268 304,282 134,957 1,170 440,409 478 36,345 157,718 336,457 39,024 45,474 33,528 648,546 (794) 647,752 (8,300) 639,452 8,853 5,260 3,156 5,966 22,998 13,128 1,233,942 171,946 605,226 96,829 169,441 1,043,442 55 12,182 1,055,679 12,152 130,811 236,131 152,028 1,129 389,288 634 48,251 143,504 309,378 37,571 51,335 29,845 619,884 (876) 619,008 (8,297) 610,711 9,020 5,769 4,165 6,224 22,401 12,344 1,203,519 166,453 569,787 90,236 192,383 1,018,859 56 12,490 1,031,405 --- --- 8,698 178,224 (8,659) 178,263 1,233,942 $ 8,698 171,353 (7,937) 172,114 1,203,519 Consolidated Balance Sheets Consolidated Statements of Income $ in thousands, except share and per share data 2016 2015 2014 Years ended December 31, 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 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, 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 $ $ $ $ 29,365 532 5,910 5,123 40,930 4,166 4,166 36,764 1,650 35,114 2,458 212 3,798 1,346 597 1,289 232 9,932 12,792 1,849 2,186 476 2,782 257 472 1,296 4,042 26,152 18,894 3,952 14,942 2.15 2.15 $ $ 30,446 254 6,776 5,438 42,914 4,183 4,183 38,731 2,009 36,722 2,250 215 3,861 1,229 603 1,295 33 9,486 12,522 1,743 1,657 546 2,692 999 608 1,288 3,580 25,635 20,573 4,740 15,833 2.28 2.28 $ $ $ $ $ $ 31,058 262 6,798 5,826 43,944 4,899 4,899 39,045 1,641 37,404 2,434 187 3,631 1,213 616 1,037 2 9,120 11,606 1,703 1,650 533 2,593 1,075 369 1,182 3,721 24,432 22,092 5,178 16,914 2.43 2.43 National Bank Board of Directors F. Brad denardo is President and Chief Executive Officer of National Bank (since 2014), Executive Vice President of National Bankshares Inc. and Treasurer and Board Member of National Bankshares Financial Services, Inc. Mr. Denardo joined the bank in 1983 and was promoted to Executive Vice President of Loans in 1989. In 2002 he was named Executive Vice President and COO and was elected to the bank’s Board. Michael E. dye is a Pharmacist and owner of New Graham Pharmacy, Cornerstone Gifts, The Last Fountain and New Graham Knives, all located in Bluefield, Virginia. Mr. Dye possesses extensive knowledge of the business activity and community life of the important Bluefield market area. He joined the National Bank Board in 2006. Norman V. Fitzwater, III is President of A Cleaner World dry cleaning business in Blacksburg, Virginia. Prior to opening the Blacksburg dry cleaning business in 1992, he was involved in the management and operation of several furniture manufacturing companies in Virginia and North Carolina. Mr. Fitzwater joined National Bank’s Board in 2013. Mildred r. Johnson is the Associate Vice Provost for Enrollment Management and Director of Undergraduate Admissions at Virginia Tech and has been at the university for 21 years. She is a recognized leader in higher education with a career which spans over 40 years, primarily in college admissions. Mrs. Johnson has served in leadership positions and on academic boards in both Virginia and nationally. She joined the National Bank Board in 2012. James G. rakes is Executive Chairman of National Bank. He served as President and Chief Executive Officer of National Bank from 1983 until 2014. Mr. Rakes has been Chairman, President and CEO of National Bankshares, Inc. since its founding in 1986. He also currently serves as Chairman, President and CEO of National Bankshares Financial Services, Inc. dr. James M. Shuler is a retired veterinarian who represented the 12th legislative district in the Virginia House of Delegates from 1994 until January 2012. Prior to his retirement, Dr. Shuler founded and ran a veterinary practice in Blacksburg, Virginia. He joined the National Bank Board in 1987 and retired from the Bank Board at the end of 2016. Dr. Shuler joined the National Bankshares, Inc. Board in 2002 and currently serves as Vice-Chairman. James C. Thompson is the Chairman of the Board of Directors of Thompson & Litton, Inc. and has been employed by the firm full-time since 1981. Thompson & Litton, Inc. is engaged in the business of engineering, architecture, and construction in seven Mid-Atlantic States. Mr. Thompson joined the National Bank Board of Directors in 2006 dr. J. Lewis Webb, Jr. is a retired dentist with 35 years of practice in Narrows, Virginia. Dr. Webb also has considerable experience as a board member with local school systems and colleges. He was elected to the National Bank Board of Directors in 1994 after serving on the bank’s Giles County Advisory Board since 1988. Standing, from left: Michael E. Dye, Dr. J. Lewis Webb, Jr., James C. Thompson, Norman V. Fitzwater, III Seated, from left: Mildred R. Johnson, Dr. James M. Shuler, F. Brad Denardo, James G. Rakes ational Bankshares, Inc. is a community bank holding company with headquarters in Blacksburg in Southwest Virginia. National Bankshares is the parent company of National Bank, a community bank with over 125 years of service in the area. National Bank currently operates 26 office locations and one loan production office throughout Southwest Virginia and offers a full range of financial products and services, including deposit accounts, commercial, consumer and mortgage loans, credit cards and trust services. National Bankshares also operates an insurance and brokerage subsidiary, National Bankshares Financial Services, Inc., which does business as National Bankshares Insurance Services and National Bankshares Investment Services. You are cordially invited to join us at the National Bankshares, Inc. Annual Meeting of Stockholders. The meeting will be held Tuesday, May 9th, 2017 at 3 p.m. at Custom Catering Center, 902 Patrick Henry Drive, Blacksburg, Virginia 24060. Corporate Information National Bankshares, Inc. Executive officers James G. Rakes Chairman, President and Chief Executive Officer Stockholder Services and Stock Transfer agent Stockholders seeking information about stock transfer requirements, lost certificates, dividends and other stockholder matters should contact: 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 9, 2017 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 Joe Buery Senior Vice President/Trust Officer (540) 961-8500 or (800) 552-4123 jbeury@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 National Bank Locations roanoke Loan Production Office Tazewell 3 offices Wytheville abingdon Pearisburg Pembroke Pulaski 2 offices radford rich Creek richlands Blacksburg 6 offices Bluefield, Va 2 offices Christiansburg 2 offices Claypool hill dublin Galax Marion VIrGINIa National Bankshares 101 hubbard Street Blacksburg, Virginia 24060