National Bankshares 2017 Annual Report Banking Built on Values National Bankshares, Inc. will strive to maximize earnings by practicing “Banking Built on Values” where our customers and shareholders can expect excellence in service based on honesty, integrity and accountability delivered by knowledgeable and valued employees who are committed to serving our communities as genuine professionals. Corporate Values of National Bankshares Positive Attitude Accountability Honesty and Integrity Excellence in Service Respect for Others Open and Clear Communication Knowledgeable How do these values translate into our daily work? By fully investing in and immersing ourselves in these values, we will exhibit behaviors that show: Team First We value our coworkers as much as ourselves Excellence in Service We value our customers Focus on Profitability We value our shareholders Focus on Stewardship We value our communities Financial Highlights 2013-2017 ($ in thousands, except ratios, share and per share data) FOR tHE yEAR 2017 2016 2015 2014 2013 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 Average equity to average assets $ 14,092 2.03 2.03 1.17 1.14% 7.64% 3.45% 14.93% $ 14,942 2.15 2.15 1.16 1.24% 8.30% 3.51% 14.92% $ 15,833 2.28 2.28 1.14 1.37% 9.22% 3.86% 14.86% $ 16,914 2.43 2.43 1.13 1.51% 10.72% 4.00% 14.08% $ 17,790 2.56 2.55 1.12 1.63% 11.90% 4.21% 13.71% At yEAR-END 2017 2016 2015 2014 2013 Loans, net total securities total assets Allowance for loan losses to total loans total deposits Stockholders’ equity Book value per share 660,144 459,751 1,256,757 639,452 440,409 1,233,942 610,711 389,288 1,203,519 597,203 385,385 1,158,798 587,463 347,109 1,114,561 1.19% 1.28% 1.34% 1.36% 1.38% 1,059,734 184,896 26.57 1,043,442 178,263 25.62 1,018,859 172,114 24.74 982,428 166,303 23.93 960,036 145,892 21.00 Net income ($ millions) Cash dividends per share ($) Loans, net ($ millions) 20 15 10 5 0 17.8 16.9 15.8 14.9 14.1 ‘13 ‘14 ‘15 ‘16 ‘17 Total assets ($ billions) 1.5 1.2 0.9 0.6 0.3 0.0 1.16 1.20 1.23 1.26 1.11 ‘13 ‘14 ‘15 ‘16 ‘17 1.2 1.0 0.8 0.6 0.4 0.2 0.0 1.12 1.13 1.14 1.16 1.17 ‘13 ‘14 ‘15 ‘16 ‘17 Allowance for loan losses to total loans (%) 1.5 1.2 0.9 0.6 0.3 0.0 1.38 1.36 1.34 1.28 1.19 ‘13 ‘14 ‘15 ‘16 ‘17 700 600 500 400 300 200 100 0 587.5 597.2 610.7 660.1 639.5 ‘13 ‘14 ‘15 ‘16 ‘17 Book value per share ($) 30 25 20 15 10 5 0 25.6 26.6 23.9 24.7 21.0 ‘13 ‘14 ‘15 ‘16 ‘17 To Our Shareholders National Bankshares continues to be a sound and profitable community banking institution. We have stayed the course that brought us here by making good loans and providing the highest level of customer service, while rewarding our shareholders’ investment and giving back to the communities we serve. On September 1, 2017, I was honored to be named as President and Chief Executive Officer of National Bank- shares upon the retirement of Jim Rakes. In his career of 35 years with National Bank and National Bankshares, Mr. Rakes provided our Company with strong leadership and a steady guiding hand. On behalf of myself as well as the Directors, employees and shareholders of the Company, we would like to thank Mr. Rakes for his decades of dedicated service and his peerless contribution to the financial success and remarkable longevity of the Company. As you may have read in the Company’s 2017 earnings announcement made on February 22, 2018, the tax Cuts and Jobs Act of 2017 (“the Act”) has had a major impact on our 2017 financial results. We anticipate that the Act will have a long-term positive effect on our earnings by reducing the Company’s tax rate from 35% to 21%. However, due to the tax rate change, we were required to recognize a $1.59 million revaluation adjustment on tax deferred assets in the fourth quarter of 2017. Bankshares finished 2017 with earnings of $14.09 million, or $2.03 per common share. Excluding the unfore- seen effect of the revaluation adjustment noted above, earnings for the year were $15.68 million, which compares favorably to earnings of $14.94 million in 2016. Our ongoing profitability, strong capital position and efforts to control costs resulted in a dividend payment of $1.17 per share in 2017, up from $1.16 in 2016. Loans provide the core of our Company’s earnings, and in 2017 we were pleased to see continued growth in this area. Net loans increased to $660.14 million in 2017, up from $639.45 million the year before. the Company has made a sustained effort to make our loan portfolio the best it can be by investing in additional loan personnel and technology while working to improve lending processes whenever possible. these efforts are paying off, and in 2017 we experienced substantial reductions in nonperforming assets as we continue to work with borrowers to restructure loans, when possible. As a result, we were able to reduce the allowance for loan losses in 2017 to $7.93 million, down 4.5% from $8.30 million in 2016. At National Bankshares we diligently reinvest in the people, technology and projects that will position us strongly for the future. 2017 was no exception as we hired several experienced employees in critical areas, implemented technology updates, launched a new website and made physical improvements to our branch offices. these efforts will continue in 2018, and along with favorable changes in the broader economic sphere, should bode well for the future of our Company. 2017 marked National Bank’s 126th year in business. Our long track record has been made possible by a commit- ment to “Banking Built on Values” – honesty, accountability, integrity and respect being foremost. At the begin- ning of 2018, we felt it was time to enshrine the values that we have always practiced by putting them into writing. these values give us direction, as reflected in the compass logo on the cover of our report, and a full statement of these values can be found on the first page. Our employees are dedicated to knowing and living these values so that our customers, shareholders and communities can continue to trust and rely on National Bankshares, Inc. thank you for your continued support. From the National Bankshares family, we wish you all the best in 2018. F. Brad Denardo President and Chief Executive Officer Consolidated Balance Sheets ($ in thousands, except share and per share data) $ in thousands, except share and per share data December 31, 2017 December 31, 2016 Assets Cash and due from banks Interest-bearing deposits Securities available for sale, at fair value Securities held to maturity (fair value of $130,113 at December 31, 2017 and $137,692 at December 31, 2016) 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 at December 31, 2017 and December 31, 2016 Retained earnings Accumulated other comprehensive loss, net total stockholders’ equity total liabilities and stockholders’ equity $ $ $ $ $ $ $ 12,926 51,233 331,387 127,164 1,200 459,751 260 34,694 166,965 340,314 40,518 51,443 34,648 668,682 (613) 668,069 (7,925) 660,144 8,221 5,297 2,817 5,898 33,756 16,454 1,256,757 182,511 622,189 140,150 114,884 1,059,734 62 12,065 1,071,861 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 1,233,942 171,946 604,093 136,789 130,614 1,043,442 55 12,182 1,055,679 --- --- 8,698 185,893 (9,695) 184,896 1,256,757 $ 8,698 178,224 (8,659) 178,263 1,233,942 Consolidated Statements of Income ($ in thousands, except share and per share data) $ in thousands, except share and per share data 2017 2016 2015 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 $ $ $ $ 29,932 791 5,711 4,826 41,260 4,125 4,125 37,135 157 36,978 2,776 205 3,948 1,530 758 1,148 14 10,379 13,746 1,820 2,275 364 2,748 68 205 1,315 4,431 26,972 20,385 6,293 14,092 2.03 2.03 $ $ $ $ 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 Boards of Directors The Directors of National Bankshares and National Bank bring a diverse range of knowledge and experience to the leadership of the Company. The depth of their contributions play a fundamental role in the success of National Bankshares as a profitable community banking institution. National Bankshares, Inc. Board of Directors, standing from left: Michael E. Dye, Pharmacist/Owner, New Graham Pharmacy; Glenn P. Reynolds, President, Reynolds Architects, Inc.; Lawrence J. Ball, President, Moog Components Group; Dr. J. Lewis Webb, Jr., Retired Dentist; William A. Peery, President, Cargo Oil Co., Inc.; Norman V. Fitzwater, III, President, A Cleaner World, Blacksburg; Dr. Mary G. Miller, Director, Regional Acceleration and Mentoring Program; James C. Thompson, Chairman, thompson & Litton, Inc.; Dr. John E. Dooley, CEO, Virginia tech Foundation, Inc. Seated, from left: Mildred R. Johnson, Dean of Admissions, Radford University; Charles E. Green, III, Financial Planner, AXA Advisors, L.L.C.; Dr. Jack M. Lewis, Past President, New River Community College; F. Brad Denardo, President and CEO, National Bankshares, Inc., Chairman, President and CEO, National Bank, Chairman, President & CEO, National Bankshares Financial Services, Inc.; James G. Rakes, Chairman, National Bankshares, Inc. National Bank Board of Directors, standing from left: Glenn P. Reynolds, William A. Peery, Mary G. Miller, J. Lewis Webb, Jr., Lawrence J. Ball, Michael E. Dye, Norman V. Fitzwater, III. Seated, from left: James C. Thompson, Charles E. Green, III, Mildred R. Johnson, John E. Dooley, F. Brad Denardo. James G. Rakes: A Distinguished Career On August 31st, 2017, James G. Rakes retired from his positions as President and Chief Executive Officer of National Bankshares, Inc., as Chairman of the Board of National Bank and as President and CEO of National Bankshares Financial Services. Mr. Rakes joined National Bank in 1982 and succeeded William Billig as President and CEO in 1983. Under Mr. Rakes’ leadership, the bank began a remarkable 35-year period of growth and financial success. In 1983, the bank had $58.6 million in assets and by the end of 1989 had grown to $162 million in assets. In 1986 Mr. Rakes led the formation of the bank’s holding company, National Bankshares, Inc., positioning the Company for future growth and acquisitions. the bank enlarged its branch footprint in the 80’s and early 90’s, adding new offices in Blacksburg, Christiansburg, Pearisburg and Pembroke. In 1996 the Company took a major leap forward when it acquired the Bank of tazewell County (BtC). the merger of National Bank and BtC increased National Bankshares’ asset size from slightly over $200 million to $388 million, and added new branch loca- tions in tazewell, Bluefield and Richlands. Bankshares ended the millennium with $472 million in assets, $292 million in loans and over 200 employees. By the end of 2009 the Company had grown to $982 million in assets and $583 million in loans, and in 2011 reached assets of over $1 billion. today, with over $1.2 billion in assets and 25 offices across Southwest Virginia, the Company’s current size, financial strength and profitability serve as testament to Mr. Rakes’ outstanding leadership. Mr. Rakes’ contributions reached well beyond the financial success of the Company and into the community at large. He contributed years of service and leadership on the boards of many local organizations, including the Blacksburg Museum and Cultural Foundation, the Blacksburg Partnership, the Free Clinic of the New River Valley, the Montgomery Regional Hospital, New River Community College and the Mental Health Association of the NRV, among others. Mr. Rakes was also a tireless advocate for the community banking industry, serving on various committees and boards of the American Bankers Association and the Virginia Bankers Association. In 1999, Mr. Rakes helped found Bankers Insurance, which has since grown to 24 locations in Virginia and North Carolina and is the 5th largest insur- ance company in Virginia. Mr. Rakes currently serves as Chairman of the National Bankshares Board and splits his time between Blacksburg and Florida where he enjoys spending time in retirement with his grandchildren. Jim Rakes in 1984 Mr. Rakes with former Bankshares Director Paul Duncan (deceased). Celebrating the Bank’s 100th anniversary with Blacksburg’s Mayor Roger Hedgepeth. Signing the BTC merger with BTC President Ray Dodson (left) in 1996. Receiving recognition for one of the Bank’s many charitable donations. Serving up ice cream for the Company’s employees with Brad Denardo. Corporate Information National Bankshares, Inc. Executive Officers F. Brad Denardo President and Chief Executive Officer David K. Skeens treasurer and Chief Financial Officer Annual Meeting the Annual Meeting of Stockholders will be held on tuesday, May 8, 2018 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: F. Brad Denardo President and Chief Executive Officer (540) 951-6300 or (800) 552-4123 bdenardo@nbbank.com Written requests may be directed to: National Bankshares, Inc. P.O. Box 90002, Blacksburg, VA 24062-9002 Stockholder Services and Stock Transfer Agent Stockholders seeking information about stock transfer requirements, lost certificates, dividends and other stockholder matters should contact: Joe Beury 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 Abingdon Pembroke Blacksburg 6 offices Bluefield, VA 2 offices Christiansburg 2 offices Claypool Hill Dublin Galax Pearisburg Pulaski 2 offices Radford Rich Creek Richlands Roanoke Loan Production Office Tazewell 3 offices Wytheville (cid:25) (cid:19)(cid:18) (cid:17) (cid:28) (cid:31) (cid:24) (cid:21)(cid:20) (cid:29) (cid:30) (cid:26) (cid:27) Virginia (cid:16) (cid:23) (cid:22) National Bankshares 101 Hubbard Street Blacksburg, Virginia 24060